This article is written by traders, for traders, with the goal of giving them the right knowledge for trading cryptocurrencies and understanding blockchain technology. With the help of this complete and easy-to-understand article, you will soon have enough knowledge to start a rewarding career in the cryptocurrency market.
Warning: High Risk
Trading cryptocurrencies on an exchange involves a high level of risk that may not be suitable for all investors. Using leverage increases the risk and potential losses. Before deciding to trade cryptocurrencies, carefully consider your investment goals, experience level, and risk tolerance. You could lose some or all of your initial investment. Only invest money that you can afford to lose. Educate yourself about the risks associated with cryptocurrency trading.
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Why is blockchain so popular? What does it offer?
Satoshi Nakamoto’s most significant contribution to cryptographic research was the blockchain. Bitcoin’s ledger is its blockchain, an unchangeable database that can only be modified if everyone agrees to the change. It is the foundation of bitcoin and a crucial element in how all cryptocurrencies reach consensus without the need for trusted third parties.
A blockchain is a series of blocks, where each block contains a record of all the transactions that occurred within a specific time period (in bitcoin, new blocks are added approximately every ten minutes).
Each new block includes a cryptographic hash of all the preceding blocks. A hash is a mathematical function that verifies that no data above it has been altered. Therefore, if any node attempts to modify the database by adding transactions that never happened or invalidating legitimate ones, all the other nodes can quickly detect these changes because their mathematical proofs will no longer match the block’s hash.
This makes it increasingly difficult for any individual or group to manipulate the ledger in their favor because they would need to change all the blocks from the beginning of the system to avoid detection by other nodes. Such an attack would be economically unfeasible as it would cost much more than blockchain benefit gained from undermining the network.
In other words, Satoshi’s system is brilliant because it assumes that no one in the network can be trusted, yet it still manages to create a system where it is economically advantageous to follow the rules rather than cheat.
What is crypto mining?
Blockchains reach an agreement between their nodes through a consensus mechanism. Another important contribution by Satoshi is the proof of work consensus, which is still the most commonly used and trusted method today.
In addition to collecting and verifying new transactions, bitcoin miners earn newly created bitcoins by using their computing power to solve a highly time-consuming mathematical calculation, which they then add to their published blocks.
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This effectively proves that they have done the necessary work to participate in the system, ensuring that they are better off following the rules and earning the mining reward rather than attempting to undermine the system.
In proof of work consensus, the expensive hardware required to compete with other miners and the electricity needed to run this hardware incentivize miners to cooperate, as they can earn more by doing so than by trying to cheat.
There are alternatives to proof of work, but currently, no other consensus mechanism has been tested on as large a scale as bitcoin.
As a result, proof of work is the most trusted consensus mechanism, and bitcoin is the most trusted implementation of it. In the cryptocurrency space, trust has shifted from third parties like banks and credit card companies to blockchains, cryptocurrencies, and their consensus algorithms.
Building trust
It’s interesting to hear prominent figures in the cryptocurrency space discuss their initial exposure to Bitcoin. You often hear the same story repeated over and over. In fact, if you think back to when you first heard about bitcoin, you’ll probably find that it was the same for you.
Initially, no one had heard of it, no one trusted it, and it was worth almost nothing. The most common responses to the idea of a new digital currency were: “It’s a scam, it won’t work, governments will never allow such a thing.” Over time, as the price of bitcoin increased, it would periodically come to people’s attention. For example, in 2011, when it surpassed $1 for the first time, rose to over $30, and then crashed back down to $10. Or in 2013, when it surpassed $100, rapidly reached $1200, and then crashed back down to the low $100s.
Crypto has proven itself over the past eight years or so, surviving in a hostile environment, never being hacked, going through multiple crises, and, importantly, being a better store of value than anything else during the same period. It’s a fascinating phenomenon to consider. Over nearly a decade, we have collectively grown to trust the mathematics behind bitcoin and other cryptocurrencies, and this trust is reflected in their increasing value.
What real-world problems does the blockchain solve?
Blockchain solves several significant problems that were previously thought to be impossible. Apart from the game-theoretical challenge of running a decentralized network where every participant may act maliciously, blockchain allows for quick and inexpensive value transfer anywhere in the world without requiring permission from anyone or relying on anything other than the private key used to unlock the wallet and sign transactions.
One of the most interesting aspects of blockchain is that people in the developing world have been able to understand its revolutionary potential more easily than their counterparts in the Western world. If you’ve ever tried to move money out of a country with capital controls, you don’t need to be convinced of the benefits of cryptocurrencies. Similarly, if you are among the majority of people on the planet who are unbanked, blockchain makes perfect sense.
Throughout history, people fleeing natural disasters or conflicts have tried to take anything valuable with them. Blockchain enables individuals to cross borders and escape potentially dangerous situations, carrying all their assets securely stored in their minds. As long as they can remember the private key to their wallet, they can maintain access to their capital, regardless of their location or circumstances. This has never been possible before. It is a fundamentally empowering technology that allows individuals to be self-sovereign, control their wealth, and transact on their own terms.
Blockchain is used by millions of people worldwide to send money back home to their families without paying exorbitant fees charged by banks or money transmitters like Western Union. It serves as an alternative payment system in troubled nations like Argentina, Venezuela, and Zimbabwe, where national currencies have been devalued to the point of worthlessness.
Cryptocurrencies have also been used as a hedge against general economic uncertainty, similar to how gold has traditionally been used. However, cryptocurrencies can be transferred more easily, cheaply, and securely than gold and have also proven to be a better investment since their inception.
Bitcoin is the star, but what about other cryptocurrencies?
Now that you have a basic understanding of what Bitcoin is, why it came to be, and how it functions, let’s take a look at the rest of the cryptocurrency space. At the time of writing, the total value of all cryptocurrencies is around $146 billion. Bitcoin, with a market capitalization of $71 billion, represents approximately 48% of this market. These figures may have changed by the time you are reading this, as the cryptocurrency market moves rapidly.
The early alternatives to Bitcoin, known as altcoins, were mostly Bitcoin clones with different issuance and hashing algorithms. None of these early contenders directly competed with Bitcoin, as it was far ahead in terms of market cap and network effect.
It’s important to note that Bitcoin is not out-competing traditional money by simply performing the same functions slightly better. Similarly, for a cryptocurrency to rival Bitcoin, it would need to be significantly more powerful and capable than Bitcoin.
There are thousands of cryptocurrencies in existence, each with its own unique features, use cases, and communities. Some aim to improve upon Bitcoin’s limitations, while others focus on specific applications or industries. It’s a dynamic and evolving space, with new projects and innovations constantly emerging.
Indeed, during the first few years of its existence, Bitcoin was unrivaled, and most other cryptocurrencies were derived as altcoins and traded for short-term gains by early crypto traders. However, in 2014, something significant changed in the cryptocurrency landscape.
The potential of blockchain technology extends beyond just money, as demonstrated by Bitcoin. Since blockchains are distributed databases, it became evident that they could be used to decentralize various industries that rely on databases. In essence, many aspects of the current internet could function in a decentralized manner by replacing centralized databases owned by existing service providers. This includes domain name registration, online publishing, social media, cloud computing, cloud storage, prediction markets, online trading, tokenized assets, and more. Blockchain technology has the potential to disintermediate these industries, reduce inefficiencies, and increase transparency.
Initially, attempts to decentralize beyond money involved creating new blockchains for specific use cases, similar to what Satoshi did with Bitcoin. Examples include Siacoin for decentralized storage and Steemit for decentralized blogging.
However, in 2014, a significant breakthrough occurred with the proposal made by a 19-year-old programmer named Vitalik Buterin. He introduced the concept of Ethereum, which is now the second-largest cryptocurrency globally. Instead of building specialized blockchains for limited use cases, Buterin proposed a general-purpose blockchain with its own programming language. This meant that any use case could be built on top of the core protocol, similar to how applications are built on Android and iOS devices.
Ethereum conducted a crowd sale in 2014, where the native currency of the Ethereum blockchain, ether, was sold to early investors in exchange for bitcoin. This was not the first crowd sale of its kind, as the first token sale took place in 2013 with Mastercoin, a digital currency built on top of the Bitcoin network that aimed to add additional functionality to the blockchain.
The innovation of Ethereum lies in its ability to run self-executing smart contracts on its blockchain, enabling the programmability of complex use cases as decentralized applications (dApps).
However, Ethereum also faced challenges. In 2016-2017, it became popular for raising funds through initial coin offerings (ICOs), which led to the DAO (Decentralized Autonomous Organization) incident. A hacker exploited a vulnerability in the DAO’s smart contract code and managed to steal a significant amount of ether (approximately $50 million at the time), resulting in one of Ethereum’s notable failures. This event led to a hard fork in the Ethereum code, resulting in two versions of the Ethereum blockchain: Ethereum (ETH) and Ethereum Classic (ETC).
In summary, while Bitcoin paved the way for cryptocurrencies, Ethereum introduced the concept of a general-purpose blockchain with programmable smart contracts, opening up possibilities for a wide range of decentralized applications beyond just digital currencies.
Hard Fork: A Critical Change in the Blockchain Protocol
In the Ethereum community, several solutions were suggested to address the issue of stolen funds. Eventually, it was agreed upon that the only way to recover the funds was through a hard fork. This involved making changes to the code to restore the network to a state before the DAO hack, thus reclaiming the money.
While most of the community supported the code change, there were many who opposed it, emphasizing the importance of blockchain immutability. As a result of the hard fork, two separate versions of Ethereum emerged. Some miners continued to mine the original chain, known as Ethereum Classic, while the forked chain that retrieved the stolen funds retained the name Ethereum and its development team.
Understanding Hard Forks
A hard fork happens when a significant modification is made to the blockchain protocol, rendering previously valid transactions invalid, or vice versa. In the case of the DAO hack, the Ethereum development community determined that the only secure solution was to revert the Ethereum code to a previous state, eliminating the hack and enabling investors to withdraw their funds.
To visualize a hard fork, imagine a set of train tracks. When a hard fork occurs, those who update their software to support the fork switch to a different track, just like a train at a railroad switch. Notably, if a sufficient number of miners decide to continue mining the old chain, it persists as if nothing has changed, while the forked chain progresses in a new direction.
The fate of a hard fork depends on whether it is contentious or non-contentious. In the case of a non-contentious hard fork, the old chain eventually diminishes as miners gradually upgrade their software and stop mining it. However, in a contentious hard fork, like during the DAO hack, miners opposing the fork persist in supporting the old chain. Thus, Ethereum Classic represents the original Ethereum chain, while Ethereum refers to the new forked chain.
Tokens and Legacy
When a blockchain undergoes a hard fork while maintaining the original chain, the tokens held on the old chain are also owned on the new chain. After the Ethereum hard fork following the DAO hack, those who held ether also received an equivalent amount of Ethereum Classic. This aspect should be considered when trading cryptocurrencies, as volumes can surge due to traders wanting to double their holdings after a fork, similar to what is happening with several Bitcoin hard forks currently.
Ethereum’s Journey
The DAO hack had a significant impact on the value of ether and eroded confidence in smart contracts, particularly Ethereum’s ability to fulfill its promises. This event highlighted the complex transition where blockchains and smart contracts are being utilized to manage traditionally centralized databases for trusted parties. It also underscored the risks of inadequately audited or tested code.
Despite the challenges, Ethereum has continued its development roadmap, reaching milestones such as Homestead in March 2016. Presently, Ethereum is undergoing testing for its upcoming milestone, the Metropolis hard fork, which consists of two parts: Byzantium and Constantinople. This upgrade aims to enhance Ethereum’s scalability to accommodate future mass adoption.
The Current Challenges: Scaling and Governance
One of the major issues faced by blockchains is scaling their usage. While blockchains are secure and decentralized, the requirement for every node to process all data for validation presents efficiency drawbacks. Bitcoin has confronted similar issues, leading to a contentious hard fork that introduced the Segwit optimization and planned block size increase in Bitcoin Cash.
Decentralization brings its own set of challenges, including governance and consensus among diverse and competing interests. To succeed, blockchain protocols must find ways to scale without compromising security or decentralization. Achieving high transaction throughput, comparable to centralized institutions like Visa, is crucial for cryptocurrencies to fulfill their potential.
Looking Ahead
The cryptocurrency landscape comprises various single-use blockchains, a smaller number of second layer protocols for enhancing functionality, and an increasing number of smart contract platforms like Ethereum. The current focus in blockchain development is achieving scalability to handle thousands of transactions per second. Without significant scaling, cryptocurrencies cannot effectively compete with centralized counterparts or realize the goal of decentralizing various aspects of society.
What is Proof of Stake?
Proof of Stake (PoS) is a consensus mechanism that eliminates the need for mining in cryptocurrencies. Instead, it relies on stakeholders of the specific cryptocurrency to validate transactions and create new blocks. In PoS systems, stakeholders are required to post a significant amount of capital as collateral to ensure their honest participation and prevent cheating.
Ethereum’s Transition to Proof of Stake
Ethereum has plans to completely replace its current proof of work mechanism with proof of stake in the future. However, this transition will take some time. Other blockchain projects like EOS, Tezos, and Cardano have already successfully implemented proof of stake and are working on building their blockchains from scratch. Tezos and Cardano aim to incorporate governance models directly into their blockchains, enabling self-governance and evolution without the need for contentious hard forks like those experienced by Bitcoin and Ethereum.
How to Trade Crypto
Trading cryptocurrencies can help diversify your assets and potentially benefit from market fluctuations. Here are the steps to follow if you want to trade crypto:
- Study the cryptocurrency market thoroughly as it behaves differently from traditional currencies.
- Plan your trading strategy for the chosen cryptocurrency, including setting stop-loss and take-profit levels, and incorporating risk management tools.
- Choose a suitable trading platform based on your needs, considering factors like user interface complexity.
Successful Crypto Trading Tools
Successful crypto trading relies on effective methods and various tools. Some essential tools include:
- Crypto Calculator: Simplifies calculations, such as currency conversions and profit/loss calculations.
- Crypto Trading Chart: Provides visual market data, trends, and trading indicators for informed decision-making.
- Portfolio Tracker: Offers a quick overview of your total investments, daily portfolio value changes, and individual coin performance.
Key Drivers of the Crypto Market
The cryptocurrency market is influenced by supply and demand dynamics, similar to traditional markets. However, it is theoretically independent of political and economic factors due to its decentralized nature. Factors affecting cryptocurrency prices include the supply of coins, market capitalization, media coverage, integration with existing commercial frameworks, and significant events in the crypto space.
The Future of Crypto
The cryptocurrency revolution is relatively young, with most significant developments occurring in the past few years. While the future remains uncertain, trends suggest increasing investments and potential for growth. The market cap of cryptocurrencies is still relatively small compared to individual companies and traditional markets like gold. The scalability of blockchains and the ability to create popular decentralized applications will determine the industry’s future success. Despite the risks, cryptocurrencies have the potential to disrupt the status quo and redistribute wealth to early investors.
By understanding the basics, you are better positioned to navigate this new market and take advantage of the innovation happening in the world of cryptocurrencies. Wishing you success in your crypto endeavors!