Despite their volatility, cryptocurrencies offer enough benefits to make widespread adoption inevitable. Large companies like PayPal have even started accepting cryptocurrencies, allowing millions of customers to buy and sell crypto with the click of a button.
What makes digital currency so lucrative? You’re about to find out.
This overview takes a look at what crypto is, how crypto generally works, what blockchain is, how to buy cryptocurrency, how to mine crypto, what NFTs are, and how to choose the right cryptocurrency for you.
What is cryptocurrency?
Cryptocurrency refers to the various encrypted, decentralised digital currencies such as Bitcoin. Think of them as virtual currencies that only exist digitally with a different underlying infrastructure than traditional currencies (also known as fiat finance).
While government-based currencies require you to have a bank connection or ATM to get more of it or make transfers, cryptocurrencies allow you to get rid of such intermediaries. Cryptocurrencies rely on blockchain technology which has no central bank or authority.
Blockchain at its simplest is a shared ledger or database which allows access and writing permission for anyone to verify transactions. Transactions are encrypted with an unhackable algorithm using cryptography, making them highly secure and enabling the name cryptocurrency.
Anyone can check the ledger at any time, everything is encrypted, so you need a key for a ledger slot to make sense of what you’re looking at, ensuring the system remains secure and public.
Developers release new coins as a ‘white paper,’ a business proposal for prospective investors. New coins used for crowdfunding are called Initial Coin Offerings (ICOs).
The first-ever cryptocurrency was Bitcoin. It was the first product of the first blockchain developed by Satoshi Nakamoto in 2008. Since then, cryptocurrencies have increased, with over 10,000 cryptocurrencies now available.
How does cryptocurrency work?
Transactions in cryptocurrency are sent between peers using software called cryptocurrency wallets. You use the wallet to transfer balances from one account, referred to as a public address, to another during a transaction.
You’ll need to have a password or private key associated with the account to transfer funds. Peer transactions are encrypted, broadcast to the crypto’s network, and queued up for addition to the public ledger.
You can download and run a copy of a full node wallet software to access the ledger of a given cryptocurrency if you want, as opposed to holding your coins in wallets like Coinbase. Transactions get added simultaneously to create ‘blocks’ added sequentially by miners, creating a ‘chain’ of ‘blocks’ of transactions.
While most cryptocurrencies like Bitcoin work this way, some like altcoins use unique mechanics, some offer fully private transactions, and others don’t use blockchain at all.
Investing in a digital currency offers unique benefits like low transaction fees, protection from inflation, and anonymity by eliminating a central authority.
Remember, cryptocurrencies come with their risks, and you must gain the necessary know-how before investing. Beginners guides like Cryptocurrency Investing For Dummies by Kiana Danial can provide the required knowledge.
What does “blockchain” mean?
The blockchain is a distributed database shared among nodes in a computer network. It’s a decentralized distributed ledger of records or transactions. Many transactions are added to the ledger at once in groups to create blocks. These blocks of transactions are then added sequentially by miners.
It creates a chain of blocks of transactions, giving the ledger and the technology behind it the name blockchain.
How does blockchain work?
The blockchain is like a bank ledger that holds a record of transactions and balances. Blockchain technology allows digital information to be recorded and distributed but not edited.
When crypto-assets or digital assets transactions occur, the transaction is sent out to all users hosting a copy of the blockchain. Users called miners attempt to solve cryptographic puzzles through software that allows them to add blocks of transactions to the ledger.
Miners who solve puzzles get rewarded with newly mined coins plus the fees paid by those who created the transactions. The algorithm relies on consensus, and at times miners can pool computing power and share the new coins.
Blockchain technology achieves decentralized trust and security in various ways. If most users attempting to solve the puzzle submit similar transaction data, the algorithm confirms that the transactions are correct. New blocks are also stored linearly and chronologically, meaning they’re continuously added at the end of the blockchain.
Through cryptography, each block links the data in the last block through one-way cryptographic codes called hashes. It makes tampering with the blockchain almost impossible.
Hash codes involve a mathematical function that turns digital information into a string of letters and numbers. Any edit on the data changes the hash code as well.
The challenge of cracking cryptographic puzzles, the reward of new coins, and the resources required to tamper, fake consensus, or add incorrect data to the blockchain help protect it against bad actors like hackers.
How do you buy cryptocurrency?
Obtaining cryptocurrencies is almost similar to getting other currencies but with a few key differences. There are usually three steps involved, which include:
Step 1: Choose a platform
You first need to decide which platform you’re going to use, and you can generally choose between a dedicated cryptocurrency exchange or a traditional broker.
- Cryptocurrency exchange – You’ll find many cryptocurrency exchanges to choose from. They usually offer standard trading platforms where buyers and sellers meet to trade crypto. Each offers different cryptocurrencies, account options, and wallet storage, many charging asset-based fees.
- Traditional brokers – These usually include online brokers who offer you ways to buy and sell cryptocurrency and other financial assets like bonds, stocks, and exchange-traded funds (ETFs). While brokers can help reduce the complexities involved and lower trading costs, they offer fewer crypto features.
As you make your selection, consider the fees charged, the cryptocurrencies on offer, the security features, withdrawal options and storage, and any available educational resources.
Step 2: Adding funds to your account
After choosing an appropriate platform, you’ll need to sign up or open an account and fund it so you can start trading. Most brokerages and crypto exchanges will allow you to purchase crypto using government-issued or fiat currencies like the British pound, US dollar, or the Euro using their credit or debit cards.
Purchasing crypto using credit cards is considered risky. Some credit companies also do not support crypto transactions because of their high volatility while others impose high fees for crypto transactions.
You may also find platforms that accept wire transfers and automatic clearing house (ACH) transfers. The time for deposits and withdrawals and the payment methods accepted may differ depending on the platform. The time needed to clear deposits may also vary depending on the payment method you use.
Keep in mind the fees, including potential withdrawal and deposit transaction fees, plus any trading fees. You need to research the costs from the outset because they can vary depending on the platform and payment method.
Step 3: Place an order
You can start to trade cryptocurrency once you have money in your account by placing an order through the exchange or broker’s web or mobile platform.
You can purchase different types of cryptocurrencies by selecting the buy option, choosing the order type, the number of cryptocurrencies you wish to purchase, and confirming the order. You’ll also use the same process when you want to sell cryptocurrencies.
Other ways for cryptocurrency investing include using services like Venmo, PayPal, and Cash App, which allow users to buy, hold or sell cryptocurrencies. You can also use investment vehicles like:
- Bitcoin Mutual Funds provide different Bitcoin EFTs and mutual funds to choose from.
- Bitcoin trusts allow you to buy Bitcoin trust shares using a regular brokerage account. They provide retail investors with exposure to the cryptocurrency market through the stock market.
- Blockchain ETFs or stocks allow you to indirectly invest in crypto through blockchain companies specializing in the technology behind crypto and crypto transactions. You can also buy ETFs or stocks of companies using blockchain technology.
You can choose a suitable option for you depending on how much you wish to pay based on cryptocurrency prices, your investment goals, and whether you’re a high-risk or low-risk taker.
What is cryptocurrency mining?
Cryptocurrency mining involves solving cryptographic puzzles using computer software to add transactions to the blockchain ledger to get rewarded with coins. To spend or receive cryptocurrency, users must create transactions and broadcast them to the entire network.
For such transactions to go through successfully, they must be recorded on the blockchain permanently. Mining involves adding such transactions to the blockchain and making them a permanent part of the public ledger.
Algorithms make mining difficult to prevent miners from creating fake transaction blocks and adding them to the ledger. Instead of adding transaction blocks to the blockchain at will, miners must solve challenging computational puzzles called proof-of-work schemes. They involve easy to verify but challenging to find solutions.
Therefore, miners are simply competing to solve a complex cryptographic puzzle first. The one who finds the solution broadcasts it to all of the other miners who verify the answer is correct. Once verified, the network permanently adds the successfully mined block to the publicly accepted blockchain.
How does cryptography work with cryptocurrency?
Crypto loosely translates to secret or concealed. The word cryptography means hidden or secret writing, and it involves exchanging messages that can only be read by the intended audience or recipient.
Cryptography technology can apply full or pseudo-anonymity depending on the configuration.
Cryptography guarantees the security of the participants and transactions in cryptocurrency, and it’s usually independent of any central authority operations and protects from double-spending.
There are different methods for encryption in cryptography, including:
- Public-key cryptography
Public-key cryptography is one-way cryptography used by keys that move around balances in the blockchain. It’s also called asymmetric cryptography and uses a pair of keys to decrypt and encrypt data, with each team consisting of a public key and a private key.
Public keys are disseminated openly, while private keys are only known to specific owners. It enables the two critical functions of encryption and authentication of cryptocurrency transactions. You can encrypt a message using the receiver’s public key, but only its private key can decrypt it.
Tokenization is one-way cryptography that points to data but doesn’t contain all the original data. In cryptocurrency, token generally refers to a cryptographic string of letters or numbers standing in for ‘real data.’ It’s also described as symmetric encryption cryptography.
The same secret key is used to encrypt the raw message at the source, and after it’s transmitted, it’s used to decrypt the message at the destination.
Any unauthorized recipients that receive the encrypted message will not know what it means unless they know the encryption methodology.
More than one part of the transaction in cryptocurrency exists as tokenized data.
Hashing is another cryptography method used in cryptocurrency to verify the integrity of transactions on the network efficiently. Hashes are one-way cryptographic codes that tie together blocks on the blockchain and use cryptography similar to public-key cryptography.
They maintain the structure of blockchain data and encode people’s account addresses. They’re also integral in the process of encrypting transactions occurring between accounts, making block mining possible. Digital signatures complement it, allowing genuine participants to prove their identity on the network.
What is an NFT?
NFT means non-fungible token, and it refers to a unique token that you can’t replace with something else. Things like Bitcoin are fungible because you can replace one Bitcoin with another and still have the same thing. However, a one-of-a-kind trading card is non-fungible because if you traded it for a different card, you’d have something completely different.
NFTs at the highest level, NFTs are part of the Ethereum blockchain. It’s a cryptocurrency similar to Dogecoin or Bitcoin, but its blockchain supports NFTs.
Choosing a cryptocurrency
With so many cryptocurrencies available today, it’s easy to get overwhelmed and confused about which cryptocurrency to choose for investment. Some of the most popular cryptocurrencies include:
- Bitcoin (BTC)
Bitcoin is the original cryptocurrency and has a market cap of over $846 billion.
- Ethereum (ETH)
Ethereum is a blockchain platform and cryptocurrency with over $361 billion in market cap. It has its crypto called Ether (ETH) or Ethereum and is a favourite among program developers because of its many applications.
- Litecoin (LTC)
Litecoin currently has a market cap of $ 9.3 billion and has quickly developed faster processes and payments for increased transactions.
Safety features of cryptocurrencies
Thanks to blockchain technology, cryptocurrencies are relatively complex, and the digital ledger makes it difficult for hackers to tamper with. It also uses two-factor authentication for increased security.
However, cryptocurrency scams still exist and include bogus websites that promise massive returns or Ponzi schemes that promote non-existent opportunities. Before investing in any crypto opportunity, due diligence is vital to avoid falling victim to such scams. And if it’s too good to be true, it probably is.
How does cryptocurrency work in simple terms?
In simple terms, cryptocurrency refers to digital money that enables you to get rid of intermediaries like banks.
How do you make money from crypto?
The various ways to make money from crypto include investing, trading, lending, staking, mining, crypto social media, and forks or airdrops. Given the inherent volatility of crypto, most involve high risk, while others require expertise or knowledge.