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Bitcoin, Ethereum, Ripple, Oh My! How Cryptocurrency Works 101

How cryptocurrency works: some countries are banning cryptocurrency, some countries are starting their own cryptocurrencies but all countries are watching cryptocurrency carefully, including the US.

Cryptocurrencies are exciting masses of people despite their volatility and despite that not many people know how cryptocurrency works. Bitcoin is the most well-known digital currency. Its price skyrocketed recently compared to where it was eight years ago when it was created. In December of last year, the price of bitcoin hit its all-time high of around $ 20,000.

But, bitcoin and its rivals have been plunging in value significantly for the past several weeks. In early February, Bitcoin dove from $ 10,000 to $6,000 in a mere four days.

Ethereum, the second-largest virtual currency, fell 60 percent to $577 on Tuesday after reaching a peak of $1,432.88 on Jan.13, CoinMarketCap data showed. Ripple, the third most popular cryptocurrency, suffered a drastic 80 percent drop from its highest record of$3,810 this month.

The total value of all cryptocurrencies surged 25 percent on Wednesday to $352 billion after slipping to $276 billion the previous day, according to CoinMarketCap.

Several factors have contributed to the downfall of cryptocurrencies. Among them are fears voiced by some of the world’s governments that crime organizations will use non-physical money to pay for illegal goods and services.

What are cryptocurrencies?

Cryptocurrency is digital currency that uses cryptography to provide transaction security. With its cryptography technology, it is impossible to manipulate. Unlike conventional money, the circulation of virtual money is not regulated by banks or authorized financial institutions.

How cryptocurrency works and is created.

Traditional money is printed and issued by the central bank. Cryptocurrencies are made from algorithms and are relatively easy to make as they are based off of open source codes. Developers can pick an open source algorithm and create a “fork” off of it to design their own currency. These virtual currencies have different values depending on the date of creation, number of users, transaction volumes, and extent of the network.

According to Emin Gün Sirer, a computer scientist at Cornell, “The biggest innovation, he added, is the use of blockchains (publicly viewable ledgers that record every transaction since its beginning) as ‘consensus protocols’ and ‘distributed systems.'”‘

It uses a decentralized system that boosts efficiency. When a person buys bitcoin, a computer system connected to blockchain will record and validate the transaction automatically so that nobody else can claim it. This technology minimizes error, is fast and efficient.

What is bitcoin? Why is it so popular?

Bitcoin is one of the most popular cryptocurrencies. It was created by a Japanese citizen using the alias  Satoshi Nakamoto.

Bitcoin has captured the world’s attention because it is easy to set up. No third-party is involved in the creation process and no banking institutions are involved.

It was the first cryptocurrency and it introduced blockchain technology.

Other cryptocurrencies later emerged with their own unique characteristics.

Litecoin, for example, was the first coin to use a security system called scrypt-that forms a keyword system based on Key Derivation Function (KDF). The system tightens users’ passwords.

Ethereum is the second-most popular digital currency and was launched in 2015. The value of ethereum rose 2.300 percent from 2015 to August 2017.

Bitcoin vs Ethereum

The number of bitcoins is limited to 21 million. There is no restriction on the amount of ethereum. Another difference is that bitcoin was developed to be an alternative currency. Ethereum was built to be a platform that supports “smart contracts”.

According to Coin Desk “Ethereum replaces bitcoin’s more restrictive language (a scripting language of a hundred or so scripts) and replaces it with a language that allows developers to write their own programs.

Ethereum allows developers to program their own smart contracts, or ‘autonomous agents’, as the ethereum white paper calls them.”

What does the finance industry think of cryptocurrenices? 

Some prominent figures in finance doubt the trend will last. JP Morgan boss Jamie Dimon said that people who buy bitcoin are stupid. He said he believed that only criminals use it for transactions.

Billionaire investor Carl Icahn told CNBC that he does not understand cryptocurrency, calling it ridiculous. Warren Buffett told CNBC that cryptocurrencies would not end well.

World Governments lash back at cryptocurrencies.

Last month South Korea announced its plan to issue a regulation banning cryptocurrency trading which caused bitcoin to drop 12 percent to $2,000, Reuters reported.

South Korea is one of the world’s largest cryptocurrency markets and demand for cryptocurrencies drove prices 50 percent higher in January, according to Bloomberg.

As of Jan.30, South Korea banned deposits into anonymous virtual accounts at banks and ordered financial institutions to report suspicious traders, including those who make a deposit or withdraw of 10 million South Korean won ($9,330) or more a day from cryptocurrency. Policymakers also outlawed minors, foreigners, and banks from domestic exchanges.

India is the latest country to speak out about the impact of cryptocurrency trading. Indian Finance Minister Arun Jaitley announced that the state does not recognize virtual money as a legitimate payment method. India also wants to reduce the usage of cryptocurrency in financing illegal activities, as CNBC wrote.

Instead of banning virtual money, India is interested in blockchain technology for supporting its own digital economy.

The United States will watch bitcoin “very carefully”.

In the United States several government institutions have been working on policies to accommodate the use of cryptocurrency, Marketwatch reported. The Department of Treasury set up a team to examine bitcoin and Treasury Secretary Steve Mnuchin said that he would watch bitcoin”very carefully.”

Some states have considered accepting the use of blockchain technology and bitcoin and some, like Vermont and Arizona, have already passed laws for their use.

China banned third-party and payment providers from using, accepting, and selling virtual currency and also prohibited raising funds through initial coin offering (ICO).

The world’s most famous social network, Facebook, announced its intention to ban cryptocurrency ads on its platform.

What’s the next step?

Central banks around the globe cannot deny the rising popularity of cryptocurrency, the Bank for International Settlements (BIS), acknowledged. According to its latest study, digital currency poses a risk to the stability of the world’s current financial system.

One possible option for central banks around the world to deal with the growth of virtual currencies is to issue “legitimate” cryptocurrencies, but they also must consider other factors such as risk from cyber attack and the privacy of virtual currency users.

“If authorities do not act preemptively, cryptocurrencies could become more interconnected with the main financial system and become a threat to financial stability,” Agustin Carstens, head of BIS, told Marketwatch.

The question is, are cryptocurrencies a passing fad, or will the nations of the world have to get on board this new wave of financing? Will cryptocurrencies mean the downfall of government run central banks?



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Yasmeen Rasidi

Yasmeen is a writer and political science graduate of the National University, Jakarta. She covers a variety of topics for Citizen Truth including the Asia and Pacific region, international conflicts and press freedom issues. Yasmeen had worked for Xinhua Indonesia and GeoStrategist previously. She writes from Jakarta, Indonesia.

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