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What are cryptocurrencies?
Generically, a cryptocurrency is a type of money that is completely digital and is not issued by any government – as is the case with the real or the dollar, for example.
Fernando Ulrich, author of the book Bitcoin: The currency in the digital age, makes a simple analogy to explain how this asset works: “What email did for information, Bitcoin will do for money.”
Before the internet, people depended on a third party to send a message to someone in another place: the post office. Cryptocurrencies, like the internet, eliminated the need for an intermediary between the two parties.
“With Bitcoin you can transfer funds from A to B anywhere in the world without ever having to trust a third party for this simple task,” explains Ulrich in the book.
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Although Bitcoin is the best-known digital currency, the concept of cryptocurrency predates it. According to the Bitcoin.org website, maintained by the community linked to Bitcoin, cryptocurrencies were first described in 1998 by Wei Dai, who suggested using cryptography to control the issuance and transactions made with a new type of money. This would eliminate the need for a central authority, as is the case with conventional currencies.
What are cryptocurrencies for?
The three main functions of a cryptocurrency are to serve as:
medium of exchange, facilitating commercial transactions;
store of value, for preserving purchasing power in the future;
unit of account, to calculate the prices of products and services based on it.
In Ulrich's view, currencies like Bitcoin have not yet acquired the status of a unit of account due to the high volatility to which their prices are subject for now.
What is mining?
To understand what mining is, it is necessary to know that digital currencies represent a complex code that cannot be altered. This is because the transactions made with them are protected by a cryptography system.
Since there is no central authority that monitors these transactions, a group of people needs to validate and record them. For this, these users use their computers, recording these transactions on the blockchain network.
The blockchain is a huge record of transactions. It is a public database that contains the history of all operations conducted with each unit of Bitcoin (other digital currencies are based on this same technology). Each new transaction is verified against the blockchain to ensure that the same Bitcoins have not been previously used by someone else.
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Those who record the transactions on the blockchain are the miners. They offer the processing capacity of their computers to perform these records and verify the operations made with the coins – in return, they receive new units of these coins as compensation.
Bitcoins are created as the thousands of computers that make up this network manage 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 the processing capacity aimed at mining, the mathematical problems that need to be solved become more difficult. This happens precisely to limit the mining process.
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Price variation of cryptocurrencies
Basically, the price of digital coins varies according to the good old law of supply and demand. In other words, during times when cryptocurrencies gain more attention, it is normal for demand from investors to increase. This ends up increasing the volume of purchases, and consequently, prices tend to rise.
As it is still a small market, few operations with cryptocurrencies are capable of causing a relevant impact on prices. In a period of just three months in 2017, for example, the price of Bitcoin jumped from about $4,370 to $13,800. Just over a year later, it had already retreated again to $3,500. As can be seen, prices can be quite volatile.
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Main cryptocurrencies
The pioneer Bitcoin is the main and most valuable cryptocurrency in the market. After it comes Ethereum, the second crypto asset to be created and whose platform serves as a basis for the creation of other cryptocurrencies to this day.
Next, get to know some of the main digital assets available in the market.
Bitcoin
Bitcoin (BTC) is the best-known digital currency. It is the first completely decentralized global payment system. It was designed in 2008, amid the global financial crisis that began in the American mortgage market, with the goal of replacing paper money, as well as eliminating the need for banks to mediate financial operations.
According to the Bitcoin.org website, the first specification of Bitcoin and proof of concept were published in a paper signed by Satoshi Nakamoto, the pseudonym of a programmer (or group of programmers) who remains unidentified to this day. He invented the logic of blockchain operation, a system that enabled the existence of Bitcoin.
In the paper, Nakamoto established that there would be a maximum of 21 million bitcoins in circulation. It is estimated that the last coin will be mined in the year 2140.
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Ethereum
The original digital currency was actually called Ether. However, in 2016, a hacker found a flaw in the system and managed to steal the equivalent of $50 million in Ether from it. Faced with doubts about what would become of the currency's future, the community that maintained it chose to create a new network.
The original Ether – the target of the theft – was renamed Ethereum Classic, and the currency that began circulating on the new network was named Ethereum. With the support of the community, it is worth more than its first version.
Originally, Ether was not created to be a digital currency like Bitcoin. This is because the idea was that it would become an asset to reward developers for using the Ethereum platform in their projects. It is a decentralized platform used to execute 'smart contracts', which are operations carried out automatically when certain conditions are met.
The blockchain is also the basis for validating transactions with Ethereum, to ensure security and also to prevent fraud. However, the creation of new coins no longer occurs through the mining process. In September 2022, the network migrated to the Proof-of-Stake (PoS) validation system, in which users who hold the cryptocurrency are randomly chosen to validate transactions.
Tether
Unlike Bitcoin and other digital currencies, Tether (USDT), launched in 2014 by a company of the same name, is a stablecoin because it is backed by a physical currency. The proposal of this cryptocurrency is to maintain parity with the US dollar. In other words, for every Tether issued, there must be an equivalent dollar in cash.
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Since the cryptocurrency was created, however, experts have questioned the parity, as the company did not provide transparency about how it maintained it. In 2019, it was announced that not all Tether is backed by a dollar. According to the company, 100% of them are guaranteed, but not only by traditional currency, but also by cash equivalents and other assets or receivables from loans made by Tether to third parties.
The characteristic of Tether is being a stable currency that represents physical currencies in the digital world. Due to its lower volatility, it has become a good option for making transfers between systems and with different cryptocurrencies. Thus, investors protect themselves from price fluctuations of other assets and avoid the risk of significant losses during these operations.
Bitcoin Cash
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Bitcoin Cash (BCH) is a new version of the original Bitcoin, created in August 2017. It was developed in an attempt to improve the first currency, which has relatively high fees and requires a long processing time for each operation.
The main difference is that Bitcoin Cash has a block size limit of 8 MB, much larger than the 1 MB limit of the original Bitcoin. This allows transaction confirmations to occur more quickly and also with lower fees. This ensures an even greater scale than its predecessor.
Those who had Bitcoins received the same amount of Bitcoin Cash in their wallets when it was created. The operating rules are similar to those of the original asset, also with a limit of 21 million coins.
Ripple
Ripple (XRP) is a distributed payment protocol created in 2011, and the currency of this system is XRP. One characteristic of the Ripple platform is that it supports other tokens representing traditional currencies and even other goods on its network. The idea is that the system allows secure and instant payments.
It is not just a currency, but a system in which any currency – including the most well-known cryptocurrency, Bitcoin – can be traded. To some extent, the functioning of Ripple resembles that of banks, as it accepts various assets and facilitates the execution of transactions.
Precisely for this reason, Ripple goes against the discourse about digital currencies in general, which idealize the non-dependence on the traditional financial system to carry out operations.
Litecoin
Litecoin (LTC) was created in 2011 by a former Google employee named Charlie Lee and has many characteristics similar to Bitcoin. The main difference lies in the mining process, which aims to reduce the time needed to confirm transactions made with the currency. The intention is to make it easier for anyone to participate in the process of creating new Litecoins.
Due to the faster processing of transactions, Litecoin is considered a better alternative for carrying out operations on a daily basis. In turn, Bitcoin would work better as a store of value. Meanwhile, Litecoin was designed to produce more units, with a limit of 84 million coins, compared to 21 million for Bitcoin.
Solana
Launched in 2020, Solana (SOL) also has its operation based on smart contracts, just like Ethereum. The difference is the high performance that this network can achieve – high speed at low cost – which makes the cryptocurrency more scalable than the pioneers.
The Solana network is widely used for the creation of digital assets, NFTs, and decentralized applications (DApps), as well as for financial transactions. SOL is considered a direct competitor to Ethereum.
Advantages of investing in cryptocurrencies
Cryptocurrencies are recent assets with a quite sophisticated logic of operation. Therefore, many people are still trying to better understand how to operate with them.
Digital currencies have some advantages over physical currencies and other means of payment. The Bitcoin.org site lists the following for Bitcoins:
Payment freedom
With one Bitcoin, it is possible to send or receive any amount instantly anywhere.
Low fees
Currently, payments made with digital currencies are processed with low or even zero fees. Charges apply if users wish to have a quicker confirmation of the operations by the system.
For general commerce, there are services based on Bitcoins where the processing of sales and the transfer of values are carried out daily and at lower costs than traditional methods, such as PayPal or credit card networks.
Security
According to the Bitcoin.org website, payments with Bitcoin can be made without linking the user's personal information to the transaction. 'This provides strong protection against identity theft,' it informs.
Another advantage is that the user can protect the money with backups and encryption.
Transparency
All information about the offer of Bitcoin units is available on the blockchain for anyone. No one can control or manipulate the protocol of the digital currency due to its cryptography. Thus, the core of Bitcoin is recognized as trustworthy for being neutral, transparent, and predictable.
Risks of investing in cryptocurrencies
On the other hand, those who invest in digital currencies need to be aware of a number of details that are specific to this segment, as we will see next.
Degree of acceptance and volatility
Although it grows year by year, the audience that invests in cryptocurrencies or uses them in financial transactions is still small. This restricts their acceptance in commercial transactions and contributes to the volatility of the asset.
“The price adjustments of cryptocurrencies resemble traditional speculative bubbles: overly optimistic media coverage provokes waves of novice investors to push the price of Bitcoin up. Exuberance then reaches a turning point, and the price finally plummets,” explains Ulrich. Some analysts are skeptical of this behavior, while others believe that the maturation of the market and the system tend to reduce volatility over time.
Data vulnerability
Although Bitcoin.org reinforces security as a positive aspect of the digital currency, Ulrich emphasizes that if users are not careful, they risk 'erasing' or losing their Bitcoins. 'Once the digital file is lost, the money is lost, just like with paper cash,' he says.
In addition, he explains that digital currency wallets can be protected by encryption, but it is up to the user to activate it. 'If a user does not encrypt their wallet, Bitcoins can be stolen by malware,' he says. Similarly, digital currency exchanges need to protect themselves from hackers – news about thefts happen occasionally.
How to invest in cryptocurrencies
There are several ways to invest in or acquire Bitcoins and other cryptocurrencies. It is possible to buy shares of cryptocurrency funds, trade them directly with a specialized broker (also known as an exchange), accept digital currencies as payment in some business, or even mine.
Acquiring shares of funds is one of the simplest ways. In 2018, the Brazilian Securities and Exchange Commission (CVM) allowed Brazilian funds to make indirect investments in cryptocurrencies abroad – by purchasing derivatives or shares of other funds, for example.
These wallets are distributed by brokers and investment platforms, and some investments require relatively low contributions. Funds can be a good alternative for those who want exposure to the cryptocurrency market but do not feel safe doing it alone, as a specialized manager decides and monitors the investments.
It is also possible to invest in cryptocurrencies through ETFs (Exchange Traded Funds), which are investment funds traded on the stock exchange, just like stocks.
Another relatively simple way to invest in Bitcoins and other cryptocurrencies is through a specialized broker. There are some houses in Brazil, called exchanges, that offer this type of service.
The first step is to open an account at an exchange, filling out a registration with personal data. It is possible that they will request the presentation of some documents or copies to validate the investor's identity.
Some brokers adopt extra protection mechanisms, in addition to the usual passwords, such as tokens. If this is the case with the exchange you have chosen, you will need to make the necessary activations. Then, just transfer money to the account and start trading.
