If you’ve been following the news, you might have asked the “What is cryptocurrency” question a few times. Who hasn’t? Especially with Bitcoin posting high returns.
So, what exactly is crypto, and how does it work? Cryptocurrencies have become increasingly valuable over the past two years, and naturally, more people have become curious about these assets.
This guide explores the ins and outs of cryptocurrencies and how the assets function.
What is Cryptocurrency?
A cryptocurrency is a digital asset that can be traded and used to pay for goods and services online. There are thousands of cryptocurrencies available today. Two of the most popular ones are Bitcoin and Ethereum.
Unlike traditional currencies, like the US dollar, a cryptocurrency uses cryptography techniques to manage its monetary systems. Cryptocurrencies exist outside of the control of governments or any central authority.
A cryptocurrency is secured by a system called “blockchain technology.” The blockchain is simply a distributed database for storing information in chunks or “blocks.”
By design, blockchain ensures valuable data can be shared, stored and confirmed without intermediaries.
Cryptocurrencies look to offer several benefits over traditional money. These include:
Speed: With cryptocurrencies, sending money – or value – across regions or continents happens in a few minutes. This trumps traditional cash, which takes hours to days in some cases.
Security: Cryptocurrencies run on blockchains, which are distributed and decentralized. Since they are not centralized, there’s no single point of failure. This makes the blockchain harder to corrupt or hack.
Censorship-resistant: Anyone can use cryptocurrencies. They offer users financial freedom. No government or central authority can censor or reverse a transaction once it’s completed.
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How Does Cryptocurrency Work?
With the fundamentals above, you might wonder how does cryptocurrency work? What makes this system tick? To understand how cryptocurrencies work, we need to explain three concepts.
They are the blockchain, cryptocurrency mining, and cryptocurrency wallets.
Blockchain Technology
A blockchain is similar to a database but better. Databases store a large volume of data electronically on a computer or on servers made up of powerful computers. These servers are often centralized in a location and built for easy storage and retrieval of data.
The blockchain differs from a database in setup. Unlike a database, the blockchain is a decentralized public ledger. The computers powering the network are not all under one roof or operated by one single individual.
In addition, a blockchain collects multiple data together in groups, otherwise known as ‘blocks.’ These blocks have specific storage capacities. Once filled, the blocks are chained and added to the previously filled block to form a chain of data known as a “block-of-chain” or the “blockchain.”
In the case of Bitcoin, the blockchain stores every Bitcoin transaction initiated on the network.
Cryptocurrency Mining
Before transactions are stored on the blockchain, they need to be verified. The blockchain network also has to be maintained. And more importantly, new cryptocurrencies are to be created from time to time. These tasks are carried out by a group of people called “miners.”
Cryptocurrency mining is the process of validating crypto transactions and then adding them to the network in exchange for crypto rewards. To validate Bitcoin transactions, for instance, miners have to solve complex mathematical questions using powerful computers. This is called the Proof-of-Work (PoW) consensus. Solving these equations involves powerful computers and energy, making the PoW an expensive endeavor.
Bitcoin miners who successfully solve the problems are allowed to add blocks of verified transactions into the blockchain. These miners are paid a reward of 6.25 Bitcoins (about $262K) for their trouble.
Other cryptocurrencies, like Solana and Cardano, use a Proof-of-Stake (PoS) consensus, where miners secure and maintain the network by “staking” their coins. PoS consensus attributes mining power based on the proportion of coins staked or held by the miner.
Cryptocurrency Wallets
Unlike the US Dollar, cryptocurrencies don’t have a physical form. You can’t hold Bitcoin or Solana in your hands. They are digital assets that are transferred over the Internet. A digital or cryptocurrency wallet is a storage facility for your crypto holdings.
Technically, cryptocurrency wallets don’t store your crypto funds. They store your private keys. A private key is a password that proves ownership of your crypto holdings and is used to initiate transactions. Since your crypto lives on the blockchain, the private keys are required to provide access to the digital assets.
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How Many Cryptocurrencies Are There?
Cryptocurrencies have advanced significantly since Bitcoin (BTC) launched in 2009.
Bitcoin’s success over the years has sparked an explosion of digital assets.
But how many cryptocurrencies are there? According to crypto market aggregator Coinmarketcap, over 20,000 crypto assets are traded in the crypto market.
Following the remarkable rallies of Bitcoin and several other alternative currencies in 2021, the crypto industry has exploded.
Each cryptocurrency is divided into different ecosystems based on its utility. There are hardcore cryptocurrencies like Bitcoin, those focused on non-fungible tokens (NFTs), decentralized finance (DeFi), play-to-earn (P2E), move-to-earn (M2E), and even the Metaverse.
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Is Cryptocurrency a Good Investment?
Investing in cryptocurrency is potentially extremely profitable but also risky. It’s considered normal for a cryptocurrency to rise by 35% in a day. The price can also fall by a similar value within the same period. By nature, cryptocurrencies have been successful when compared to other assets.
For instance, when compared with other asset classes such as the stock market, bonds or gold, Bitcoin investors took home a 5,507% return on their investment, per data from YCharts. The total profit earned from Bitcoin from 2011-2020 was about six million percent.
The cryptocurrency market also grew to a market cap of $2.31 trillion, making it larger than the market capitalization of any company, including Apple Inc.’s $2.08 trillion, at the time. The crypto market grew by 851%, from $243 billion in 2020 to a high of $2.31 trillion in May 2021.
Despite these gains, it’s common knowledge that the crypto market crashes from time to time. These price slumps rarely last long due to the volatility of the market. However, when choosing a cryptocurrency to invest in, it’s advisable that you only select assets with strong use cases and fundamentals, like Bitcoin or Ethereum. These assets are bound to post long-term gains irrespective of the general volatility in the market.
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How Does Cryptocurrency Gain Value?
Cryptocurrency gains value primarily through the laws of demand and supply. When a coin’s demand starts to soar, its value increases – and vice versa.
This is the primary reason why you might notice slight price variations on exchanges. For instance, the price of Bitcoin on a platform like Binance might be $50,500, while one BTC goes for $50,700 on Coinbase.
Although these variations represent the exchange demand and supply metrics differences, they can be aggregated to find Bitcoin’s true value.
Another factor that affects a cryptocurrency’s value is scarcity. Cryptocurrencies tend to be more valuable once they’re scarce.
For instance, Bitcoin has a hard cap of 21 million, meaning that only 21 million BTC units will ever be produced. Once this happens, Bitcoin becomes increasingly rare and more valuable.
The digital asset’s utility is another factor that affects the value of a cryptocurrency. As the use case for a coin rises, the value would follow suit. Some exchanges offer discounts on trading fees and cash back on their crypto cards to customers who own their native digital assets.
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Should I Invest in Cryptocurrency?
Cryptocurrencies are widely seen as the future of money, but the space is still largely unregulated. In some countries, crypto is outlawed. Is cryptocurrency legal in your jurisdiction? These are some of the details you should worry about. The crypto market is also more volatile than traditional stock markets. Before investing in crypto, we recommend learning how the market works, the fundamentals of the digital asset and how to trade cryptocurrency.
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What Are The Current Cryptocurrency Rates?
Assess the live crypto prices below, the chart displays the current rates across a selection of the most popular cryptocurrency pairs.
How to Buy Cryptocurrency
These are the steps to follow for investors who want to buy cryptocurrency:
Select a Platform
Cryptocurrencies, like other financial instruments, are traded on crypto exchanges. Investors can choose between a multi-asset broker that offers cryptocurrency trading and dedicated cryptocurrency exchanges.We’ve screened through the leading exchange offerings, and tons of data, to determine the best crypto exchanges and crypto brokers.
Traditional Brokers – Brokers act as intermediaries between the crypto market and the users. They facilitate the buying and selling of digital assets in addition to other markets such as stocks, bonds, and commodities. Most provide crypto contracts for difference (CFD) trading, essentially trading the asset’s price movement without owning the asset. They do, however, provide limited support for crypto asset trading.
Cryptocurrency Exchanges – These are crypto-facing platforms that offer a broader range of tradable assets, lower fees, and asset-earning opportunities, among other things.
Investors should research the supported digital assets, trading and other fees, and overall trading experience before deciding on a platform to use. Once a platform has been selected, investors can create an account, verify their ID, deposit the stipulated minimum, and begin trading.
Depositing Funds
The next consideration is how to fund the newly opened account. Each platform features a set of preferred payment methods.
For example, Coinbase accepts debit card purchases of cryptocurrency in USD but does not accept credit card deposits from US investors. Traders can also use the automated clearing house (ACH) and bank wire transfers as payment methods on some selected platforms. Deposit fees should also be considered. For instance, eToro offers free deposits on all payment options, including debit card payments.
Remember that the processing time would be influenced by the chosen payment method. Consequently, the deposit time for each payment method is determined by the method chosen.
Buying Crypto
The final step is to purchase the cryptocurrency asset. Most platforms allow traders to buy cryptocurrency the instant their deposit is initiated. The process of buying the asset differs from platform to platform. Exchanges offer a more elaborate and complex structure that includes features that allow users to purchase an asset once it drops to a certain price. Once the asset is purchased, the crypto asset will be visible in the investor’s wallet.
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How to Store Cryptocurrency
Cryptocurrencies, like most financial assets, must be kept securely. This is especially crucial given the number of crypto hacks and thefts that have plagued the emerging industry. Investors rely on the following services to store digital assets:
Hot Wallets
Hot wallets, also known as online wallets, are digital wallets that are always connected to the internet. These wallets are best known for their ease of use and are better suited for beginners. Since they are always connected to the internet, hot wallets make it easy to conduct trades or transfer crypto back to an exchange. Hot wallets are often free to download and use. One drawback of this type of wallet is its security. Since they’re always online, they are more prone to attacks.
Cold Wallets
Cold wallets are also called offline wallets. They are typically designed in USB-like devices. Because they are offline, they are thought to be more secure. This is because all assets are kept on a device that is not connected to the internet. The only drawback is that cold wallets are not suited for frequent trading due to their slow access speed. They are also pricey as they retail for $200 upwards a pop.
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What Can You Buy with Cryptocurrency?
Cryptocurrencies are gaining real-world acceptance every day. Besides being a place to store value, investors can use cryptocurrencies to:
- Own both virtual and physical properties,
- Pay for goods and services,
- And even purchase plane tickets.
Many companies are incorporating cryptocurrency payments into their business processes, adding more utilities to cryptocurrencies.
Cryptocurrency Fraud and Cryptocurrency Scams
Despite the cryptocurrency market’s adoption on a global level, the industry remains plagued by bad actors on the prowl to exploit unsuspecting investors. Phishing websites, virtual Ponzi schemes, dubious celebrity endorsem*nts, and rug pulls are some of the most common methods online crooks use to fleece crypto users. Crypto rug pulls picked up steam in 2021. Chainalysis data revealed that about 32% of all crypto scam revenue came from rug pull scams.
Investors can protect themselves against cryptocurrency fraud and scams by storing their funds in secure crypto wallets and setting up two-factor authentication. More importantly, crypto users should always do their due diligence on new projects before investing. Traders should also avoid crypto protocols with anonymous developers – the market is filled with them. Remember the old saying – if it’s too good to be true, it probably is.
For safety reasons, traders should stick to proven and time-tested cryptocurrencies like Bitcoin, Ethereum, and popular large-cap altcoins.
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Is Cryptocurrency Safe?
Blockchain technology, a highly secure and immutable public ledger, supports cryptocurrency. Transactions are confirmed using a highly sophisticated mathematical system that ensures the integrity of the blockchain. But, there are risks inherent with investing in cryptocurrencies.
Cryptocurrency protocols have been breached in the past. The sector is also rife with bogus and elaborate scams.
Furthermore, crypto assets are quite volatile. Their prices can change from bearish to bullish within a short period and vice versa.
Besides these and their relative novelty as an investment option, cryptocurrencies are generally safe.
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Conclusion
Cryptocurrencies are taking the world by storm. They’ve gotten the attention of some of the biggest names on Wall Street and their profiles continue to rise. Whether as an investment or a utility, more people are owning cryptocurrencies by the day. Investing in cryptocurrencies long term can also be profitable. As you take this next step, remember never to invest more than you’re willing to lose.
