Cryptocurrency Trading: What is Cryptocurrency Trading & How does it Work?

What are Cryptocurrencies?

A cryptocurrency is a digital or virtual currency created from code and designed to work as a medium of exchange. Essentially, cryptocurrencies are limited entries in a database that no one can physically own or actually hold and save in a safe. They function autonomously, outside of traditional banking and government systems.

Cryptocurrencies follow the ideas set out in a white paper by the mysterious Satoshi Nakamoto, whose identity has yet to be verified.

Popular cryptocurrencies: Bitcoin, Litecoin, Ripple and Ethereum.

How does Cryptocurrency trading work

Today there are over 1,000 cryptocurrencies available online.

The vision to design a cryptocurrency was to create a decentralized currency system that did not require the involvement of banks or any other intermediaries. The currency would operate using a distributed ledger with underlying technology known as a blockchain. As a decentralized currency, it was designed to be free from government oversight or influence, and the cryptocurrency economy is instead monitored by peer-to-peer internet protocol. The individual units that make up a cryptocurrency are encrypted strings of data that have been encoded to represent one unit.

Cryptocurrencies differ significantly from traditional currencies. Nonetheless, you can still buy and sell them like any other asset. You can now also trade on the price movements of various cryptocurrencies via CFDs.

Bitcoin in Cryptocurrency trading

The first digital coin introduced was Bitcoin, which remains today the benchmark for all other digital coins. The idea of Bitcoin was to allow money to change hands without a bank’s involvement, thus making it the first decentralized cryptocurrency. Similar to all cryptocurrencies, transactions would have a unique cryptographic signature, allowing for the creation of an indisputable record.

Since Bitcoin’s arrival, many other cryptocurrencies, such as Ethereum, Litecoin, Dash and Ripple, have entered the scene.

What are the features of Cryptocurrencies?

There are several key principles that govern cryptocurrency use, exchange and transactions.

Cryptography: This method is used in a number of ways in order to make cryptocurrency transactions extremely secure. Historically, cryptography is a method for sending hidden messages- One person encrypts a message using some sort of key and algorithm, the other person then can decrypt it.

In present times cryptography has come a long way since then, and in today’s digital world, it’s based primarily on computer science and mathematical theory. It also draws from communication science, physics and electrical engineering.

Two main elements of cryptography apply to cryptocurrencies – hashing and digital signatures:

Hashing in Cryptocurrency Trading

Hashing verifies data integrity, maintains the structure of the blockchain and encodes people’s account addresses and transactions. It also generates cryptographic puzzles that make block mining possible.

Digital Signatures in Cryptocurrency Trading

Digital signatures allow an individual to prove that they own a piece of encrypted information without revealing that information. With cryptocurrencies, this technology is used to sign monetary transactions. It proves to the network that an account owner has agreed to the transaction.

What is Blockchain technology in Cryptocurrency trading?

A blockchain is a distributed ledger or list of a cryptocurrency’s transactions that form a “chain of blocks.” Each block includes information and data that are bundled together and verified. Completed blocks, comprised of the latest transactions, are recorded and added to the blockchain.

How does Blockchain technology work in Cryptocurrency trading?

These blocks are then validated and strung onto the chain of transactions and information in previous blocks. These blocks of transactions are permanently recorded in the distributed ledger that is the blockchain. They follow a set protocol for validating new blocks. Each ‘node’ or computer connected to the network automatically downloads a copy of the blockchain. This allows everyone to track transactions without the need for central record keeping.

Blockchain was invented by a person (or group of people) using the name Satoshi Nakamoto in 2008 to serve as the public transaction ledger of the cryptocurrency bitcoin. The identity of Satoshi Nakamoto is unknown. Blockchain technology creates a record that can’t be changed without the agreement of the rest of the network.

What is Block Mining in Cryptocurrency trading?

Mining is an important and integral part of Bitcoin that ensures fairness while keeping the Bitcoin network stable, safe and secure. Miners include transactions sent on the Bitcoin network in their blocks. The issuance rate is set in the code, so miners cannot cheat the system or create bitcoins out of thin air. They have to use their computing power to generate new bitcoins.

A piece of software that is used to solve mathematical puzzles, and this validates the legitimate transactions which make up blocks. These blocks get added to the public ledger (blockchain) and miners are rewarded new bitcoins every 10 minutes. The faster a miner’s hardware can process the mathematical problem, the more likely it is to validate a transaction and earn the bitcoin reward.

Popular Cryptocurrencies that are traded

Bitcoin

Bitcoin is the oldest and most well-known cryptocurrency. Various versions of cryptocurrencies came and went over the years without garnering much attention until Bitcoin’ introduction in 2009.

The vision of Bitcoin was to create a decentralized currency system that did not require the involvement of banks or any other intermediaries. The currency would operate using a distributed ledger with underlying technology known as a blockchain. However, its characteristics more closely resemble commodities rather than conventional currencies. This is reflected in the fact that it is now used more as a form of investment than a method of payment.

As of June 2018, there were around 17 million bitcoins in circulation (there may be a finite number of 21 million available). Traders can either purchase bitcoin through an exchange, or speculate on its price movements via CFDs. Since Bitcoin’s arrival, many other cryptocurrencies, such as Ethereum, Litecoin, Dash and Ripple, have entered the digital market.

Bitcoin cash

To improve the current Bitcoin system, Bitcoin Cash (BCH) was created in December 2017. The developers of Bitcoin-ABC initiated a hard fork of the Bitcoin blockchain to increase the block size. This new chain had 8MB blocks and was called Bitcoin Cash.

After a fork, the blockchain splits in two and it is left to the miners and the wider community to decide which cryptocurrency to align themselves with. When the bitcoin hard fork took place, one bitcoin cash token was typically awarded for every bitcoin held.

Ethereum

Bitcoin might be leading the crypto arms race right now, but Ethereum is charging right behind. Ethereum is relatively new in the cryptocurrency world, having launched in 2015. It operates in a similar way to the bitcoin network, uses blockchain technology to replace centralized computing systems that store people’s data. Ethereum leverages blockchain technology by validating and securing all the transactions made in its cryptocurrency, Ether, with smart contracts.

Smart contracts automatically perform the transactions and other actions agreed upon by both parties, so users can conduct safe and reliable transactions with each other. The limit on Ether also works slightly differently to bitcoin. Issuance is capped at 18 million Ether per year, which equals 25% of the initial supply. So, while the absolute issuance is fixed, relative inflation decreases every year. Ethereum’s average block mining time is a quick 12 seconds, while Bitcoin’s average block mining time is a sluggish 10 minutes.

Litecoin

Litecoin is a peer-to-peer Internet currency that enables instant, near-zero cost payments to anyone in the world. It was set up by Charlie Lee (a former Google employee) in 2011. Litecoin is also open-source, decentralized, and backed by cryptographic math to secure transactions. It is an alternative payment solution of bitcoin. It was not made with the intention of producing completion for bitcoin. You may consider litecoin as the silver to bitcoin’s gold. The reason behind the discovery of Litcoin is to reduce block confirmation timings of 10 minutes to 2.5 minutes so that a higher volume of transactions could be confirmed. That’s why; Charlie has enhanced the speed of transaction by 4X (when compared to Bitcoin).

Ripple

Ripple (XRP) is a network of institutional payment-providers such as banks and money services businesses that use solutions developed by Ripple to provide a frictionless experience to send money globally. It aims to ensure secure, fast and low-cost transfers across the network, with no risk of fraud or chargeback. The network is considerably faster than bitcoin – it is able to settle transactions in just a few seconds.