What is Cryptocurrency and How does it Work?

A cryptocurrency is a digital currency that only exists online. Some of the most popular cryptocurrencies are: Bitcoin, Litecoin and Monero. You can use them as a medium of exchange like fiat currencies like the Dollar, Euro, Yuan etc.

The difference is that cryptocurrencies are not issued by governments or banks except Central Bank Digital Currencies.

Cryptocurrencies are an Innovation in Money

You could ask; “aren’t fiat currencies already digital?” because you can make transfers online and pay with your credit card. The difference is what happens behind the scenes for the transaction to go through. Instead of using the traditional banking system cryptocurrencies use blockchain technology.

What the internet did to information, cryptocurrency will do to currency

Charlie Lee

In a nutshell, blockchain is a revolutionary technology. It is a database across thousands of computers that can record transactions or any other digital records. Blockchain to create money is a perfect use case for the technology.

The beauty of cryptocurrencies lies behind the fact that there are no third parties involved in transactions. It is fully peer to peer. Even though no banks are needed for clearance it is the most secure book keeping system to date.

How Cryptocurrencies Work

Firstly the blockchain keeps records of all the transactions that happen on its network. Transactions are approved by the computers of the network. They are grouped together in blocks and when blocks are full they are attached to a chain. Hence the name blockchain.

what-is-blockchain

A few cryptocurrencies do not use blockchain, but a DAG system instead. Or a hybrid network which is part blockchain and part DAG. Usually this means that individual transactions are linked to each other. They may or may not form a chain, it would depend on how the system is built.

dag

Whether the network uses blockchain or DAG, the computers only approve transactions that are legitimate. As a result they ensure that no fraud is happening on the network.

This means the network is kept honest and people can use the cryptocurrency with no issue at all. People can place their trust in the network. Moreover anyone can get a computer, join the network and verify no fraud is happening on the network. It is fantastically transparent.

The Different Types of Cryptocurrencies

There are actually 4 types of cryptoassets:

  • Cryptocurrencies – are purely to act as a medium of exchange and transact with. Like for example Bitcoin, Litecoin and Monero.
  • Crypto commodities – act as a platform for other cryptocurrency projects to build on them. Like for example the Ethereum platform. Developers are building a whole range of services on DeFi (decentralised finance) on Ethereum. Dero is another example of a crypto commodity.
  • Crypto tokens – These are tokens that sit upon crypto commodity platforms. They are made to provide digital goods and services that traditional banks usually provide, but within crypto instead. For example Aave which allows users to lend, borrow and earn interest on their crypto.
  • Crypto collectables – these are more commonly known as NFTs (Non-Fungible Tokens). They are provable, one of a kind artwork or a collectable.

When people say cryptocurrencies they use it to mean 3 types of cryptoassets; cryptocurrencies, crypto commodities and crypto tokens. Additionally there are different cryptocurrencies that fulfil different functions. They are:

Stablecoins

These are cryptocurrencies that are pegged one-to-one to a fiat currency. As a result you get the benefit of having a cryptocurrency without the wild swings in price. Stablecoin examples include Tether (USDT) and USD Coin which are pegged one-to-one with the US dollar..

Privacy Coins

These are cryptocurrencies that support privacy. Their blockchain is not transparent like Bitcoin’s. So you cannot see which wallet addresses are transacting with each other and by how much.

However the blockchain still allows you to audit it. So you can still hook up a computer to the network and verify that the blockchain is honest. That is to say there is no fraud happening on the network.

Examples of privacy coins include Monero and Pirate Chain. On the other hand Dero is a private crypto commodity.  

Oracles

Oracles sit on crypto commodity blockchains. They act like a bridge that receives and carries data. Either to and from a blockchain, to different blockchains or completely off-chain. The blockchain then uses data from oracles to distribute crypto funds. That is to say in a way that is established within a smart contract.

An example of an oracle is Chainlink or Equilibria.

Central Bank Digital Currencies (CBDCs)

Central banks are also looking at the benefits of cryptocurrency and looking to implement their own versions. Some CBDC’s are in the process of development, but some have already launched.

However one major difference between regular cryptocurrencies and CBDC’s is that they are centralised. In fact quite a lot of people within cryptocurrencies really do not like the idea of CBDC’s at all.

This is partly because CBDC’s will allow governments to oversee everything we do. Governments will have far too much control of currencies. Healthier systems are decentralised systems because there is not one point of failure.

How Many Cryptocurrencies Are There?

At this point there are 18,000+ cryptocurrencies available. All of them have different specifications and use cases. Bitcoin is by far the most popular with a 41% dominance of the cryptocurrency market. All cryptocurrencies have different price evaluations.

Bitcoin and Ethereum are always listed at the top of the most popular cryptocurrencies. Other cryptocurrencies rise and fall within the top 10 list. So every so often you can see a reshuffling in the most popular list.

You can see a full list of cryptocurrencies on CoinMarketCap. This website will also show you cryptocurrencies by market cap. That means the total market value of each individual crypto. It is equal to all the coins of that cryptocurrency in circulation multiplied by the price of the crypto.

Are Cryptocurrencies a Good Investment?

Cryptocurrencies are volatile. This means they can go up by ridiculous amounts over a short span of time. Moreover they can just as easily go down in price.

Some investors cannot take the ups and downs. They do not want to imagine their crypto holdings could go down in value tomorrow. However who can handle the volatility thinks it’s great because cryptocurrencies have done well over the long term.

bitcoin-price-chart

Sourced from CoinMarketCap

In fact Bitcoin is the best performing asset of the decade, returning ten times more than the Nasdaq 100. That is according to Yahoo Finance. As a result Bitcoin is attracting a lot of investors, plus they are getting interested in other cryptocurrencies.

However not all cryptocurrencies are good investments and quite a lot of them are scams. So you should take great care when you go picking cryptocurrencies to invest in.

The Squid Game crypto is a great example where the team did a rug pull scam. They developed the coin and promoted it to investors. Then they withdrew millions of investor funds and sent the crypto plummeting to zero. The team behind the scam crypto disappeared.

squid-game-cryptocurrency
Squid Game crypto

However, getting back to volatility – traders love volatility. It is the perfect scenario for the ones who understand the market and know how to analyse charts and coins. Traders pick the coins which they feel will give them the most returns. 

What Average Investers Can Do

For the average investor, cryptocurrency trading is very risky. They should not engage in trading unless they understand cryptocurrencies and the cryptocurrency market well. 

You could consider investing as opposed to trading, but regardless it is always best to ask for financial advice. There are some advisers or analysts that are invested in cryptocurrencies that have outperformed all other advisers. Some that invest on behalf of their clients have made great returns. You can find recommended expert advisers to follow or subscribe to them here.

What Drives the Market?

Bitcoin has been around since 2009 and it is the cryptocurrency which drives what happens in the markets. Where Bitcoin goes all the rest will follow, although at times with some lag.

There have been noticeable trends in the bitcoin chart which has developed a 4 year cycle. Investors noticed both highs and lows on the Bitcoin chart from one record breaking price high to another.

By following this trend you can buy, hold and sell at particular points in time. That is to say the times which are the most beneficial for you. There are also ways to spot the Bitcoin market peak.

Cryptocurrencies especially Bitcoin are gaining popularity among institutions and the populations. This is most certainly a positive trend for the case to buy. If it has greater adoption the price will inevitably go up.

We suggest you have a look at the price predications for Bitcoin. Here you can find predications by well-known institutions who predict Bitcoin is going much higher. You can also have a look at the percentage adoption by populations as can be seen by this statista poll.

crypto-adoption-statista

As we hinted, if you are looking to invest it is safer to buy and hold the coins for longer periods of time. Like this you do away with the short term price fluctuations. Also a word of advice – never invest more than you can afford to lose!

How to Buy Cryptocurrency

You can buy the most popular cryptocurrencies like Bitcoin, Ethereum and Litecoin from exchanges. All you need to do is create an account with the exchange of your choice.

Once your account is verified you can transfer currency in dollars, euro etc. onto the platform and make the exchange. If you prefer more detailed information there is a dedicated page on how to buy cryptocurrency. It lays out the process step by step.

How to Use Cryptocurrency

It is easy to use cryptocurrency because there are many web or app based platforms to manage your funds. They display things much like your traditional bank account does. So it is easy to keep track of your finances in one place.

You can do this from the exchange you use to buy cryptocurrency. However storing your funds on the exchange long term is not safe. In fact we recommend you store them safely offline which we will get to in a moment.

Here for example is how the interface on Ledger Live looks like. Ledger Live is a downloadable application for desktop and mobile that you use with the Ledger hardware wallet:

ledger-accounts

Highlighted on the left is where you can go to send and receive funds to your account. In this case an account for a cryptocurrency is called a wallet.

You have a unique wallet address which acts like your bank account number. You can share it with other people to send you crypto. Additionally you can also send funds to another wallet if someone shares their wallet address with you. Or send funds to other wallets, exchanges or platforms you own or have accounts with.

If you click on any of the accounts, you will see a list of transactions. All of these transactions are all the transactions effected on that cryptocurrency wallet. Moreover the transactions will have the date and time they were made and the amount transferred. Exactly like a bank account would.

Safely Store Your Cryptocurrency

Once you purchased your cryptocurrency you should take it off the exchange. This is because a lot of exchanges have gotten hacked over the years. As a result thieves made off with many millions of client crypto funds.

For example in 2014 an exchange called Mt. Gox was hacked and had hundreds of millions worth of Bitcoin stolen. Nothing beats not having third party liability and the exchange could be a liability.

In fact this is why we recommend you store your cryptocurrency in a hardware wallet. Quite a lot of cryptocurrencies are supported on hardware wallets. However some cryptocurrencies are not supported by hardware wallets and have their own dedicated wallets which you should use instead.

Easily Spend Cryptocurrency

Not a lot of businesses accept Bitcoin much less other cryptos as payment for their goods and services. This is where cryptocurrency debit and credit cards come in. They enable you to have a broader choice of retailers where to spend your money.

By broader choice we mean you can spend your money anywhere with no restrictions. So any retailer around the world that accepts credit card payments.

These cards are a cross between a bank and an exchange where you can store either crypto or sovereign currencies. They make the exchange from fiat to crypto or vice versa easy.

Depending on the company they enable payment with fiat by either using fiat or the crypto directly from your account. Some cards directly convert crypto to fiat to make a payment on the fly. That is to say without you needing to do anything from your end.

The cards are supported by Visa or Mastercard. There are some recommended and established companies supporting cryptocurrency debit cards listed here.

The Benefits of Cryptocurrency

Peer to Peer (Decentralised)

One of the most appealing reasons for cryptocurrencies is that they are peer to peer. It is the same concept as the separation of church and state. It is separating finances from the state which have a monopoly on money.

There is a moral case for this as it eliminates any instances of fraud by banks and governments. There are actually many recorded cases of fraud by institutions and governments. The most notable fraud is how central banks in agreement with government print money. This is called Quantitative Easing or QE which is currency debasement.

By doing this central banks devalue the currencies and cause inflation. As a result we get higher prices for goods and services. It leaves you with less money in your pocket.

Transparency

Developers can code blockchains to either be fully transparent or private. Most blockchains are fully transparent, unless you are using Pirate Chain or other privacy coins. However we are still able to audit privacy coins to verify their honesty. Even though we might not see full details there is still enough information to check that the blockchain is honest.

Bitcoins blockchain on the other hand is fully transparent. Once a transaction is made it will remain recorded in the public block for everyone to see. Additionally there is no way anyone can alter it. In fact it would be good for governments to be fully transparent as this creates accountability.

On the other hand traditional banks in the past have altered or fully deleted records. In fact they did it very easily and effectively.

Trustworthy

As a consequence of decentralisation and transparency comes trust which is one of the most important requirements of finance.

Not everyone is trustworthy and some cryptos are not trustworthy also. So you have to ensure that you do your due diligence and pick the right ones. By choosing Bitcoin or other trustworthy cryptocurrencies you are placing your trust in the blockchain. You do not need to trust the other person involved in the transaction.

Secure

For the cryptocurrencies that are trustworthy, blockchain is the most secure system of financial bookkeeping we have to date. The only way someone can modify the blockchain is if they have access to 51% of the computers.

In Bitcoin’s case this scenario is an impossibility at this point. If in the unlikely event where this does happen, it will be immediately noticed by everyone on the network. They will stop the attack dead in its tracks.

The larger a blockchain network gets the more secure it becomes.

Low fees

There are fees associated with exchanges when you convert your fiat to crypto. However once you have crypto you can send it to anyone around the world easily with minimal fees or charges. Sometimes some cryptocurrencies have suffered from high fees. However usually developers figured out a work around to fix the problem by time.

When you pay in fiat, banks need to match numbers and all sorts of thin­­­­gs which is time consuming. The blockchain automates this process making it quicker and easier for transactions to go through.

So the fees charged peer to peer are charged by miners who make their systems available around the clock. They approve transactions in real time. Additionally a number of different miners need to approve a transaction before it gets included in the blockchain.

The Disadvantages of Cryptocurrency

Privacy

Since most blockchains are transparent anyone can hop online and see you wallet. They can see the amount of cryptocurrency you have in your wallet. They can also see the list of transactions, that is, what was sent and received in your wallet. This is great when we need to monitor governments to hold them accountable, but not so much for individuals.

The way you personally can have more privacy is by owning a couple or more wallet addresses. You can keep one with minimal crypto amounts which you top up using other wallet addresses.

You can also consider changing wallets every so often. Another option would be to use more private coins like Pirate Chain which keep transactions anonymous and untraceable. 

Majority Attack

Like all systems, blockchain isn’t perfect. A majority attack is highly remote for Bitcoin. There is a more likely chance it could happen to other cryptocurrencies.

This would happen when more than 51% of the network is taken over by a bad actor. This person could end up changing the blockchain so it favours them. However, since the network is so transparent the community on the network will quickly notice and shut down the attack.

History

During the 90s several companies tried to create an electronic cash system. However they ended up failing for one reason or another.

Fast forward around a decade later and on the 31st October 2008 Bitcoin’s creation was announced by Satoshi Nakamoto. He is an anonymous individual or group that sent the announcement by email to a cryptography mailing list. Since then there have been many other cryptocurrencies known as “altcoins” which have been created and launched.

Purchase Cryptocurrencies

There are several cryptocurrencies mentioned in this article. If you are interested in purchasing you can find out where and how to buy them from here. Buy Bitcoin, buy Ether, buy Tether, buy Litecoin, buy Monero, buy Pirate Chain, buy Dero and buy Equilibria.

Other Articles In This Section
What is cryptocurrency? Start with the basics of crypto.
How to buy cryptocurrency? Find out how to buy crypto safely.
How to cash out cryptocurrency? How to cash out your profits.
Crypto slang. Get to know the everyday terms used in crypto.
Hard Money vs Easy Money. And why it matters for your wealth.
Types of cryptoassets. The main ways to invest in crypto.

Frequently Asked Questions

Is crypto different to Bitcoin?

Cryptocurrency is digital currency that exists solely online. Bitcoin, Litecoin and Monero are all examples of different types of cryptocurrency.

Is cryptocurrency safe?

Cryptocurrencies have the most secure form of book keeping system to date. The cryptocurrencies with the largest market capitalisations are the safest. However there are quite a lot of scam cryptocurrencies like for example the Squid Game cryptocurrency.   

Is crypto real money?

There are cases where people use cryptocurrency to buy goods and services worldwide. Mostly people invest into cryptocurrency either by buying coins or take part in blockchain ecosystems to earn passive income or mine. Cryptocurrencies are mostly considered as assets.

Who controls cryptocurrency?

Since cryptocurrency is decentralised the miners and developer teams of a crypto have control over it. Miners can vote on features and things that they would like on the network and developers can implement the changes.

How can I buy crypto?

To buy crypto you can go the how to buy cryptocurrency guide. There are also individual guides for cryptocurrencies.
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