What is a cryptocurrency and how does it work?

The popularity of cryptocurrency stays steadily high, and the scope of blockchain technology is only expanding. That is why a lot of users started to get actively involved in cryptocurrency, for a long time they monitor the value of coins, studying the factors that can affect the price of crypto assets today. Of course, to invest in cryptocurrency and make more profit out of it.

Even though cryptocurrency has been around for a long time, it wasn’t talked about en masse until recently, when Bitcoin skyrocketed in value. Some people are even considering buying a course to learn how to handle crypto and that’s a good idea. The problem is that really good classes about cryptocurrency work are quite expensive for a beginner, so you can learn this one on your own with our material.

Today we will help you understand the basics of cryptocurrency, what blockchain technology is that crypto is based on, and why types of cryptocurrency are so demanded and expensive. We will talk not only about well-known cryptocurrencies like Bitcoin or Ethereum but also some other crypto. Not only newbies but also more advanced crypto enthusiasts will find useful information here.

Starting with the basics: what is cryptocurrency?

To discuss the more complex aspects of crypto, it’s best to start with the basics, so newcomers will get up to speed more quickly. So, cryptocurrency is a digital asset and a decentralized means of payment that exists only on the network. Cryptocurrency has no paper expression, and crypto value does not depend on the state. 

What does it mean to be decentralized? This is the main distinguishing feature of crypto. In this way, a decentralized asset means that cryptocurrencies do not have a common, defined storage location like other information data. 

There are at least a thousand cryptocurrencies, but the most well-known are Bitcoin and Ethereum. The unit of cryptocurrency is a code that appears as a score of machine mathematical calculations. To summarize all this info about cryptocurrency work, let’s highlight the following features of all crypto assets:

  • Decentralized aspect and lack of control. Digital ledger transaction information is kept on a lot of servers around the world. This ledger and transactions are equally accessible to all participants.
  • The anonymity of crypto. Despite the openness of digital ledger transaction information, users see only each other’s wallet numbers. The owner of the crypto wallet remains unknown.
  • Transaction irreversibility. Recording a transaction in a block leads to a change in the whole chain. That’s why you can’t undo the transaction.
  • Absence of physical form. All cryptocurrency images or photos of wallets with Bitcoin are nothing more than symbolism. This means that cryptocurrency is a code, you can’t touch Bitcoin and all crypto or put it in your pocket. And a cryptocurrency wallet is a storage of information online or on a device, a digital wallet has nothing in common with the usual wallet.

Despite this, cryptocurrency, like traditional money, has an issue. Using Bitcoin for an instance, there is a total number of possible coins in the Bitcoin source code. Issuance affects cryptocurrency prices: if a new batch of coins is released, the worth of a unit usually falls.

What about the market cap for cryptocurrency?

If we are talking about cryptocurrency (Bitcoin or any other), the market cap means the total worth of all issued coins. It is important to note that this is one of the points for evaluating a cryptocurrency’s stability. You need to know that crypto with a larger market cap ratio will be a more stable deposit and less subject to market fluctuations.

What is blockchain technology?

Crypto is considered a decentralized asset, so cryptocurrency transaction info is kept on thousands of devices. It is combined into blocks, then into chains, which are defended by crypto keys, hence the name of the technology. The entire chain will be modified if you change the info in any of the blocks.

Crypto is not controlled by governments or banks. It makes the processing of cryptocurrency transactions independent, transparent to all participants in the network of devices in the chain, and anonymous simultaneously. In simple terms, cryptocurrencies like Bitcoin or Ethereum work as a replacement for banks and traditional payment systems, taking financial transactions out of the control of states and corporations. So, let’s a recap:

  • With this technology, transaction records of network participants are encoded, distributed to other users, and formed into linked blocks. It is like a branch of the bank on your computer.
  • If someone tries to make changes to get crypto in an unfair way, such as rewriting an existing transaction or creating a new one without the consent of the other participants, that’s not work. The system will compare that information with other bases and lock transactions

Theoretically, an ordinary data cloud can be hacked, and with cryptocurrency, this problem could also arise. Each participant of this system has info on all transactions made with crypto kept on the user’s computer. Indicators are automatically checked against each other with special schemes and updated. The basis of cryptocurrency as Bitcoin is cryptography (a reliable way to encrypt any data). Hacking an encrypted system is very difficult.

This technology also allows fast and commission-free processing of financial operations. The work speeds of many modern cryptocurrencies are close to or exceed those of the traditional payment systems we use in our daily lives. In simple words, what decentralized cryptocurrency is for can be described as financial operations that are fast, unmediated, and anonymous.

How does cryptocurrency work?

So, how does cryptocurrency work? We have already figured out that it is a unit of account of a decentralized payment system. It is a record of transactions that are kept on devices around the world. This transaction information is packaged into blocks, protected by cryptographic keys, and combined into a chain.

In the creation of crypto, particularly Bitcoin, a mechanism such as proof of work was first invented. Let’s discuss proof of work in more detail because it is very important for understanding the way crypto works:

  • Thanks to proof of work, a new block is added to the chain, transactions are confirmed and a single version of the registry is validated.
  • Proof of work provides the economic incentive that has become the basis to mine Bitcoin and another crypto.
  • The essence of proof of work comes down to the ability to quickly and easily verify results and the need to perform complicated time-consuming tasks.

These tasks are not originally intended for people, their solution by a machine is always achievable in a finite time, but requires a lot of computing power. At the same time, the verification of the obtained solution requires much fewer resources and time.

The need to solve the issue of how transactions will be approved and provide protection against abuse led to the emergence of another mechanism, the proof of stake. In simple terms, it is a set of rules by which network members agree on exactly how transactions can be approved and included in new blocks. 

So, there is also a proof of stake mechanism based on which various crypto and platforms, such as Ethereum, are built. According to the original concept of proof of stake, the right to manage the chain is given to all its participants according to the share of crypto they own. The demand for proof of stake is due to the lack of the need to buy expensive equipment to mine and the possibility of easy passive earnings (to stake cryptocurrency).

In addition to the two well-known proofs, there are several other types. A beginner user should deal with them to understand how crypto works:

  • Proof of history solves the problem of scaling and transaction processing speed. It is a consensus algorithm that has a built-in timing mechanism – a clock. It allows validators to match time.
  • A feature of proof of capacity, is that the chain requires free hard drive space, which is provided by users, who are paid for it. Thanks to this, the developers have achieved a reduction in power consumption.
  • Proof of space is based on a way of expressing interest in a service by allocating a non-trivial amount of memory or disk space to solve a problem presented by the service provider.
  • Proof of spacetime allows network participants to prove that they have spent a space/time resource. In turn, they have allocated storage capacity to the network over a period of time.
  • According to the proof of burn, the user who burned some of the coins has the right to join the block and receive the reward.
  • Proof of selection helps crypto fight confirmation bias by proving the correctness of token mining in the process of confirming that specified requirements are complete.
  • Proof of participation is that all decisions that are made are distributed evenly among all members of the network. This leads to better decentralization.
  • The essence of proof of activity is that mining is divided between two groups, one using proof of work and the other using proof of stake.

It is very important for beginners in the crypto field to get informed about a lot of proofs, because miners are constantly competing for coins.

What does it mean to mine a cryptocurrency?

Every person interested in crypto has heard that it can be mine. Here everything is very simple – to mine digital currency means the process of creating new coins. For a certain number of processed operations in the network, the miner gets paid in coins. This process requires powerful computing equipment because of the large number of operations performed and the high complexity of calculations. There are several ways to mine cryptocurrency:

  • It was more relevant to mine on CPUs in the early days of the first cryptocurrencies. However, now CPU power is not enough to process data on transactions stored in long chains. And this type of mining is considered only for crypto – newcomers to the market, not having a great history of operations.
  • Any digital currency can be released on the GPU, but some are better suited because they have an algorithm more compatible with the GPU. Older algorithms are not ground up to work with GPUs, so they can take a long time to process. Market flagships such as Bitcoin or Ethereum.
  • Only the miner who is the first to process the operation receives the reward, so there was a need for specialized equipment. This is the ASIC – a chip that is customized to calculate a specific algorithm for each digital currency. For example, SHA-256 for Bitcoin and Ethash for Ethereum.
  • There is also cloud mining, where large, industrial miners on the market rent out some of their equipment to online users. Some investors have even started to set up large enterprises (farms) in favorable locations for this purpose.

Today you can even mine in your browser or on your smartphone. Some programs allow you to work simultaneously on the CPU and GPU. It is also necessary to set up a wallet, which will receive the cryptocurrency. Thus, the process of crypto mine requires expensive equipment, and its cost is constantly growing, and today it can amount to tens of thousands of dollars. In addition, such equipment consumes a lot of electricity to work and requires additional cooling of the system.

Is cryptocurrency safe?

The high level of protection is because the information in each block is encrypted, and the blocks are linked together in a chain. It takes too much power to hack the system, because, for the sake of one cell of information, you would have to change the encryption of all the others. Other features guarantee safety:

  • Unique addresses are used to transfer funds.
  • Operations are open and transparent, but it is impossible to link the data to a specific person.
  • Operations are instantaneous and cannot be intercepted.
  • The authenticity of addresses is verified by encryption keys.

There are public and private keys. The public key is the address of the user’s electronic purse, it is in the public domain. A private key is a cipher known only to the owner of the wallet. The keys work like this: one user wants to send a digital asset to another and encrypts it with the public key, and the recipient uses the private key to receive it.

Are there any associated risks?

The security of digital assets remains a hot topic in the market. Despite the increasing number and diversity of projects using the technology on which crypto is based, it carries risks. The wrong assessment can lead to the most serious consequences, both for the average user and for a large company. That is why it is worth talking about the security of crypto and possible risks:

  • In particular, the vulnerabilities of this ecosystem include the lack of recoverability of stolen funds, the partial or complete anonymity of users, and the lack of legal regulations to protect their info.
  • Every time you transfer digital currency, you need to put in a digital signature, there is a password for this. If it is stolen, then it is possible to dispose of the money in the name of the owner. Thus, a person can lose a lot of money because of a stolen cryptographic key.

As a rule, the attackers targeted the encryption keys of sensitive user data. Once in their possession, they gain access to cryptocurrency management and then steal it. Back to the issue of security, it’s hard to answer the question of which digital currency is the safest, but most likely it’s Bitcoin. A large number of developers work with it, so it would take a huge amount of resources to organize such an attack.

Should I use a Ledger wallet?

But is there a reliable way to increase the security of digital currency? Of course, you can use a Ledger wallet for higher security, it’s a great way to protect your assets. Such devices for storing keys and other digital currency are a kind of flash drive. There are other brands of such wallets, but this one is now the most popular among users. The developers have also provided for the possibility of full information recovery in the case of loss of the device. 

If you are planning to get serious about crypto and keep large amounts of assets in your wallet, then be sure to consider getting a wallet as a stand-alone storage medium. Hardware wallet devices are the type that provides high reliability when saving personal keys. They are completely isolated from other systems and local or global networks. This is what makes such wallets invulnerable to hacking and accidental loss of information.

How can you use cryptocurrency?

It was assumed that you can use this digital asset not only on special exchange but also to buy anything for it: from household items to expensive real estate. However, despite the growing popularity of the use, large operations with Bitcoin or Ethereum are made quite rarely – but in ordinary online stores this payment option is found more and more often, which cannot but please users. Let’s consider where crypto is needed and for what purposes you can successfully use it:

  • Payment for goods and services mainly in online/physical stores: today you can pay with crypto in even real-life outlets, such as some coffee shops.
  • Exchange for various things and benefits: the owner of a store, after receiving payment in crypto, can convert it into the national currency. The exchange of crypto for goods and services is not common everywhere but is gaining momentum.
  • Long-term investment: the rate of digital currencies grows in long-term dynamics, so they can be considered a great investment. So, crypto attracts investors with high returns on deposits.
  • Earnings on exchange rate differences: knowledge of the cryptocurrency market and analytical skills allow you to buy and sell crypto in time and at a profit.
  • The need to store money safely: these are amounts that will not be affected by standard economic processes and crises.

Now crypto is to some extent integrated into the global economy – it is widely used to pay for various operations, and states and major banks are beginning to interact with this asset. 

It is also worth mentioning that prices on the crypto market are an easy object of speculation. The variability in the worth of digital money creates a difference in exchange rates. Advanced traders use this difference to make money on cryptocurrency exchanges.

Why are there so many kinds of cryptocurrency?

Differences in networks create a large number of coins. The Bitcoin blockchain is very slow, it is difficult to scale, and operations can be both very cheap and very expensive. Ethereum has it faster, but because of its great popularity, this currency has also faced a bandwidth problem, which has led to a dramatic increase in the price of operations.

In other words, anyone can make a token on some network. Making a new network, on the other hand, is not an easy task. People want fast transactions, and almost for free. That’s why programmers create faster and more scalable chains, nobody wants to wait for a long time when his operation with a huge commission is confirmed. At the moment, there are a huge number of networks. For the average user, they differ only in the cost of operations.

Another good reason why there are so many types of crypto is that anyone can create it as long as they have new developments. There is no regulatory body here to decide which coins can be produced and which cannot. Let’s take a look at some types of crypto:

  • Decentralized. These are cryptocurrencies that are mined. For example, Bitcoin, Ethereum, Zilliqa, and Elastos.
  • Pseudo-decentralized. The issue and turnover of such currencies are controlled by a closed group of persons. It is impossible to mine this asset. Such crypto includes Bitcoin Cash, Ripple, and TRON.
  • Stablecoins. The value of a such currency is tied to some value, less often to another crypto, so its worth changes more often than other currencies. Gemini Dollar is equal to the USD, while DigixDAO is equal to a gram of gold.

Judging by the market, the number of scams exceeds the number of normal coins by several times. Behind every coin, there must always be technology and an idea. One way or another, the purchase of any crypto has the sense to support the idea of its developer.

For instance, the Dogecoin project has always been surrounded by a lot of skepticism, and its creators themselves called it a joke. Nevertheless, thanks to the rapid development of the crypto sphere and active community, the project is not only at the top by capitalization, but it is also one of the most mentioned in the media and social networks.

How can you buy cryptocurrency?

Before you can make money from crypto, you need to acquire it. There are several ways to do this. Above we have already mentioned mining – calculating crypto keys for the network for a fee. This is a good way, but too expensive and time-consuming for beginners. It is much easier to buy crypto for traditional money. There are several places to buy and sell crypto:

  • Сryptocurrency exchanges often have quite high commissions because of the large number of intermediaries, but there are a lot of tools for trading and earning. Among the largest exchanges, today are Coinbase, Kraken, and Binance. When choosing, it is better to be guided by the quality of support, ease of deposit, and withdrawal.
  • Platforms where sellers and buyers publish their ads. They ensure the safety of operations by blocking funds on the buyer’s account until the seller confirms that the deal took place.
  • Online exchange services are fast, the rate is less floating than on cryptocurrency exchange, and commissions are small. It is important to choose carefully because there are a lot of fraudsters on the network. Do not trust too favorable exchange rates or suspiciously small commissions.
  • You can use custodial wallets with fiat topups (like Coinbase or Kraken). In addition, these wallets have certain advantages, such as less user responsibility for private key control.
  • There are also crypto trading TG bots like Cornix or TradeSantaBot (this is the is soft that connects to your account to help you make deals).

It is also worth mentioning the portfolio. It is all crypto collection, that a person has. Keeping track of your portfolio is quite difficult, especially if your assets are not in the same place. In that case, it is better to use a special tracker like CoinStats.

How do I choose crypto for my portfolio? This is the main question that both experienced and novice investors are interested in. No one has ever made a fortune in the crypto area by trading futures or buying hot tokens.

There are also a lot of pyramids and scams that masquerade as great projects. A lot of newbies trade things they have no idea about. And if they manage to make a short-term profit, that temporary success blinds them. When they lose in a year or another, they do not understand how it happened. To avoid this situation, check the following aspects before purchasing crypto:

  • The project behind the coin and where did you learn about it?
  • As a user, what does this coin give you?
  • And what is the capitalization of this project?
  • How much profit do you want to get out of it?

If you can not answer these questions when buying cryptocurrency, you just hope that it will grow in value. At a distance, such an approach is guaranteed to bring you losses. 

When you’ve decided on the crypto you want to buy, it’s time to find the right marketplace. If you are just starting in this area, then of course the first option to buy on the stock exchanges will be the best for you.

Crypto exchange working

The time when trading on exchanges was available only to a narrow circle of people has long been history. Today, anyone can become a crypto trader, regardless of the amount of initial capital. Now exchange trading is available to most users of the network. To become a crypto pro, it is fundamental to understand how such exchanges operate. 

So, crypto exchange is a platform where one digital currency is traded and exchanged for another. In addition to mining (the original method of creating crypto) exchanges are considered one of the ways to obtain them.

Each member of the exchange has the right to perform operations related to the analysis of bets, and sell and exchange digital assets for real money. There are resources where users can exchange crypto for real money and platforms that only allow the exchange of digital assets for another crypto.

When analyzing the activities of exchanges, we can distinguish two areas – trading and exchange. Some users even store their assets on such resources, using them as a wallet. However, experts advise against doing so, because exchanges, although rare, are sent to scams. The main function of the exchange is the sale of currency pairs, bringing enormous income to traders.

What does the price of crypto on the exchange depend on? Here are a few things:

  • The most important point for forming the price of a cryptocurrency coin is demand. The more users are interested in buying for one reason or another, the higher their value.
  • Also, the price of mining equipment, the overall complexity of its mining, and how widely a coin is distributed on popular exchanges affect the quotation of the digital currency.
  • Separately, it is worth noting the hard-to-predict factors that make investing in digital assets quite risky – political reasons, the influence of media, or crypto whales (users who own a large percentage of the digital asset).

Due to the high level of volatility, crypto can be used as a speculative tool, allowing you to maximize your profits. This method is similar to the trading that takes place on conventional currency exchanges. In general, online earnings through cryptocurrency can be really big. This market environment attracts a large number of investments, fueling interest in virtual currencies. A cryptocurrency exchange allows trading and, importantly, earning.

So, you don’t have to be an expert in crypto exchanges to make a profit. You can also make a fortune through speculation. To understand that you are only one step away from making a large income, you only need to observe how quickly the rate of online crypto changes.

What is the future of cryptocurrency?

Because of the significant decline in the crypto market capitalization last year, the question of the future of such a digital asset has become particularly relevant. It has also provided new arguments to those people who think crypto is a massive scam and a huge bubble. Optimists, on the other hand, remind us that such an adjustment is not the first.

The crypto market is relatively young and poorly regulated at the legal level in most states, with a high concentration of power in the hands of whales and a significant number of inexperienced users. All of this makes it extremely manipulative and sensitive to situational factors. The result is high fluctuations in the exchange rate.

Nevertheless, crypto is becoming more and more tangibly embedded in everyday life. This is especially evident in the increasing number of outlets and services where it is possible to pay with digital assets. Famous global brands are joining them. Even popular payment systems are also actively integrating crypto. Also, the number of users who buy digital currency and make money on cryptocurrency exchange is constantly increasing.So does crypto have a future? Definitely yes, even despite the pessimistic sentiments about a bubble that will burst sooner or later. This market is developing dynamically, and the interest in crypto both investors and ordinary users is only growing. Thanks to advances in technology, the security of operations with such a digital asset will only increase. Thus, claims that crypto is just another bubble are not entirely valid.