Are cryptocurrencies safe? – Introduction
Investing in cryptocurrencies is not unusual or peculiar anymore. Since Bitcoin popularization and the growth of altcoins’ transaction volume, an increasing number of people have been recognizing this type of asset as a valid option for investment.
However, an important question is still on many people’s mind: are cryptocurrencies safe? If yes, what to take into account when investing in them?
With the objective of answering these types of questions, we have written this article with significant information. Continue reading and find out more.
How does blockchain technology work?
Even those that do not know deeply the cryptocurrency universe certainly have already heard of blockchain technology. It is basically a concept that provides security to transactions involving Bitcoin and other cryptocurrencies.
In a few words, we can say it is a structure very similar to a database, although presenting some important differences. For now, for a better understanding, it will help to visualize an actual database, such as a spreadsheet with hundreds of cells.
Blockchain works similarly, however, it is as if each cell of this “worksheet” could only contain a limited number of information, which after completely filled in would form a block that cannot be altered. This block is then added to a chain, connected to other pre-existing blocks.
Once the addition has happened, the block cannot be modified and it receives something similar to a digital authentication that provides it an identity. That is, each block on the blockchain has its own specific identification code.
Blockchain and decentralization
When we are talking about cryptocurrencies and blockchain, it is also very important to approach one of the important principles of this technology: decentralization.
That is because the blockchain is decentralized, it is a network formed by thousands of computers located in different places around the world. Each of these computers is called node and it is responsible for storing the data of each cryptocurrency transaction.
However, apart from that, these computers have the fundamental role of storing all the blocks of information created since day one of that network.
This specific characteristic is what ensures the authenticity of the information on the network, since any type of alteration is easily perceived by other nodes. This form of organization also allows the system to work without a central or single entity validating transactions.
Transactions made with cryptocurrency for example do not require a monetary agent such as a central authority coordinating normative acts or controlling the volume, for example.
What are the main methods to validate transactions?
There are many validation methods for transactions carried out with cryptocurrencies. In the following lines, we can see some of the most important of them.
Proof of Work (PoW)
Proof of Work is a consensus method developed by Satoshi Nakamoto. In this method the agent that is responsible by mining a block of information is going to have its work rewarded based on a fraction of the coin mined.
In operational terms, what miners do is to use the computational power of their computers to solve highly complex equations. The first to solve the equation obtaining the correct result is rewarded for the work and becomes responsible by the adding of the block to the chain.
In the PoW system, all miners compete to be the first to solve the equation. Consequently, the number of organized groups whose objective is to obtain good results in this work by using supercomputers is increasing, while making it difficult for individual efforts of mining.
This validation method is totally related to what we explained about decentralization, since it does not require a centralizing agent.
Proof of Steak (POS)
Proof of Work method is the most commonly used in cryptocurrency transactions. However, the spreading of mining activity resulted in an exponential growth of energetic expenditure on it, which ended up being expensive and an undesirable environmental risk.
In this scenario, other validation methods for transactions were created, such as proof of steak. In this method instead of miners, there are users responsible for building blocks of coins.
Those engaged in the process need to consign a certain quantity of coins on the network (the steak) in order to qualify for building blocks. The size of the stake will determine the chances a node has to become the next validator of a transaction. In other words, the higher the bet, more chances to become a validator.
At the same time, in order to not favor only those who hold large volumes of coins, it is also possible to be chosen to validate transactions via two methods: Randomised Block Selection and Coin Age Selection.
In the first case, the Randomized Block Selection, validators are nominated from nodes with a combination of the lowest hash value (an algorithm that maps variable length data to fixed length data.)
In the Coin Age Selection method, on the other hand, the nodes are chosen based on how long their tokens have been used for participation. The age calculation is made by multiplying the number of days the coins were kept as stake by the number of coins participating.
After a node is selected through this method, its coin age is reset to zero and it will only be allowed to build another block after waiting a certain period. This prevents large nodes from monopolizing transactions carried out with the Proof of Stake method.
How to keep your cryptocurrency investments safe?
Now that you know what is behind the main validation methods for cryptocurrencies and you are familiar with how blockchain technology works, for those who are considering obtaining this type of asset we can talk about how to store it securely.
There are currently some companies, exchanges, that trade cryptocurrencies. What they do is, basically, to connect buyers and sellers of digital assets, ensuring that the negotiated currency reaches the recipient for the value agreed between parties.
Those purchasing have the option of allowing the exchange to be in charge of the identification key or to hold it in a wallet for cryptocurrencies. As we have already said in this article, the second option is safer, since exchange may be targets of cybercriminals.
With a cryptocurrency wallet, you can keep the key of your cryptocurrencies either in a hardware or in a cloud storage. For that, you will receive a private key that provides you access to the coins and allows you to make any transaction.
Your private key is unique and non-transferable. If you lose it, you will not be able to access your cryptocurrencies.
To reduce this risk, each wallet has what we call seed-phrases, which are phrases that you create to help you to remember your private key.
Are cryptocurrencies safe? – Conclusion
As explained throughout this article, transactions carried out with cryptocurrencies are effectively safe, since their system ensures protection. The risks are more connected with the way investors store the keys of their cryptocurrencies, which does not have any relation with the type of transactions carried out on the blockchain.
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