How Cryptocurrency Works

The most popular cryptocurrency is the Bitcoin. Cryptocurrencies modeled after this one are often called “altcoins” and are often less secure than the Bitcoin.

Bitcoin was created in 2009 (at present, nobody knows exactly who created it). Investopedia says it offers “lower transaction fees than traditional online payment mechanisms and, unlike government-issued currencies, it is operated by a decentralized agency.”

How Cryptocurrency Works

There aren’t any physical Bitcoins you can see or touch. Instead, there is a totally public ledger that everybody on Earth has access to. Bitcoins aren’t issued or backed by any government or bank, and individual Bitcoins aren’t valuable as a commodity.

All Bitcoin transactions are verified by a huge amount of computing power, though. The system consists of a collection of
computers, referred to as “nodes” or “miners,” that all run the Bitcoin code and store the blockchain record of all transactions.

Since every computer running this blockchain has the same lists of blocks and transactions, and everyone can see the new blocks being filled, it’s almost impossible to cheat the system.

As of January, 2021, Bitcoin has around 12,000 different nodes (and that number is growing), so such an attack is highly unlikely.

Even if it did occur, the Bitcoin miners (the actual people involved in the Bitcoin network with their computers) would notice the change and simply “fork” to a new blockchain and make the whole attack a waste of time.

Bitcoin mining is the process by which the bitcoins are released into circulation. Investopedia explains that this mining “requires the solving of computationally difficult puzzles to discover a new block, which is added to the blockchain.”

When a new block is added, miners are rewarded with a few Bitcoins. This reward is halved after every 210,000 blocks, so the 50 Bitcoin reward in 2009 is now down to 6.25 Bitcoins.

You can use a variety of different hardware to mine Bitcoins. Some will get you better results, of course, and these are called “mining rigs.”

For example, certain computer chips (Application-Specific Integrated Circuits, or ASIC) and more advanced processing units (like Graphic Processing Units or GPU) will yield higher rewards than other systems.

One Bitcoin can be divided into eight decimal places. The smallest unit is called a Satoshi (0.00000001 of a Bitcoin) because the mysterious entity who created the Bitcoin used the pseudonym Satoshi Nakamoto. If participating miners agree, the Bitcoin may be divided even further in the future.

Bitcoin can be used as a means of payment for products or services. Physical stores can accept Bitcoin in lieu of fiat money—transactions would be handled with a special terminal or with QR codes and touch screen apps.

An online business can easily accept Bitcoins along with its other online payment options like credit cards or PayPal. There are also job-site websites that will hook up prospective employees with employers who pay in Bitcoin, like Cryptogrind, Coinality, or Bitwage.

Many Bitcoin supporters feel that digital currency will become the norm in the future. In 2014, the IRS proclaimed that all virtual currencies, including Bitcoins, would be taxed as property instead of currency. This means that gains or losses from Bitcoins held as capital will be realized as capital gains or losses, while those held as inventory will incur ordinary gains or losses.

To purchase cryptocurrency like Bitcoins, you will need an online “wallet,” an app that can hold your investments. Usually, you create an account with an exchange, and then you can transfer fiat money into cryptocurrencies.

One popular trading exchange is Coinbase, which allows you to create a wallet and buy and sell cryptocurrencies.

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