We introduced crypto as an asset class on HYW before. But we never answered the question “what is crypto?” in detail. This is mainly because crypto is a complex and polarising asset class. It has been either dismissed by critics or hyped by fans since its creation. This is why we had to produce a guide that is both comprehensive and impartial. So, what is crypto? let’s find out.
What is Crypto?
Crypto is an abbreviated term referring to cryptocurrencies and crypto tokens. Cryptocurrencies and tokens are digitally secured using cryptography. Cryptography makes it almost impossible to counterfeit or double-spend these tokens. Many decentralized networks, which rely on blockchain technology enforced by a network of computers, use cryptocurrencies to reward the network maintainers. Users who use the services provided by the network will also need the network crypto to pay for these services. Central authorities do not generally issue cryptocurrencies, a defining feature that makes them resistant to government interference or manipulation. In summary, crypto has these distinct features:
- Digital
- Secured by cryptography
- Earned through decentralised network protocols (more on that later)
- Used in the network in exchange for network service
Cryptocurrencies vs Crypto Tokens
Cryptocurrencies and crypto tokens are often used interchangeably, but they are not exactly the same thing. A cryptocurrency is a type of digital or virtual currency that uses cryptography for secure financial transactions. This means that they have their own dedicated blockchains. Bitcoin and Ethereum are two well-known cryptocurrencies.
On the other hand, crypto tokens are digital assets created on top of an existing blockchain. Tokens can represent a wide range of assets, including currencies, physical objects, and even rights to intellectual property. Some crypto tokens are designed to be used as a means of exchange, similar to how cryptocurrencies are used. While others are intended to represent a particular asset or to be used for a specific purpose.
So, to summarize, all crypto tokens are cryptocurrencies, but not all cryptocurrencies are crypto tokens. The biggest differentiator is that cryptocurrencies have their own blockchains, also known as layer 1, and crypto tokens are built on existing blockchains, and they are known as layer 2.
Crypto Mining Protocols
A cryptocurrency mining protocol is a set of rules that govern the process of validating transactions on a blockchain and creating new blocks to be added to the chain. The process of validating transactions and creating new blocks is known as mining.
In a cryptocurrency network, miners use their computer’s processing power to verify transactions and add them to the blockchain. In return for their efforts, they are rewarded with a certain amount of the cryptocurrency. The mining protocol specifies the rules that miners must follow in order to participate in the mining process. This includes the process for validating transactions and creating new blocks. It also determines how the mining rewards are distributed and how the difficulty of mining is adjusted.
Types of Mining Protocols
The mining protocol is an important part of a cryptocurrency’s design, as it helps to ensure the security and integrity of the blockchain. Some of the most common mining protocols are:
- Proof-of-Work (PoW): This is the most well-known and widely used mining protocol. In a PoW system, miners compete to solve a complex mathematical puzzle, and the first one to solve it gets to create a new block and receive the mining reward. PoW is used by many well-known cryptocurrencies, including Bitcoin and Litecoin.
- Proof-of-Stake (PoS): In a PoS system, the probability of a miner creating a new block is proportional to the amount of cryptocurrency they hold. This means that the more cryptocurrency a miner holds, the more likely they are to create a new block. PoS is used by a number of cryptocurrencies, including Ethereum and NEO.
- Delegated Proof-of-Stake (DPoS): DPoS is a variation of PoS in which stakeholders can delegate their voting power to “witnesses,” who are responsible for validating transactions and creating new blocks. DPoS is used by a number of cryptocurrencies, including EOS and Steem.
- Proof-of-Authority (PoA): In a PoA system, block validation is controlled by a set of pre-approved “authorities,” who are responsible for validating transactions and creating new blocks. PoA is often used in private blockchain networks, where the identities of the authorities are known and trusted
How To Store Crypto?
Since cryptocurrencies and tokens are digital, storing them is not as straightforward as storing gold or cash. A crypto wallet is a digital wallet that allows individuals to store, send, and receive digital currencies. These wallets typically use a private key for access and can be stored on a computer, mobile device, or hardware device. They also have a public key, which allows people to send you crypto. Some crypto wallets also have additional features, such as the ability to exchange one digital currency for another. There are many different types of wallets, and it is important to understand them.
Types of Crypto Wallets
- Hardware wallets: These are physical devices that are designed to securely store a user’s private key offline, making them resistant to hacking attempts. Examples of hardware wallets include Trezor and Ledger.
- Software wallets: These are digital wallets that can be installed on a computer or mobile device. They can be further divided into three types:
- Desktop wallets: which are installed on a computer
- Mobile wallets: which are installed on a smartphone
- Web wallets: which are accessed through a web browser.
- Paper wallets: These are a form of “cold storage” where the user’s private key is printed on a piece of paper, allowing them to store it offline.
- Brain wallets: These are a type of software wallet where the user’s private key is generated from a passphrase or a mnemonic phrase, and the passphrase is memorized by the user.
- Custodial wallets: These are wallets where the private keys are managed by a third party, such as an exchange or a bank.
Use Cases of Cryptocurrencies
1. Digital Money
It is critical to understand the potential use cases of cryptocurrencies before even considering to invest. The first blockchain network was developed to function as a decentralised bank with Bitcoin as the bank’s currency. This means that financial transactions was the first use case of cryptocurrencies and the blockchain technology in general.
Advantages of Using Crypto as Digital Money
Using cryptocurrencies as digital money has a number of potential advantages:
- Inexpensive: Cryptocurrencies can be transferred at a very low cost, making them a fast and efficient means of payment.
- Secure: Cryptocurrencies are secured by cryptography, which makes them difficult to counterfeit or double-spend. This can help to reduce the risk of fraud and other types of financial crimes.
- Global: Cryptocurrencies can be used and accepted anywhere in the world, as long as there is an internet connection. This makes them a convenient option for cross-border transactions.
- Decentralized: Cryptocurrencies are decentralized, which means that they are not controlled by any central authority. This can make them resistant to government interference or manipulation.
Disadvantages of Using Crypto as Digital Money
However, there are also some disadvantages to using cryptocurrencies as digital money:
- Volatility: The value of cryptocurrencies can be highly volatile, which means that their value can fluctuate significantly over a short period of time. This can make it difficult to predict the value of a cryptocurrency and make it risky to use as a means of payment.
- Limited acceptance: While the acceptance of cryptocurrencies as a form of payment is increasing, they are not yet widely accepted. This means that it may not be possible to use them to make purchases at all merchants.
- Lack of regulation: Because cryptocurrencies are not regulated in the same way as fiat currencies, there is less protection for users if things go wrong. For example, if a user loses their cryptocurrency due to a hack or other security breach, there may be no way to recover it.
- Decentralized: This is a double-edged sword, it may prove useful in countries with authoritarian regimes. But in more just regimes, this could be used for nefarious purposes.
2. Smart Contracts
A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist on the blockchain network.
For example, a smart contract could be used to automatically transfer ownership of a piece of property from one person to another upon the completion of a certain event, such as the payment of the purchase price. The smart contract would contain the terms of the agreement, including the price to be paid and the conditions under which the transfer would take place. Once the conditions of the contract are met, the transfer would be executed automatically.
Advantages of Smart Contracts
Some potential advantages of smart contracts include:
- Accuracy: Smart contracts can reduce the risk of errors or misunderstandings, as they are executed automatically based on predetermined rules.
- Speed: Smart contracts can facilitate faster transaction times, as they can be executed without the need for manual processing.
- Cost savings: Smart contracts can reduce the need for intermediaries, which can save on costs.
- Immutability: Once a smart contract is deployed on the blockchain, it is extremely difficult to alter or tamper with. This adds an additional layer of security and trust.
- Autonomy: Smart contracts allow parties to transact directly with one another, without the need for external oversight.
Disadvantages of Smart Contracts
Some potential disadvantages of smart contracts include:
- Limited programming languages: Currently, there are only a limited number of programming languages that can be used to write smart contracts. This can make it difficult for developers who are not familiar with these languages to work with smart contracts.
- Complexity: Writing and deploying smart contracts can be complex, and may require the assistance of experienced professionals.
- Lack of legal recognition: In some jurisdictions, smart contracts may not be legally recognized or enforceable. This can create uncertainty and potential legal risks.
- Immutability: While the immutability of smart contracts can provide added security, it can also be problematic if a mistake is made in the contract code. Once the contract is deployed, it cannot be easily altered or corrected.
- Scalability: As the use of smart contracts increases, the scalability of blockchain networks may become an issue. This could lead to slow transaction times and high fees.
What About Decentralised Finance (DeFi)
Decentralized finance (DeFi) refers to financial applications that are built on top of blockchains with the smart contract feature. DeFi applications are designed to provide financial services that are open, transparent, and accessible to anyone with an internet connection.
Some examples of DeFi applications include:
- Cryptocurrency exchanges (DEX): DeFi exchanges allow users to buy and sell cryptocurrencies in a decentralized manner, without the need for a central authority (e.g. broker).
- Lending platforms: DeFi lending platforms allow users to borrow and lend cryptocurrencies to one another, using smart contracts to automate the process.
- Payment processors: DeFi payment processors allow merchants to accept cryptocurrency as a form of payment, and also enable users to send and receive cryptocurrency payments.
- Stablecoins: DeFi stablecoins are cryptocurrencies that are pegged to the value of a real-world asset such as the US dollar.
- Governance systems: DeFi governance systems allow users to vote on protocol decisions and contribute to the development of a DeFi application.
DeFi has the potential to disrupt traditional financial systems by making financial services more accessible, transparent, and secure. However, it is important to note that DeFi is a relatively new and rapidly evolving space, and the use of DeFi applications carries its own set of risks. It is always a good idea to do your own research and assess the risks before using any DeFi application.
How Can You Make Money With Crypto?
We had to decipher some crypto fundamentals before we introduce the different ways you can make money with crypto. However, it is important to note that investing in cryptocurrencies carries a high level of risk, as the value of these assets can fluctuate significantly. It is always a good idea to do your own research and assess the risks before making any investment decisions.
Buy and hold
One of the most common ways to make money with cryptocurrencies is to buy a coin at a low price and hold it until the price appreciates. This requires patience and the ability to identify coins with long-term potential.
Mining
As mentioned previously, cryptocurrencies are created through mining. Miners who contribute their computing power to the network are rewarded with a small amount of the cryptocurrency they are mining. You can either purchase mining equipment or use a cloud mining service to participate in mining.
Staking
Some cryptocurrencies, such as Tezos, require users to “stake” their coins in order to participate in the process of validating transactions on the blockchain. Stakers who participate in this process can earn a reward in the form of additional coins.
Earning Interest
Some platforms, such as Nexo, allow users to earn interest on their cryptocurrency holdings by lending them out to borrowers.
Yield Farming
Yield farming, also known as liquidity mining, involves providing liquidity to a protocol, usually a decentralised exchange (DEX), by depositing cryptocurrency into a liquidity pool. In return, users receive a share of the fees generated by the protocol, as well as any additional rewards that may be offered. In simpler terms, you will be providing liquidity to DEX’s and earning a share of the trading fees.
Liquidity Farming
Liquidity farming involves providing liquidity to a protocol in exchange for a share of the protocol’s governance tokens. These tokens can then be staked or used to vote on protocol decisions, and may also appreciate in value if the protocol is successful.
What Are The Risks?
As you all know by now, high returns are never risk free. Crypto is no different, and comes with a unique set of risks as summarised below.
- Volatility: The value of cryptocurrencies can change rapidly and unpredictably. This can make it difficult for investors to determine the right time to buy or sell, and it can result in significant losses if the value drops suddenly.
- Lack of regulation: Cryptocurrencies are not regulated by governments or financial institutions, which can make it difficult for investors to protect themselves from fraud or scams.
- Security risks: Cryptocurrency exchanges and wallets can be vulnerable to hacking attacks, which can result in the loss of digital assets.
- Lack of understanding: Cryptocurrencies and blockchain technology can be complex and difficult to understand, which can make it challenging for investors to make informed decisions.
- Lack of adoption: Cryptocurrencies are not widely accepted as a form of payment, so it can be difficult to find places to use them.
- Market manipulation: The market for cryptocurrencies is still relatively small and illiquid, which makes it more susceptible to manipulation.
In Conclusion
The crypto space is a new and growing space, but lack of regulations combined with bad actors promising astronomical risk free returns make it difficult to navigate for beginners. We have summarised everything you need to know about crypto, from what crypto is to the risks of investing in it, and everything in between. You can now start researching crypto projects and exploring this space with a bit more confidence. We recommend the Binance Academy for getting to grips with more advanced crypto topics.
