Understanding cryptocurrencies: the basics

Cryptocurrency represents a decentralized form of digital money based on blockchain technology. You may have already heard of the most popular versions, such as Bitcoin and Ethereum, but there are nearly 10,000 different cryptocurrencies in circulation.

Understanding cryptocurrencies: the basics

Table of contents




How cryptocurrencies work?

  1. A cryptocurrency is based on a blockchain, distributed via a decentralized register and secured by a computer protocol. Unlike American ($) or European (€) currency, no central authority is in charge of managing and maintaining the value of a cryptocurrency. Instead, these responsibilities are widely distributed among cryptocurrency users via the Internet.
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  2. Cryptocurrencies can be used to acquire everyday goods and services, although most individuals invest in cryptocurrencies in the same way they would other assets such as shares or precious metals. Despite the innovative and exciting nature of cryptocurrencies as an asset class, buying them can involve risks that require in-depth research to fully understand how each system works.
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Bitcoin

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Bitcoin, created in 2009 by an entity or group of people under the pseudonym Satoshi Nakamoto, is the first and best-known cryptocurrency. Unlike traditional currencies issued and regulated by governments and central banks, Bitcoin operates on a decentralized peer-to-peer network, using a technology called blockchain to record all transactions securely and transparently. This blockchain is a public register containing every transaction ever made with Bitcoin, making the system resistant to tampering and manipulation. 

Bitcoin can be used for online transactions, as an investment or as a store of value similar to gold. Its programmed scarcity, with a limited supply of 21 million units, contributes to its appeal as a financial asset. To find out more about Bitcoin, visit our full article: Understanding Bitcoin.

Blockchain

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The blockchain is essentially the heart of cryptocurrency operations. It takes the form of a shared register accessible to all, recording every transaction made since the beginning of the network. These transactions are collected into blocks, which are successively added to the chain.

Each participant in the network, called a node, maintains and verifies its own copy of the blockchain, going back to the very first block, called the genesis block. The validity of a blockchain is measured by its ability to be verified from this founding block. With no central authority, the blockchain operates in a decentralized manner, with each node contributing to its security and reliability.

To guarantee the integrity of the chain, blocks are linked by cryptographic functions, ensuring that no alterations have been made to previous blocks. Each node, in reality a computer connected to the network, participates in the verification and recording of transactions.

The decentralized nature of blockchain can cause delays in the transmission of transactions and blocks across the network. In the event of discrepancies between versions of the chain, the rule is to adopt the longest version, which is therefore considered the most valid.

To find out more about blockchain, read our article: Complete guide on blockchain technology.

Consensus: proof of work vs. proof of stake

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  2. For all participants in the decentralized network to reach consensus and synchronize, the consensus problem needs to be solved. The latter aims to determine which entity will be responsible for proposing a new block to the network, while ensuring that the creation of new currency units is progressive. Most cryptocurrencies set a limit on the total amount of currency that will eventually be issued. This limit is designed to reproduce the scarcity (and therefore value) of precious metals, while avoiding hyperinflation.
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  4. Once a block has been created and validated, each node that contributed to its creation receives a reward in cryptocurrency, proportional to its contribution.
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  6. Proof-of-work and proof-of-stake stand out as the two main consensus mechanisms used to validate transactions before integrating them into a blockchain. Subsequently, those who confirm these transactions receive a cryptocurrency reward for their contribution.
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1. Proof of work

Proof of work (PoW) is a process used by cryptocurrencies to secure and validate transactions on their network. In practical terms, it's a complex mathematical problem that computers have to solve. The first to find a valid solution wins the right to validate and add a new block of transactions to the blockchain, the cryptocurrency's secure public database. This process requires a great deal of computing power and energy, making it costly in terms of resources. As a reward for their efforts, participants who successfully validate a block receive remuneration in the form of new units of the cryptocurrency in question.

2. Proof of stake

Proof of stake (PoS) is a mechanism used by some cryptocurrencies to validate and secure transactions on their network. Unlike proof-of-work, where participants must solve complex mathematical problems, proof-of-stake works differently. Instead, validators are selected according to the amount of cryptocurrency they hold and immobilize, i.e. the “stake” they put on the line. In other words, the more cryptocurrency you hold, the more likely you are to be chosen to validate transactions and earn rewards. This system is supposed to be more energy-efficient than proof-of-work, but it can also be criticized for favoring those who already own a large amount of cryptocurrency, thus increasing their influence on the network.

Stablecoin

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  2. A stablecoin, or stable cryptocurrency, is a type of cryptocurrency designed to maintain a stable value relative to an underlying asset, such as the US dollar, euro or gold. Unlike other cryptocurrencies such as Bitcoin, whose value can fluctuate considerably, stablecoins are usually indexed to fiat currency or another stable asset to reduce volatility. This makes them attractive to users who want to enjoy the benefits of fast, low-cost transactions offered by cryptocurrencies, while avoiding the uncertainty associated with price fluctuations. 
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  4. Stablecoins are often used as a means of payment, fund transfer or store of value in cryptocurrency exchanges and decentralized finance (DeFi) applications.
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Among the best-known stablecoins are: USDT (Theter), USDC (USD Coin), DAI, PYUSD (Paypal USD), EUROC, EURL. 

Pros and cons of cryptocurrencies

1. Pros of cryptocurrencies

Cryptocurrency has many advantages that make it attractive to users around the world. Firstly, designed for the Internet, it offers an alternative to traditional payment systems, increasing the accessibility of online commerce, particularly in developing countries.

In addition, transparency is a key element, as all transactions are recorded publicly, enabling owners and recipients to be identified through specific addresses.

Security is also a major advantage of cryptocurrency. Thanks to its robust encryption protocol, it is difficult to counterfeit or usurp, offering protection against many computer threats.

Moreover, transfer fees are often minimal or non-existent, making them far more advantageous than those charged by traditional payment institutions such as Paypal or Western Union. What's more, transfers are fast, usually taking from a few seconds to a few minutes, unlike traditional bank transfers, which can take several days.

Another major advantage is the absence of intermediaries in cryptocurrency transactions, meaning that funds are sent directly to the receiving address without going through a bank or other third party.

Additionally, cryptocurrency enables transfers on a global scale, regardless of country, facilitating international trade. It also offers the possibility for any individual or company to transfer cryptocurrency, and can be securely stored remotely on a server or on a physical medium such as a USB stick.

  1. Finally, for some cryptocurrencies, the total quantity that can be created is capped, making them deflationary in nature, offering the prospect of stable and even increasing value over time.
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2. Cons of cryptocurrencies

Cryptocurrency also has a number of drawbacks worth considering. Firstly, although its use is growing, it still has a relatively low impact on the general public, with transaction volumes sometimes limited.

Plus, the payment network associated with cryptocurrency is still developing and can be considered underdeveloped compared with traditional payment systems.

Another major disadvantage is the diversity of cryptocurrencies, which are often incompatible with each other, which can complicate exchanges and transactions.

High price volatility in a poorly regulated sector is also a point of concern, as this makes investing in cryptocurrencies particularly risky. In addition, the abundance of scams in the cryptocurrency field is another major problem, with frauds reaching considerable amounts every year.

Security is also a concern, as users need to take steps to protect their funds, such as using strong passwords and additional authentication techniques.

Another major drawback is the risk of permanent loss of cryptocurrency in the event of loss of private keys or storage devices. Once lost, cryptocurrency generally cannot be recovered.

What's more, the mining activities required to secure the network of certain cryptocurrencies entail considerable energy consumption, raising environmental concerns.

Finally, cryptocurrency may be illegal in some countries, which may limit its global adoption and use.

Further thoughts

In conclusion, cryptocurrencies represent a fascinating technological advance with the potential to transform global financial systems. Their decentralized design and enhanced security offer undeniable advantages, such as fast, inexpensive and globally accessible transactions. However, it is important to recognize that they are not without their drawbacks, particularly in terms of price volatility, security and regulation. Despite these challenges, interest in and adoption of cryptocurrencies continues to grow, paving the way for a future where digital currency could play an even greater role in our daily lives. It remains to be seen how this technology will evolve and how it will be integrated into our existing financial and economic systems.


  1. Sources: 
  2. https://www.forbes.com/advisor/investing/cryptocurrency/what-is-cryptocurrency/, consulted on 09.05.24
  3. https://coinmarketcap.com/, consulted on 09.05.24
  4. https://fr.wikipedia.org/wiki/Cryptomonnaie_stable, consulted on 09.05.24
  5. https://fr.wikipedia.org/wiki/Cryptomonnaie, consulted on 09.05.24
  6. https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-proof-of-stake, consulted on 09.05.24
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Disclaimer : This is not financial advice. The purpose of the site is to inform readers. Any type of investment involves risk. Do your due diligence and do your own research on the projects featured on the site. Act as a good father and do not invest more than your objectives or financial means allow you.  In this regard, read our page: Warning about virtual currencies.

 

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