Explained: digital currencies and how they work

A cryptocurrency is a medium of exchange, like the rupee or the US dollar, but its format is digital and uses encryption techniques both to control the creation of currency units and to verify the exchange of money. . Bitcoin is considered the most famous cryptocurrency in the world and is the largest in the world by market capitalization, followed by Ethereum.

In traditional financial transactions, where two parties use fiat money, a third party organization – usually a central bank – guarantees that the money is genuine and that the transaction is recorded. With cryptocurrencies, a chain of private computers – a network – is constantly working to authenticate transactions by solving complex crypto puzzles. To solve the puzzles, these systems are rewarded with cryptocurrencies. This process is called mining.

At the back of these transactions is a technology called “blockchain”.

What is blockchain?

Satoshi Nakamoto – the person (or a group of people) who allegedly conceptualized an accounting system in the aftermath of the 2008 financial crisis – brought up an idea where transactions and the value of money would be recorded digitally in a publicly accessible medium. . and an open ledger that contains all transactions ever made, albeit in an anonymous and encrypted form. This ledger is called the blockchain.

Bitcoin and the thousands of cryptocurrencies are basically codes stored on a blockchain that gets longer and longer as more and more people use them.

There have been voices calling for stablecoins as an alternative to volatile cryptocurrencies. What are stablecoins?

Stablecoins are digital currencies backed by a fiat currency such as the US dollar, giving it intrinsic value. From an investor perspective, stablecoins become easier to understand given the underlying reserve asset. Sovereign governments are also arguing for stablecoins like Tether, USD Coin, and Diem (offered by Facebook parent company Meta) as they could increase the reach of their fiat currencies in the digital ecosystem.

How are cryptocurrencies bought?

There are two ways. The first is to buy it from someone and the second is to mine new crypto coins. Buying it from someone is usually done in two ways: an exchange facilitated transaction or a peer-to-peer transaction. For Indians, the easiest way to invest or trade cryptocurrency has been through one of the many exchange and trading platforms operating in India. These include WazirX, CoinDCX, CoinSwitch Kuber, Zebpay, Bitbns, Giottus, etc.

In order to be able to trade or invest in cryptocurrencies using INR, users must register on one of the exchanges by completing a KYC process. Next, a user purchasing crypto for the first time will need to load INR money into their cryptocurrency exchange’s wallet. The cryptocurrency wallet is identified by a unique address represented by a randomly generated combination of numbers and letters. There are two ways to load money into a cryptocurrency wallet – through online banking or through an e-wallet.

This is where the first barrier to entry occurs. Despite the Supreme Court order that overturned the RBI directive banning banks from allowing their systems to be used for virtual currency transactions, several large banks do not offer their financial infrastructure for investing or trading in crypto. Of the e-wallets that work in the country, only MobiKwik is supported on platforms such as WazirX and CoinDCX. Once the transaction is completed, the purchased cryptocurrency holding is reflected in the exchange’s wallet.

How are they sold for the INR?

Indian stock exchanges also allow the sale of cryptocurrencies in exchange for INR, but given that many small banks that support transactions do not have the digital infrastructure to handle withdrawal volumes and the volatility experienced. by these virtual currencies, a disruption of withdrawals services is a common phenomenon.

The government plans to introduce a bill banning “all private cryptocurrencies”. What are private cryptocurrencies?

While there is no clarity yet on how private cryptocurrencies are defined, it looks like all digital currencies that are not issued by the state will be banned.

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