Curious about cryptocurrency? Here's everything you need to know
From altcoins to mining nodes, here's a guide to the digital economy
Cryptocurrency is big business.
Despite only coming into the public consciousness a decade ago with the invention of bitcoin, it's developed into a multibillion-dollar industry.
A tumultuous year in 2018 saw bitcoin's value skyrocket to nearly $150 billion Cdn before dropping to just a fraction of what it was once worth, and more than a dozen other coins began to catch up, with market caps creeping into the billions.
And recently Canadian cryptocurrency exchange QuadrigaCX went into a tailspin after news its founder had died — leaving customers no way to access roughly $190 million worth of digital currency.
Despite its growth, for many people not involved in tech cryptocurrency is still a big unknown. Here are answers to some questions you might have.
What is cryptocurrency?
Cryptocurrency is digital currency, but that's not what makes it unique.
"We've had digital currency for years," said Ben Perrin, head of marketing at Calgary-based cryptocurrency brokerage BitNational and host of an educational cryptocurrency YouTube channel.
Perrin said it's estimated the amount of legal tender around the world that exists in a physical form is only between two and 11 per cent, with the rest being stored digitally.
That's no surprise to anyone who uses their debit card or Apple Pay more often than cash.
Instead, cryptocurrency is different from government-issued legal tender in two big ways.
Encrypted, decentralized
First, it's encrypted — hence the "crypto" part of its name. The creation of coins and transactions are verified by a type of cryptography.
Second, it's decentralized, so it gets rid of the middle man.
"Banks run on the fractional-reserve system, making them the intermediary between borrowers and savers," said Perrin.
Records of deposits and withdrawals at banks are all recorded on a ledger. Some of that money ends up in circulation, but the rest is held by the bank.
Cryptocurrencies also use a ledger, but a decentralized one called the blockchain (more on that below). It records transactions publicly, on servers around the world, cutting out the need for a central bank to manage and hold on to that money.
Why do people use cryptocurrency?
For some, the appeal of cryptocurrency is that it's a currency system separate from banks and governments.
So, hypothetically, a corrupt government can't shut it down and it wouldn't be hit by a banking crisis, like the stock market crash of the 1930s.
That's because most of the currencies aren't controlled by a corporation or run on a central server.
"Like, compare Napster to Bittorrent," said Perrin.
Napster was a file-sharing site that was shut down in the early 2000s after a court injunction due to complaints of copyright infringement. Users uploaded their own files directly to the server, making it easy for the government to pull the plug on the file transfers.
After Napster's demise came more resilient sites like BitTorrent, that instead split up the downloads to host files on computers around the world.
"When the government took down Napster, it's because it was one central file-sharing site.
"They can't take down BitTorrent, because it's a network hosted on servers around the world. Even if they pulled all the Canadian servers, the torrents would still be up."
Comparing the Canadian dollar to Napster isn't exactly flattering, but if you talk to some cryptocurrency advocates, that's exactly how they view government-issued currencies — risky, and soon-to-be defunct.
Secure, anonymous
So for many, the security and anonymity of cryptocurrency is a big draw.
But it's not the only reason people buy in. Some are speculative investors, hoping to make a buck off coins that are rapidly rising in value.
Others like that it can be a fast and inexpensive way to transfer large sums.
And others are experimenting with the blockchain technology itself, seeing how it can be used to push past the traditional definition of money.
What is the blockchain?
The easiest way to explain the blockchain is using the mother of all cryptocurrencies — bitcoin.
It was invented in 2008 by an anonymous inventor (or group of inventors) who call themselves Satoshi Nakamoto.
Bitcoin uses the blockchain, which is a distributed ledger that publicly records all transactions.
On the blockchain, a bunch of different people around the globe hold onto identical copies of the transaction ledger on their computers.
Those computers are called nodes.
Each time a transaction happens, the nodes have to independently update and verify it from chunks of data called blocks, which are strung along in a chain that together comprises the entire record of transactions that have occurred, going back to the first bitcoin ever transferred in 2009.
Those blocks are verified by miners.
What is mining?
Bitcoin miners keep the blockchain running by verifying outstanding transactions.
This makes sure no coins are sent or deposited twice.
Each block contains a collection of unconfirmed transactions, the timestamps of the transactions, and a reference to the last transaction on the ledger that was confirmed.
Miners set a computer program to work solving a difficult mathematical puzzle that's unique to each block.
The program crunches numbers until it spits out a string of letters and numbers — a hash — that act as a proof the miner has solved the block's puzzle and verified the transaction. That proof then gets broadcast to all the other nodes to confirm they're on the same page.
If the nodes come to a consensus, the transaction gets added to the ledger and each miner starts work on a new block.
A lucrative operation
So what's in it for miners to keep the network going? Well, they get paid in bitcoin for verifying the transactions.
There's a finite amount of bitcoin and the individual coins have risen sharply in value since the network began, meaning that mining can be quite lucrative especially in places where electricity is cheap.
One bitcoin mining facility near Drumheller, Alta., has dug up hundreds of bitcoins so far. For context, a single bitcoin's value fluctuated between $7,000 and $19,000 Cdn in 2018.
And many people have chosen to lend their home computing power to bitcoin mining operations as well, earning between dozens and hundreds of dollars a month above their power bills.
Is bitcoin the only cryptocurrency?
Bitcoin is the most well-known cryptocurrency and, currently, the most valuable.
But Perrin said there are more than 2,000 cryptocurrencies — colloquially called altcoins, or alternatives to bitcoin — most of which are wildly different from each other. And that number is rapidly growing.
"Some cryptocurrencies are similar to cash, where they can be used in exchange for goods or services, while others function more like an asset like gold — so they can either be held, like a bond, or used as a raw material for other products," he said.
Examples include:
- Ripple, a network that allows cross-border currency exchanges within seconds.
- Ether, which powers smart software applications that can do things like make online voting more secure.
- VeChain, which lets retailers track and collect data on products as they move through the supply chain.
How do you buy cryptocurrency?
The first thing you need to buy cryptocurrency is a wallet — and not the leather kind you keep in your pocket.
"Funds should always be stored in a wallet, digital or paper," said Perrin.
A wallet is a software program that stores private and public keys that are used to send and receive cryptocurrency.
A wallet can be as complicated as an app on your phone or computer, or a string of numbers you write down on a piece of paper.
But be careful — if you lose your keys, your cryptocurrency will be gone forever.
There's no way to recover those coins because it's not stored or backed up centrally, the way you can still access your bank account if you lose your debit card.
Instead, all of the transactions are sent between keys.
Funds are sent to a public key — that's kind of like an email address an e-transfer is sent to. Then you can access your money with a private key, which functions like your password and should be kept secret.
Once you have a wallet set up, you can buy currency at either ATMs or at brokers or currency exchanges.
But while you can trade between Canadian dollars and cryptocurrency on an online exchange, you should never leave your money sitting in one like you would with a bank, said Perrin.
"It's like a honeypot for hackers. And it's much less safe than a bank, as exchanges are newer and they have varying levels of security."
That's a hard lesson clients of the aforementioned QuadrigaCX learned.
What can you buy with cryptocurrency?
While bitcoin initially gained notoriety for being used to purchase illegal goods like drugs on the dark web, it has a variety of legitimate uses.
Coffee shops, clothing stores and other businesses across Canada accept cryptocurrencies.
In Calgary, an office building accepts lease payments in cryptocurrency, and another company will let you pay for your renovations in bitcoin or ether.
- Cryptocurrency could be 'innovative tool' for Calgary office vacancy problem, says landlord
- Calgary reno company could be 1st in Canada to accept bitcoin, ether payments
Do you have to pay taxes on it?
Yes, even though cryptocurrency is touted as an anonymous investment, the Canada Revenue Agency's rules still apply to all digital currency transactions as it's considered a commodity.
Investors are expected to keep track of their own trades and report any profits as part of their income.
The Financial Consumer Agency of Canada has a website with advice and information on the laws surrounding cryptocurrencies.
Why does the price of cryptocurrency fluctuate so much?
Since cryptocurrencies aren't backed by governments, the coins' only value is assigned by those who decide it has worth — meaning that value can fluctuate wildly.
The combination of very few coins in the market and speculation-fueled demand led to a meteoric rise in late 2017, followed by a massive crash in January 2018 — bigger than the tech stock crash during the dot-com bubble.
But that hasn't dampened the coins' appeal for advocates who say cryptocurrency has the long-term potential to be a game-changer in the global economy.
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