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Decoding cryptos

Basics

  • Blockchain recap: A digital, decentralised ledger where transactions are recorded in blocks linked sequentially.
  • Verification need: Every transaction must be validated before being added to the blockchain.
  • Difference from banks:
    • Banks → verified by officials in a centralised system.
    • Cryptos → verified by miners/validators in a decentralised network.
  • Consensus mechanism: The method by which blockchain participants agree on the validity of transactions.

Relevance : GS 3(Economy – Digital Currencies , Technology – Block Chain

Consensus Mechanisms

  • Proof of Work (PoW):
    • Miners solve complex puzzles using computing power.
    • Winner adds block + earns rewards (coins + fees).
    • Secure but energy-intensive, slow, costly.
    • Example: Bitcoin.
  • Proof of Stake (PoS):
    • Validators chosen based on how much crypto they “stake.”
    • Honest validators earn fees/rewards; dishonest ones lose staked coins.
    • Faster, more energy-efficient.
    • Example: Ethereum (post-Merge), Solana.
  • Core purpose of both: Prevent fraud, ensure security, incentivize participation.

Other Consensus Mechanisms (Emerging)

  • Delegated Proof of Stake (DPoS): Voting system where stakeholders elect validators (EOS, Tron).
  • Proof of Authority (PoA): Validators selected based on reputation/identity.
  • Hybrid models: Combining PoW + PoS for balance of security and scalability.

Key Factors Before Investing in Cryptos

  • Network security: Must have active, decentralised nodes that resist hacking.
  • Transaction efficiency: Speed (TPS – transactions per second) + fees (affect usability).
  • Market reputation: Coin’s history, community support, transparency of developers.
  • Real-world utility: Adoption potential in payments, finance, supply chain, gaming, healthcare.
  • Volatility: Prices swing dramatically; not suitable for risk-averse investors.
  • Regulatory environment: Varies across countries; legal uncertainty remains a big risk.

Types of Cryptocurrencies

  • Bitcoin (BTC): First, most famous; store of value (“digital gold”).
  • Altcoins:
    • Ethereum: Smart contracts, DeFi, NFTs.
    • Solana, Cardano, Polygon: Faster transactions, scalable dApps.
  • Stablecoins: Pegged to assets (e.g., USDT, USDC); reduce volatility.
  • Utility tokens: Access to services (Binance Coin, Chainlink).
  • Governance tokens: Voting rights in decentralised organisations (UNI, AAVE).
  • Meme coins: Community/hype driven (Dogecoin, Shiba Inu).
  • Sector-specific coins: Gaming (Axie Infinity), supply chain (VeChain), finance (Ripple/XRP).

Opportunities

  • Wealth creation: Early adopters of BTC/ETH saw exponential gains.
  • Financial inclusion: Provides access where banking infrastructure is weak.
  • Innovation: Smart contracts, decentralised finance (DeFi), NFTs, tokenisation of assets.
  • Portfolio diversification: Non-correlated asset, but very high risk.

Risks & Challenges

  • Extreme volatility: Gains/losses can exceed 30% in days.
  • Regulatory crackdowns: Uncertain legal status in India, US, EU.
  • Scams & rug pulls: Many coins are hype-based, without real value.
  • Environmental impact: PoW energy consumption (e.g., Bitcoin mining).
  • Custody risk: Losing private keys = permanent loss of funds.
  • Liquidity traps: Small coins may lack active buyers/sellers.

Takeaways

  • Cryptos are more than speculation: They represent a new financial architecture (DeFi, Web3, tokenised economies).
  • Long-term value likely lies in:
    • Coins with real-world utility (payments, contracts, decentralised apps).
    • Strong developer community + transparent governance.
  • Short-term risk: High; better suited for informed, risk-tolerant investors.
  • Cautionary stance: Research > Hype. Diversify. Don’t over-allocate.
  • Global future: Cryptos may evolve into mainstream finance if regulation balances innovation + investor protection.

 

September 2025
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