MC ESMA prepared this guide thinking that you want to get started in the world of digital currencies and need to know where to start.
It is a new asset class on the market and, precisely for this reason, arouses many doubts in those who are still learning. This is your case We invite you to follow the next paragraphs to get closer to cryptocurrencies:
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• What are cryptocurrencies?
• What are worth for
• What is mining?
• How price variation works
• Major cryptocurrencies
• Advantages and risks of investing in cryptocurrencies
• How to invest in cryptocurrencies
What are cryptocurrencies?
Generally speaking, a cryptocurrency is a type of money - like other currencies that we live with daily - with the difference that it is completely digital. In addition, it is not issued by any government (such as the real or the dollar, for example).
But is that possible?
To explain that, Fernando Ulrich, author of the book Bitcoin: Currency in the digital age, makes a very simple analogy: “What e-mail did with information, Bitcoin will do with money”. Before the Internet, people depended on the post office to send a message to anyone who was elsewhere. An intermediary was needed to deliver it physically - unimaginable for anyone who has access to e-mail and other messaging services.
Something similar will happen with virtual currencies in the future. "With Bitcoin you can transfer funds from A to B anywhere in the world without ever having to rely on a third party for this simple task," explains Ulrich in the book.
Although Bitcoin is the most well-known digital currency, the concept of cryptocurrency predates it. According to Bitcoin.org, maintained by the Bitcoin-linked community, cryptocurrencies were first described in 1998 by Wei Dai, who suggested using cryptography to control the issuance and transactions carried out with a new type of money. This would dispense with the need for a central authority, as with conventional currencies.
What are worth for
Cryptocurrencies can be used for the same purposes as physical money itself. The three main functions are to serve as a medium of exchange, facilitating business transactions; reserve of value, for the preservation of purchasing power in the future; and also as a unit of account, when products are priced and the economic calculation is performed accordingly.
In Ulrich's view, currencies like Bitcoin have not yet acquired the status of unit of account, due to the great volatility to which their prices are subject for the time being.
What is mining?
To understand what mining is, you need to know that digital currencies - like Bitcoin - represent complex code that cannot be changed. Transactions made with them are protected by encryption.
As there is no central authority to monitor these transactions, they need to be registered and validated one by one by a group of people, who use their computers to record them on the so-called blockchain.
The blockchain is a huge record of transactions. According to Ulrich, it is a public database containing the history of all transactions carried out with each Bitcoin unit (other digital currencies are based on this same technology). Each new transaction - a transfer between two people, for example - is checked against the blockchain, to ensure that the same Bitcoins have not been previously used by someone else.
Those who register transactions on the blockchain are the so-called miners. They offer the processing power of their computers to carry out these records and check the transactions made with the coins - in return, they are remunerated with new units of them. Bitcoins are created as the thousands of computers that make up this network are able to solve complex mathematical problems that verify the validity of the transactions included in the blockchain.
In other words, mining represents the creation of new units of some types of digital currencies. If more computers are used to increase processing capacity for mining, the mathematical problems that need to be solved become more difficult. This is exactly to limit the mining process.
"Bitcoin was designed to reproduce the extraction of gold or other precious metal from Earth: only a limited and previously known number of bitcoins can be mined," explains Ulrich in his book. (More details in the “Bitcoin” section of this guide)
How price variation works
Basically, the price of digital currencies varies according to the good old law of supply and demand. In times when cryptocurrencies gain more attention, it is normal for them to be more sought after by investors, which increases the volume of purchases - and consequently, prices tend to rise.
"There are only a limited number of bitcoins in circulation and new Bitcoins are created at a predictable and decreasing rate, which means that demand must follow this level to keep its price stable," explains the Bitcoin.org website.
As it is still a small market, few cryptocurrency transactions are capable of having a relevant impact on quotes. In a period of just three months in 2017, for example, Bitcoin's price jumped from about $ 4,370 to $ 13,800. Just over a year later, it had already dropped back to $ 3,500. As you can see, quotes can be quite volatile.
