What is Cryptocurrency: Definition, Types and How it Works
The Definition of Cryptocurrency and Blockchain Technology
Cryptocurrency is a digital currency based on blockchain technology. A blockchain is a public digital ledger where data about each transaction is stored and assigned a unique identifier - a transaction hash. The blockchain is a very reliable architecture because it is decentralized, which means that this network's data is provided by tens of thousands of devices around the world. Removing any of them will not cause any problems or interruptions in the entire system's operation. It is easy to guess that the blockchain is a reliable and transparent system, and interference with bad intentions is extremely complicated and noticeable due to the openness of the blocks to any user. So, you know how cryptocurrency works, but is it limited to the financial sector? The answer is no. Nowadays, blockchain technology has been widely used in a variety of areas other than finance, including:
- Gaming
- Real Estate
- Healthcare
- Art
- IoT
- Insurance
- Cybersecurity
- Voting
Crypto Coin and Crypto Token: How Do They Differ?
Are you ready to answer the question: what is the difference between a token and a coin? Frankly speaking, many people won't be able to answer, although it is very easy. A coin is a digital asset that operates on its own blockchain, while a token is a digital asset that runs on a previously created blockchain. Cryptocurrencies are designed to be used as a means of exchange, and owning tokens provides certain functions and opportunities in the ecosystem of a given project.
Main Types of Cryptocurrencies
Well, we have come to one of the most challenging questions - what types of crypto can be divided into, and by what criteria? The bottom line is that specific cryptocurrencies can fall into several categories at once, and it is difficult to categorize them since they can be evaluated by functionality, purpose, capitalization, etc. In addition, the same cryptocurrency can serve both as a payment token and a platform cryptocurrency, such as Ethereum, whose role has grown significantly in recent years. In general, most people divide crypto assets into several main types, including:
- Bitcoin, which is the progenitor of all cryptocurrencies;
- Altcoins, the name of which suggests that they are alternative cryptocurrencies. They include almost any crypto, such as Ethereum, DOGE, or TWT;
- Stablecoins, the essence of which is also in their name. Its exchange rate is pegged to the US dollar, and one stablecoin always equals 1 dollar;
Nevertheless, we decided to group cryptocurrencies according to different parameters, so here is a breakdown of the main types of cryptocurrencies.
Types of Cryptocurrencies by Functionality and Purpose:
Payment cryptocurrencies
Payment cryptos were created primarily as a means for international transfers and payments. Their blockchain was designed in such a way that it is impossible to create smart contracts or Dapps on its basis, so the role of these cryptocurrencies remains unchanged today.
Examples: Bitcoin (BTC), Litecoin (LTC), Bitcoin Cash (BCH), Ripple (XRP).
Platform Cryptocurrencies
Platform Cryptocurrencies were created as projects based on which smart contracts and decentralized applications (dApps) can be created. They allow blockchain developers to build their own tokens and services using parent blockchain technology.
Examples: Ethereum (ETH), Polkadot (DOT), Cardano (ADA).
Security Tokens
Security tokens, sometimes called equity tokens, determine the ownership of a real asset or a part of it in the blockchain. Any asset can be tokenized, but since such tokens are considered financial assets, they are subject to regulation. Such tokens serve the same purpose as bonds or stocks, so serious investors often consider them for investment.
Examples: Polymath (POLY), Propbase (PROPS), Synthetix (SNX).
Utility Tokens
Utility tokens are created to provide access to specific services or functionalities in their native blockchain. This token type is usually created during Initial Coin Offerings (ICOs) or Token Generation Events (TGEs) to power the network. Utility tokens are often used to pay for transaction fees, vote in the blockchain ecosystem, etc.
Examples: Binance Coin (BNB), Chainlink (LINK), Ethereum (ETH).
Governance Tokens
The main purpose of governance tokens is to allow holders to vote and make decisions on the further development of blockchain projects and their modification. This approach allows the creation of decentralized projects where a collective majority makes decisions. As a rule, governance tokens are most common in DeFi and GameFi projects.
Examples: Uniswap (UNI), Maker (MKR).
NFT
NFTs (non-fungible tokens) are tokens that are widely used in the art world. NFT is a unique digital token, which means that it cannot be sold in parts. The main identifiers of an NFT are its blockchain information and metadata, which make it impossible to counterfeit. Usually, a non-fungible token is just a picture, but nowadays, NFT covers a wide range of digital assets, from skins in the meta-universe to music files and digitalized paintings created by great artists of the past.
Examples: CryptoPunks, Bored Ape Yacht Club (BAYC).
DeFi Tokens
DeFi, or decentralized finance, is one of the most exciting and popular blockchain technologies, as it opens up the widest opportunities for investors and traders. DeFi tokens are used for staking, providing liquidity on DEX, lending, and borrowing funds. Most DeFi protocols use native DeFi tokens to access all the abovementioned features.
Examples: Chainlink (LINK), Maker (MKR), Uniswap (UNI).
Memes Tokens
Meme coin is a cryptocurrency created as a fan project of popular memes or jokes. A few years ago, no one could have predicted that meme tokens would become so popular, and now this industry is rapidly gaining momentum. As a rule, such projects have no value and are often used for speculation. The success and price of meme tokens depend on marketing and community support.
Examples: Dogecoin (DOGE), Shiba Inu (SHIB), Pepe (PEPE), Bonk (BONK).
Central Bank Digital Currencies (CBDC)
In simple terms, CBDCs are a digital version of a country's currency that its central bank regulates. Among the advantages of these coins is that they have all the pros of digital money, such as fast transfers, low fees, publicity, and the pegging of the coin's price to the country's main currency.
Examples: e-CNY (China), eNaira (Nigeria), e-Rupee (India).
Types of Cryptocurrencies by Consensus Mechanism:
Proof of Work (PoW)
To create new blocks and validate transactions, Proof of Work requires miners to solve complex mathematical problems. They can be solved with powerful computing hardware that requires a lot of energy to operate.
Examples: Ethereum (before ETH 2.0), Zcash (ZEC), Litecoin (LTC).
Proof of Stake (PoS)
Proof of Stake works differently because to confirm transactions and mine new blocks, validators must stake their coins, i.e., accumulate and block them, making any actions with them unavailable. This method is much more economical in terms of energy consumption.
Examples: Cardano (ADA), Ethereum (after ETH 2.0), Solana (SOL).
Delegated Proof of Stake (DPoS)
In fact, Delegated Proof of Stake is the same as Proof of Stake, with one difference - the ecosystem's token holders vote to delegate the validation of transactions and the mining of new blocks on their behalf. This method of consensus significantly reduces the centralization of the project.
Examples: EOS Network (EOS), Sui (SUI).
Hybrid Mechanisms
Some blockchains use multiple consensus mechanisms to improve security and scalability.
Examples: VeChain (VET), NEM (XEM).
Types of Cryptocurrencies by Market Capitalization:
Small-Cap Cryptocurrencies (less than $1 billion)
Cryptocurrencies with the smallest capitalization. They are promising for explosive growth, which can yield 10x or more. Still, due to their low capitalization, they are very volatile and unprotected from transactions by large players who can manipulate the price.
Examples: Starknet (STRK), The Sandbox (SAND), Gala (GALA).
Mid-Cap Cryptocurrencies ($1 billion to $10 billion)
Mid-cap cryptocurrencies. These cryptocurrencies can still get good gains with the development of blockchain projects and the overall positive trend in the market, but you should be careful, as the risks still remain.
Examples: Render (RENDER), Stellar (XLM), Toncoin (TON).
Large-Cap Cryptocurrencies (more than $10 billion)
Large-cap cryptocurrencies are usually the safest investments because they have a large amount of liquidity, and their price is very difficult to manipulate. Such cryptocurrencies, however, are unlikely to bring you the desired tens of Xs, so with low risk comes low returns.
Examples: Bitcoin (BTC), Ethereum (ETH), Binance Coin (BNB).
Types of Cryptocurrencies by Privacy
Privacy Coins
The primary purpose of private coins is increased anonymity and security. Such protocols use ring signatures, coin mixing, stealth addresses, and other advanced cryptographic technologies to make it impossible to identify the user.
Examples: Monero (XMR), Dash (DASH), Zcash (ZEC).
Non Privacy Coins
Everything is easy with non privacy coins, as their role is the opposite of privacy coins. Such coins are designed for better publicity and transparency instead of privacy.
Examples: Bitcoin (BTC), Ethereum (ETH).
Interact With Different Types of Crypto
Innovations are creating new opportunities and transforming the world of finance today. The wide variety of digital assets opens up new horizons for investing, asset management, and simplifying and reducing the cost of transactions. That is why it is important to understand what cryptocurrencies exist and what groups they are divided into, as we are entering an entirely new era in the world of finance. So, it is now clear that the world of cryptocurrencies is much richer and more complex than it seems. I hope this article will help you better navigate the world of cryptocurrencies and explore new coins, improving your financial situation. I wish you good luck!