How do Cryptocurrencies work?

Now that we understand the history of Cryptocurrencies and Bitcoin from week one of the blog, it is crucial to understand how Cryptocurrencies operate and what makes them different from normal currencies. 

Research suggests those who understand how Cryptocurrencies operate are more likely to trust and use them (Arli et al. 2020, p.1). Therefore, if our research in the coming weeks suggests a large role for Cryptocurrencies going forward, understanding them will be crucial for us everyday consumers to get the most out of them. 

 

This can be broken down into how the currencies are created, government regulation and how they are traded.

How they are created

How Cryptocurrencies are created is one of the most confusing elements associated with them. The most common term related with this process is ‘mining’. 

 

The following video briefly explains how mining works;

Therefore, in simple terms cryptocurrencies are created in code using algorithms. For most cryptocurrencies such as Bitcoin, the algorithms will be set up to release new coins to computers that have completed transactions and added them to the blockchain – the process of ‘mining’.

Government regulation 

Given how they don’t fall under the jurisdiction of one government like a traditional currency, Cryptocurrencies have traditionally been very hard to regulate. The UK government sees the current state of play being that most Cryptocurrencies fall outside of governments usual regulatory boundaries, leaving everyday consumers like us without many of the safeguards that normally protect our traditional use of the pound and regulated financial institutions (UK Govt, 2021).

 

However, Cryptocurrencies associations with illegal activity that have plagued them since their initial launch means that many governments are looking to regulate their use. With recent news that the US Treasury is looking to introduce new reporting guidelines for crypto exchanges that will make them more accountable for the transactions going on within them (Kruppa & Murphy, 2021), we can be almost certain that new regulation across the globe is likely to be introduced in coming years. 

How they are traded 

Cryptocurrencies are traded on specific exchanges such as Coinbase. When a consumer purchases a Cryptocurrency on one of these exchanges they are then held within their digital wallet. 

 

Rather than seeing them as a daily use currency, many investors trade cryptocurrencies for potential financial gain like with other asset classes. Research has suggested that in recent years trading Cryptocurrencies as assets has become ever more popular with investors engaging in leverage, short selling as well as position holding activities (Hasso et al., 2019, p.3).

 

In terms of how owners of currencies such as Bitcoin can use them in the real world to make purchases, currently their options are limited but growing. Bitcoin can currently be used to make donations to Wikipedia or to buy games and apps on Microsoft’s digital store (Vega, 2021). Some individual car dealerships have been accepting Bitcoin as payments for years (Jin, 2021), however Tesla’s recent announcement that they are looking to accept the currency (Kovach, 2021) could bring this more into the mainstream. 

For the moment, however, using Cryptocurrencies as means of payments remains more novelty than the general rule.

 

My research in the next few weeks that will look to understand how big a role these currencies are likely to play in our future lives should help determine if these exploits by organisations to accept them as payment are more marketing ploy than nod to serious future use. 

 

Next week in the blog I will begin looking at how widespread the use of cryptocurrencies is likely to be in the future, as well as what we can do to prepare. Keep following @CryptoCollege2 on Twitter to keep up to date with the latest Cryptocurrency news! 

References 

Arli, D., Esch, P.V., Bakapayev, M., Laurence, A. (2020) ‘Do consumers really trust cryptocurrencies?’, Marketing Intelligence & Planning, 39(1), pp. 74-90 [Online]. Available at https://www.emerald.com/insight/content/doi/10.1108/MIP-01-2020-0036/full/html

 

Hasso, T., Pelster, M., Breitmayer, B. (2019) ‘Who trades cryptocurrencies, how do they trade it, and how do they perform? Evidence from brokerage accounts’, Journal of Behavioural and Experimental Finance, 23(2019), pp. 64-74 [Online]. Available at https://www.sciencedirect.com/science/article/pii/S2214635018302806

 

HM Treasury. (2021). UK regulatory approach to cryptoassets and stablecoins: Consultation and call for evidence. UK Government. Available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/950206/HM_Treasury_Cryptoasset_and_Stablecoin_consultation.pdf(Accessed February 23^rd 2021)

 

Jin, H. (2021). ‘Buy a car with bitcoin? Some car dealers were years ahead of Musk’, Reuters, February 9^th. Available at https://www.reuters.com/article/us-crypto-currencies-autos/buy-a-car-with-bitcoin-some-car-dealers-were-years-ahead-of-musk-idUSKBN2A92X2?edition-redirect=in

 

Kovach, S. (2021). ‘Tesla buys $1.5 billion in bitcoin, plans to accept it as payment’, CNBC, February 8^th. Available at https://www.cnbc.com/2021/02/08/tesla-buys-1point5-billion-in-bitcoin.html

 

Kruppa, M., Murphy, H. (2021). ‘Crypto industry fears impact of proposed treasury rule’, Financial Times, January 11^th. Available at https://www.ft.com/content/97ec59d6-bc68-4ffc-853e-0de561b82c1e

 

Vega, N. (2021). ‘Bitcoin passed $50,000—here’s what you need to know about the popular cryptocurrency’, CNBC, February 18^th. Available at https://www.cnbc.com/2021/02/18/bitcoin-passed-50000-dollars-heres-what-you-need-to-know.html