What is Cryptocurrency and How Does it Work?

Do you understand how cryptocurrency works? This article will teach you all you need to know about the decentralized currency. Here, we deeply examine the question, “What is cryptocurrency?” and show you how to buy it. We also discuss the safety of these blockchain assets.

Author: Adesuwa Ebuehi   -   Last updated: 12/04/2024

Summary

Cryptocurrencies are an investment vehicle and a decentralized alternative to traditional currencies. They have been in existence since 2009 and currently have a total market cap exceeding $1.09 trillion. This innovation runs on the blockchain and is protected using highly secure cryptographic techniques. 

This is a comprehensive guide on everything about crypto. It explains how mining works, the types of cryptos, and how to buy them via an exchange platform. It also covers some of the most common crypto scams and how to safeguard your assets from fraud. 

What is Cryptocurrency?

Unlike paper money that can be seen, held, and felt, cryptocurrency is a virtual asset. Over the years it has become popular as a means of exchange and an instrument for preserving value. It exists solely as digital entries on the blockchain that are secured by cryptographic techniques such as hashing functions and public-private key pairs. It operates a decentralized system. So, there are no middlemen who help to process your transactions. Instead, it is based on a peer-to-peer model. 

The history of decentralized money began with the need to create an alternative system after the tragic financial crisis in 2008. An individual or group of individuals who referred to themselves as Satoshi Nakamoto created and launched Bitcoin, the first ever cryptocurrency, in 2009. Use cases for the top cryptocurrencies in the world continue to increase as they become more ubiquitous. Several other digital currencies, such as Ethereum, Cardano, Solana, and Binance Coin, have become widely accepted as unconventional means of payment. 

How Does Cryptocurrency Work?

Cryptocurrencies use the blockchain as a ledger to keep records of peer-to-peer digital transactions. Data transfer on this ledger via this technology is immediate and cannot be modified. Below, we explain some critical aspects of how crypto works, including mining, buying, selling, storing, and investing. 

Mining

Crypto mining is a term used to describe the computational process of generating new cryptos to buy. Individuals who participate in this activity are called miners. A finite number of available coins can exist for each cryptocurrency. Miners use supercomputers with high processing capacities to solve complex mathematical problems and verify transactions on the blockchain. As a reward, they are offered new cryptocurrencies. 

Buying, Selling and Storing

Anyone can buy or sell their cryptos using an exchange. Several popular platforms, such as Binance, Kraken, Coinbase, and Huobi, allow individuals to purchase digital tokens with cash or swap one type of cryptocurrency for another. 

Furthermore, you can store your cryptos in a hot or cold wallet. Hot wallets are an online storage option usually accessible via an app. A perfect example of this is the crypto wallets provided by exchange platforms.

Cold wallets, however, are only accessible offline and are generally considered the safer option for keeping large amounts of crypto. Cold wallets require custom hardware or paper documentation, although the paper method is no longer commonly used. 

Investing

Most cryptocurrencies are viewed as a store of value and a high-risk, high-reward investment option. Furthermore, because the price of digital coins tends to fluctuate due to forces of supply and demand, many traders earn by speculating on the price of a crypto. Investors anticipating a rise in the value of a particular coin may choose to hold a specific amount of that crypto and sell it for profit when the price increases. In addition, investors can identify crypto ICOs to invest in with hopes of making profits or staking to reap other benefits. 

There are other ways of investing in crypto, such as trading crypto CFDs or crypto-related ETFs on an exchange. Crypto CFD trading allows investors to hold long or short positions on their coins. 

Types of Cryptocurrency

There are several types of cryptocurrencies, and these terms are often used interchangeably. In this section of our article, we differentiate between crypto coins, altcoins, and tokens. 

Crypto Coins

Although many people broadly classify all cryptocurrencies as coins, this is untrue. Crypto coins are digital currencies that run on their own blockchain network. For example, Ethereum and Bitcoin are the native coins of the Ether and Bitcoin blockchains, respectively. 

Altcoins

This term is commonly used to describe all crypto coins created as a proposed improvement on Bitcoin. These assets are considered an alternative to the first ever crypto, hence the name “alternative coins” or altcoins. Most of these coins run on the Bitcoin network. However, others like Ethereum, Ripple, and Neo have their own blockchain. 

Crypto Tokens

Crypto tokens are digital assets that do not run on a native blockchain network. It is an all-inclusive term that encompasses currencies, commodities, and NFTs. The Ethereum blockchain is popular for creating tokens, although many creators also use options such as Lisk or Neo. 

How to Buy Cryptocurrency

Below, we list the steps to buy and own cryptocurrencies. 

Step 1: Select a Crypto Platform (Broker or Exchange)

Before you can buy any crypto, you need to create an account with an exchange. There are several options available, including popular companies like Coinbase, Binance, eToro, and Robinhood. 

Step 2: Fund your Account

After opening your account, you will be required to deposit money and purchase your preferred crypto. The accepted currency and funding method vary depending on the crypto platform you use and your country of residence. 

Step 3: Buy Crypto

Once your account is funded, search for the cryptocurrency you wish to purchase. Next, specify how many units of that coin you need to confirm your transaction and take ownership of the asset. 

Step 4: Store your Crypto in a Wallet (Using hot or cold wallet storage)

Finally, you can store your crypto on your online exchange or transfer it to any other hot wallet. Or, you could opt for offline storage via a cold wallet. 

What is Cryptocurrency used for?

Cryptocurrency is gaining popularity across several regions and has become applicable in several use cases, such as gaming, purchasing, money transfer, tipping, and investments. We discuss each of these uses in more detail below. 

Purchasing

Cryptocurrencies have become widely used for making payments on several websites, e-commerce platforms, and physical stores. For example, when you buy Solana on eToro or any other exchange, you can use it to pay for coffee at Starbucks or purchase goods from other companies that accept digital coins as a mode of payment. 

Gaming

Many games currently use cryptocurrencies as a tool to incentivize gamers to keep playing. Under the play-to-earn (P2E) system, gamers can own digital assets such as Ethereum, Sandbox, or Axie Infinity, which they can trade for stable coins or fiat currency on several exchange platforms. Furthermore, there are gambling sites that accept crypto, such as bitcoin. 

Money Transfer

One of the most common use cases of digital tokens is for money transfer, especially across continents. Cross-border payments have been one of the biggest global challenges till date. However, with cryptocurrencies, individuals can instantly send and receive payments regardless of their location. For instance, a person could purchase Ripple on Binance or any other exchange platform and send it to another crypto wallet owned by an individual in another region or continent. 

Tipping

Crypto tipping is becoming increasingly popular with the proliferation of tipping platforms such as Tipprbot, Gitcash, and Chaintip. Now, crypto adopters can make micro-payments and tip content creators or friends on various platforms like Reddit or GitHub with Cardano, Dogecoin, Litecoin, or any of the multiple cryptocurrencies available. 

Cryptocurrency vs Traditional Currency

Traditional currency (also called Fiat money) and cryptocurrencies share many similarities as well as differences. Below, we outline some of them.

Differences Between Traditional Currency and Cryptocurrency

– Cryptocurrencies do not run on a centralized system. This means that banks do not regulate transactions involving this asset. All transfers go directly from the sender to the receiver without the involvement of any intermediaries. 

– Security with cryptos is more challenging because owners can only access their coins or tokens via a private key. Unfortunately, if this key is misplaced, these individuals can lose their digital currencies permanently. 

– The lack of regulation with cryptocurrencies also means that transactions involving coins have a higher level of anonymity. Unlike with fiat money, digital currency transfers do not require personal information. This anonymity is arguably the biggest selling point of the best bitcoin online slots sites and similar companies that thrive on privacy, as users can get involved while keeping their identities hidden.

– Cryptocurrencies are more volatile than traditional currencies. While the latter typically maintains its value over time, the valuation of cryptos changes over time, and it can experience sudden spikes or falls due to supply and demand forces. 

Similarities Between Traditional Currency and Cryptocurrency

– Cryptocurrencies and traditional money are both widely accepted as a means of exchange. You can purchase goods and services in many regions using either of these options. 

– Both assets offer different denominations. While you can choose between various cryptos, such as Bitcoin and Ethereum, you can also select from any available fiat money options, including pounds, dollars, and euros. 

– Like traditional currency, digital currencies also exist in smaller fractions. For example, a person can purchase 0.01 bitcoin. 

Cryptocurrency Fraud and Cryptocurrency Scams

Cryptocurrency frauds are not uncommon. However, you can avoid them if you know what to look for. Here, we list some of the most popular crypto scams and how to prevent them.

Crooked Investment Schemes

This type of fraud is carried out by individuals posing as investment managers. These scammers promise to help others manage their crypto portfolios with the promise of large guaranteed returns. Unfortunately, they use this ploy to gain access to the wallets of unsuspecting victims and steal from them. Avoid this trap by doing thorough due diligence before using an investment manager. Also, beware of any individual or company that assures you of unreasonably high returns or demands a huge upfront fee. 

Phishing Scams

Phishing scams involve emails with spoofed links to steal a person’s wallet key or other sensitive personal data. To protect yourself from these hacks, avoid visiting redirected sites from email links. It is always best to go to these web pages directly. Also, confirm that a site is secure before you enter your details. 

Fake Exchanges

Fake exchanges are fraudulent platforms that take users’ deposits without offering any service. Always stick to tested and trusted exchanges and visit review sites to know what people say about a platform before registering and funding your account. 

Pump and Dump

Pump and dumps are one of the most common types of crypto fraud. In pump and dump scams, fraudsters rapidly purchase large volumes of a relatively unpopular coin to drive its price up and attract an influx of investors who wish to make a quick profit. However, not too long after, they maximize their profits by selling all their coins and causing a sudden drop in the value of that asset. Investing mainly in well-known coins is the best way to avoid pump and dump scams. 

Is Cryptocurrency Legal?

There are many opinions regarding whether the pros of cryptocurrency outweigh the cons. Depending on your specific country of residence, trading cryptocurrency may be considered an illegal activity. For individuals in the United States, cryptocurrency trading is legal. However, bodies such as FinCEN are currently exploring ways to provide improved regulatory measures for this asset. Exchanges registered in the US are required to comply with the Bank Secrecy Act to prevent money laundering. 

For European Union nations, bitcoin and all other cryptocurrencies are considered legal. However, the specific regulatory protocols vary in each member state. The European Commission created the Markets in Crypto Assets Regulation (MiCA) blueprint for the regulation of cryptocurrencies which will be authorized in the near future. 

Other countries, such as Japan, the United Kingdom, Australia, Singapore, and Korea consider cryptocurrencies as a legal property and permit its use but do not officially recognize it as legal tender. Also, exchanges operating in these locations must be registered with their authorized financial regulatory bodies. 

Despite the mass appeal of digital counts, not all regions allow their use in transactions. Some countries, including Cameroon, Central African Republic, Gabon, Qatar, Saudi Arabia, and China, do not sanction the use of cryptocurrencies. 

Is Cryptocurrency Safe?

Cryptocurrency is built on blockchain technology, which is very secure. However, individuals who own this asset must be aware of the numerous fraudulent schemes in the crypto space. Typically, as long as you take the necessary precautions and safely protect your private key, your coins will remain safe. Some of the required steps to safeguard your assets include using strong passwords for your wallets, purchasing crypto via reputable exchanges, and enabling two-factor authentication (2FA). 

Bottom Line

Cryptocurrencies are rapidly gaining popularity as an investment tool and an alternative to traditional currency. However, it is essential to maintain best practices when investing or purchasing this asset to avoid losses. 

It is a decentralized digital asset that is secured via cryptography. 

The first crypto was created in January 2009.

The first coin launched was Bitcoin. 

The total crypto market cap is $1.09 trillion. 

Miners get digital currencies by solving complex problems involving cryptography to verify transactions carried out on the blockchain.

To invest in cryptocurrency, all you need to do is open and fund an account with a reputable exchange.

You can purchase this asset on any well-known exchange platform. Popular options include Coinbase, Binance, and Huobi.

The best crypto to buy or invest in depends on your investment goals and the outcome of your market research. However, beginners are advised to stick to less volatile coins. 

A cryptocurrency exchange is a platform that enables individuals to purchase digital coins with traditional money. 

Verification of transactions is a complex process involving grouping, mining new blocks, and adding these transactions to the blockchain. 

You can buy anything with cryptocurrency, provided the service provider accepts it as a valid means of payment. 

Although the future of crypto is unclear, it is widely believed that digital coins will gain more adoption and become widely used. 

Yes, you will. Any income or profit from the sale of a cryptocurrency will be subject to taxation. 

Yes, you can. However, it requires high processing power, and the likelihood of success is slim.

Yes, crypto transactions can be traced.

You can make money by speculating on crypto prices.

Crypto crashes are caused by factors that affect supply and demand, such as interest rates and regulatory complications. 

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