Frequently Asked Questions About Crypto
Blockchain is a decentralized and immutable digital ledger technology. It consists of a chain of blocks, each containing a secure record of transactions. This technology ensures transparency, security, and eliminates the need for intermediaries in various industries like finance, supply chain, and more.
Imagine a digital notebook that many people can write in and see, but no one can change what’s already written. This notebook keeps a record of transactions like who gave what to whom. These transactions are put together in blocks, and each block is connected to the previous one, forming a chain. This helps keep everything transparent and secure, making it useful for things like money or tracking items in a big store.
Proof of work is a security method used in blockchain systems. It requires participants, called miners, to solve complex mathematical puzzles to validate and add new transactions to the blockchain. This process ensures that the transactions are legitimate and helps maintain the integrity of the decentralized network by making it computationally expensive to alter past transactions.
Proof of stake is another way to secure a blockchain network. Instead of solving puzzles like in proof of work, participants, known as validators, are chosen to create new blocks and validate transactions based on the amount of cryptocurrency they hold and are willing to “stake” as collateral. This method aims to reduce energy consumption compared to proof of work and encourages validators to act honestly to avoid losing their staked funds.
A smart contract is like a digital agreement that automatically executes actions when certain conditions are met. It’s written in code and runs on a blockchain, so it’s secure and can’t be changed once set up. These contracts eliminate the need for middlemen in various situations, ensuring that actions are taken exactly as agreed upon.
A cryptocurrency wallet is like a digital pocket for your digital money. It’s a secure place where you can store, send, and receive cryptocurrencies like Bitcoin or Ethereum. Just like a physical wallet holds your cash and cards, a cryptocurrency wallet holds your virtual coins and keeps them safe.
Cryptocurrency coins are standalone digital currencies that operate on their own blockchains, like Bitcoin or Ripple’s XRP. They have their own unique networks and use cases. Cryptocurrency tokens, however, are built on existing blockchains like Ethereum and represent assets, contracts, or access rights within a specific ecosystem, such as tokens used for decentralized finance (DeFi) applications or digital collectibles.
Staking in cryptocurrency involves holding and “locking up” a certain amount of a particular cryptocurrency in a wallet to support the operations of a blockchain network. In return, participants earn rewards or interest, often in the form of more of that cryptocurrency. Staking helps secure the network and validate transactions, offering an alternative to traditional proof of work mining.
Decentralized finance, often abbreviated as DeFi, refers to a financial system built on blockchain technology that aims to recreate traditional financial services in a decentralized and open manner. It enables activities like lending, borrowing, trading, and earning interest without relying on traditional financial intermediaries like banks. DeFi applications use smart contracts to automate and streamline these processes, providing greater accessibility and transparency to the financial ecosystem.
Dollar cost averaging is an investment strategy where you regularly invest a fixed amount of money into a particular asset, like stocks or cryptocurrencies, regardless of the asset’s current price. This approach helps smooth out the impact of market volatility over time, as you buy more when prices are low and less when prices are high. It’s a way to potentially reduce the risk of making poor timing decisions in the market.
The 10 worst crypto mistakes are:
Lack of Research:
Jumping into investments without understanding the projects, technologies, or teams behind cryptocurrencies.
FOMO (Fear of Missing Out):
Buying in during hype without careful consideration, leading to potential losses when prices fall.
Neglecting to secure your cryptocurrency holdings with strong passwords, two-factor authentication, and hardware wallets.
Making too many trades based on emotions or short-term fluctuations, leading to transaction fees and potential losses.
Not staying updated on legal and tax regulations related to cryptocurrency transactions in your country.
Chasing Hyped Projects:
Investing solely based on hype or social media trends rather than evaluating fundamentals.
Leverage and Margin Trading:
Using leverage without understanding the risks can lead to significant losses.
Investing More Than You Can Afford to Lose:
Placing a significant portion of your savings into cryptocurrencies, which can be highly volatile.
Falling for Scams:
Getting involved in fake ICOs, fraudulent projects, or Ponzi schemes promising unrealistic returns.
Not Backing Up Wallets:
Failing to back up private keys or recovery phrases can result in losing access to your cryptocurrency holdings.
What Is A Rug Pull?
Rug pulls are malicious scams where the project’s creators use slanderous marketing techniques and project positioning. By doing so, they get investors to invest in their project and later abandon ship, leaving the investors rekt.
The developers usually pump up hype around the project and artificially inflate the value of the token by riding on pop culture trends (Squid Game token) and by extensive shilling. This often lures newbie investors to purchase them and inject liquidity into the project’s pool.
At this juncture, the developers “pull the rug” by withdrawing the capital locked in the liquidity pool or halt users from withdrawing funds and closing down all social media handles and communication forums. This causes the price of the token to drop rapidly and investors lose their invested capital in the project.
How To Spot Rug Pulls?
So, with all the noise on social media, how can you, as a new investor, be smart enough to avoid these cash grabs?
Below are a few red flags that you could watch out for when you do your research on a cryptocurrency or an NFT project.
Project Creators Seem Shady
If little to no information regarding the token’s origins or founders, or team is accessible, this might be a potential cause for concern.
Many blockchain projects have un-doxed teams. But that does not mean that it is a scam. BAYC, Soul Dogs City, Bitcoin, and Monero are examples of good projects with anonymous teams.
Nevertheless, scammers are extra careful to not reveal their identities. So, if it’s your first time or you choose to invest an uncomfortable amount of money in a project, it is best to know the team.
Make sure that the project creators do not have a history of scams or illicit activities.
Further, you must examine how the distribution of the circulating supply of the token across wallets. If only a few wallets hold a majority of the coins, it’s possibly a red flag. The fact that a few wallets own a large share of the token supply suggests that they can very well manipulate the coin’s value.
“Whatever the reverse in this space of a rug pull is, is exactly how I went into it.”
No Locked Liquidity
To inspire confidence in investors, developers of ventures typically restrain holding authority over the liquidity pool. This is known as locked liquidity, because it prevents developers from transacting any of the pool’s tokens, making token theft or substantially lowering liquidity extremely difficult.
The longer the pool is sealed, the more trustworthy it is and lowers the chance of a rug pull. If the liquidity, on the other hand, is not locked, nothing prevents the developers from withdrawing it and making a run for it.
Inactive or Shilling Community
Ingenuine projects tend to have a high social media following but poor engagement.
Some rug pull projects rely on social media influences, crypto influencers, and paid advertisements to garner support for the project. For instance, the Squiggles rug pull involved the project supposedly holding the support of 232,000 Twitter users and 360,000 members in discord.
This points out clearly the fact that the project is trying to fake user engagement on their forum and project to investors that they have a strong community.
Skyrocketing Prices and Short-term High Yields
Many DeFi pools offer to ease token trades and claim to generate additional returns for pool investors. WhaleFarm, for example, had an APY of over 100%. If a yield farm appears to be giving profits that are too good to be true, they most likely are.
Scammers might inflate a project by investing money into it or shilling excessively to get others to participate out of FOMO.
Always DYOR on news about the venture including new exchange listings, partnership announcements, or other related news. It might be a rug pull or a pump-and-dump scheme if these aren’t present. Unless you have a compelling reason to be otherwise, be wary.
An airdrop in the context of cryptocurrency is a distribution of free tokens or coins to holders of a particular cryptocurrency or users of a specific platform. This can be done as a promotional strategy by projects to gain attention and adoption, or as a reward for loyal community members. Airdrops often involve sending a certain amount of the new tokens to eligible participants’ wallets, increasing their involvement in the project’s ecosystem.
A DAO, or Decentralized Autonomous Organization, is a type of organization that operates based on rules defined by code and executed on a blockchain. It aims to achieve decision-making and governance through a decentralized process, where participants holding the organization’s tokens can vote on proposals and changes. This concept eliminates the need for centralized authorities and enables community-driven management of projects, funds, and protocols in a transparent and open manner.
A soft fork maintains compatibility with older nodes, while a hard fork introduces changes that are not backward-compatible and can lead to a split in the blockchain’s history.
Soft Fork: A soft fork is a backward-compatible upgrade to the blockchain protocol. It involves tightening or restricting the rules of the network. Nodes that haven’t upgraded can still operate on the network, but they might not be able to participate in new features or transactions.
Hard Fork: A hard fork is a more significant and potentially disruptive change to the blockchain protocol. It introduces new rules that are incompatible with the old ones, leading to a split in the blockchain. This can result in two separate chains and requires all participants to upgrade to the new rules to remain on the same network.
An NFT, or Non-Fungible Token, is a unique digital asset that represents ownership or proof of authenticity of a specific item or piece of content, such as artwork, collectibles, music, videos, and more, using blockchain technology. Unlike cryptocurrencies like Bitcoin or Ethereum, which are fungible and interchangeable, NFTs are distinct and cannot be exchanged on a one-to-one basis. Each NFT has a verifiable and unchangeable record on the blockchain, making it valuable for digital ownership and provenance in the digital world.
Here are ten potential challenges or downsides associated with cryptocurrencies:
Cryptocurrencies can experience extreme price fluctuations, leading to uncertainty and risk for investors.
Lack of Regulation:
The regulatory landscape for cryptocurrencies is still evolving, leading to concerns about scams, fraud, and illegal activities.
Cryptocurrency exchanges and wallets can be vulnerable to hacking, resulting in the loss of funds.
Lack of Consumer Protection:
Unlike traditional financial systems, cryptocurrencies often lack the same level of consumer protection and recourse.
Some cryptocurrencies, especially those relying on proof of work, have been criticized for their energy-intensive mining processes.
Scams and Fraud:
The relatively new nature of the technology has led to a proliferation of scams and fraudulent schemes.
Understanding and using cryptocurrencies require a certain level of technical knowledge, which can be a barrier for some people.
Unclear regulations in different jurisdictions can create challenges for businesses and users operating with cryptocurrencies.
Some smaller or less-known cryptocurrencies might have liquidity problems, making it difficult to buy or sell them.
Misuse for Illegal Activities:
The anonymity and privacy features of certain cryptocurrencies have raised concerns about their use in illegal activities like money laundering and ransomware attacks.