Cryptocurrency, also known as crypto, is a form of currency that does not exist physically. It is a decentralized virtual currency system that is not issued or regulated by any trusted third party. You can also take it as a digital asset that does not involve any bank, government, or central monetary as a regulating authority.
Cryptocurrency is a digital network in which transactions are made from peer to peer. Transactions are not verified by any bank and also they are saved as a digital assets. Defining crypto in limited words is quite difficult, but I’m sure by the end of this post you will be able to understand: What is Cryptocurrency, and how does cryptocurrency work?
How does Cryptocurrency work?
The currency exists digitally or virtually and its transactions are made using cryptography. To understand “how cryptocurrency works” it is critical to understand the concept of cryptography.
What Is Cryptography?
Cryptography is the data communication technology that is used to protect and send digital data. This computer science knowledge allows users to transform data into formats that are end to end encrypted and no unauthorized user can access that data. Since cryptocurrency doesn’t rely on any trusted third party, its transactions are made through cryptography.
History Of CryptoCurrency
The idea of cryptocurrency dates back to the 1980s when American programmer David Chu introduced digital currency that was secured by cryptographic techniques. However, due to the lack of software and programs needed to create an independent transaction system, this idea did not gain popularity.
The modern concept of crypto dates back to 2009 when an unknown programmer or a group of programmers under the name of Satoshi Nakamoto developed the first cryptocurrency coin “Bitcoin” Before the launch of the first cryptocurrency coin a paper was published that outlined the effective method of creating a digital currency system that doesn’t rely on any bank or trusted third party.
After the launch of the first Bitcoin protocol in 2009, it was released as open-access software. The first transaction with this protocol was made on 12 January 2009 between Haul Finley and Satoshi Nakamoto. By early 2010 Bitcoin was the only cryptocurrency, but later on, many other protocols were introduced to the market.
Initially, the value of bitcoin was a few cents and the value of cryptocurrency seemed to vary over 7 years. 2017 is known as the year of cryptocurrencies as the total asset for cryptocurrencies was recorded at around $820 billion. In February 2017 the market cap for cryptocurrency faced a major crash and after that, it has grown with steady yet more stable growth.
What is Blockchain?
Before we jump to “How cryptocurrency work”, it is crucial to understand the concept of blockchain. Blockchain is a technology that keeps the record of data collection on cryptocurrency networks. The term is often confused with bitcoin. The key difference between bitcoin and blockchain is that bitcoin uses blockchain as a public ledger to make secure and independent transactions.
Blockchain is a shared network technology that has a crucial role in cryptocurrency. It is shared among nodes of a computer network and it stores the information in digital format. A collection of transaction data over a crypto network is assumed as one block. A block on a crypto network contains information like person “A” sent a particular crypto amount to person “Z” or person “Y” received the particular amount from person “Z”.
It is stored over a shared database that secures this data and limits the access of unauthorized users. When a new block is added to the network it holds the reference of the previous one and in this way, a chain is created, known as the blockchain. A blockchain is very secure larger as the references are added to every new block coming to the chain. If a scammer or hacker wants to hack a block, he needs the exact reference that the previous block in that chain holds.
He needs to recreate the whole chain of blocks that are following that particular block. Invalid references are not accepted by blockchain making it a secure system. However, the blockchain is not 100% secure and crypto has lost the trust of many users due to scamming and hacking issues that we will discuss later in the post.
To make the blockchain more secure cryptocurrency uses the method of proof-of-work to ensure the validity of blocks that are added to the chain. The crypto miner who wishes to add a new block uses immense computing power that helps them with complex mathematical problems and puzzles. The process is known as mining and miners are rewarded with Bitcoins.
If a miner fails to provide a solution he cannot add a new block to the puzzle. As the chain grows longer the computing power required to add a new block increases. The longer the blockchain the more secure it is. To alter or tamper with the transaction data a hacker needs computing power that is equivalent to the sum of all computing powers on a blockchain. So as the chain grows longer the chances of hacking and scamming are also reduced.
Another method to add a block to the chain is proof of stake. This method doesn’t require computing power, instead, it allows the most wealthy cryptocurrency holders to verify the transaction and add blocks to the chains. The wealthy crypto holders or old stakes are chosen randomly on the network and they are allowed to make the certified transactions.
How Does Cryptocurrency Work?
Cryptocurrency works on blockchain technology and every crypto holder is provided an address on a particular blockchain to keep the funds. This address is known as “Wallet”. You keep your digital currency in the wallet. Since this wallet is provided on a shared network database it contains both public and private keys that are used to complete the secure transactions.
To buy a cryptocurrency, you need to understand Cryptocurrency exchange. A cryptocurrency exchange is an online marketplace that is similar to brokerage platforms. The crypto exchanges contain all the tools and resources you need to sell, buy or exchange your crypto coins.
All the crypto exchanges have different assets, payment methods, security, and fees and you need to consider all these features while buying a cryptocurrency coin. In addition to buying and selling cryptocurrency, you can also buy products and goods with cryptocurrency. Once you make a purchase, you need to authorize a transaction that transfers the currency from your wallet address to the wallet of the seller on a blockchain.
Also, you need to specify the amount you need to transfer. Once you authorize the transaction the miner on the blockchain uses the public key to ensure if you have used your private key for the authorization. After the confirmation of the transaction, the new balance is updated on your wallet and the seller’s wallet.
How To Buy A Cryptocurrency?
Find A Trusted Seller
The first thing you need to consider is where to buy the cryptocurrency. As a beginner, it is not a good idea to buy currency from a decentralized exchange. Certified exchanges or third-party sellers ensure that you are getting something against the value you are paying. Centralized exchanges are trusted and reliable but they charge fees for the services they provide.
Most of the centralized exchanges sell the cryptocurrency at market rates. If you are not new to this crypto world you may take risks to buy the cryptocurrency from brokerage platforms. Weibull and Robinhood are among the famous online brokers that give you access to cryptocurrencies and stocks.
The third option you have is the platform that only deals in the cryptocurrency world. The famous crypto-sellers are Gemini and Coinbase. You may not get full access to the core assets, but you will have a wide range of choices while buying a cryptocurrency. These platforms are known for their better selection of currencies.
Using a decentralized platform is tricky and you need high computing power and sound knowledge of crypto trading. Decentralized crypto exchanges have better coin selection and also they charge you less than the decentralized platform. Although decentralized exchanges have a complex mechanism and some trust issues, they are very secure against cyber attacks.
Trading on a secure blockchain makes it difficult for hackers to attack a single block or transition and in this way, it keeps your amount secure. Once you enter the crypto world and become a part of the blockchain, you can now buy and sell cryptocurrencies through peer-to-peer transactions. You can authorize transactions from your wallet using your private key. This is known as peer-to-peer crypto trade.
Choose The Payment Method
If you are new to crypto, most likely you need to pay the fiat currency to purchase the cryptocurrency. The most common currency used for buying cryptocurrency is US dollars. However, those who already keep cryptocurrency in their wallet can use it to buy a new currency. Thre are multiple types of cryptocurrencies Bitcoin and Ethereum being the most popular. If you don’t want to use the existing crypto holdings you can also use regular money to invest in a currency whose value can increase in the coming days.
Add Fund To Your Account
Once you have made a purchase, it’s time to add value to your account. If you buy a cryptocurrency with regular money, the currency will be transferred to your account via bank or debit. Mostly centralized exchanges authorize debit and bank transactions. If you already hold a wallet on the blockchain, you can transfer the currency to your account. However, trading the currencies over the crypto exchanges is not as simple as you think.
You need to consider many factors to ensure that you are authorized to do trading or not. Some crypto exchanges do not allow the trading between particular assets. Also, you may not be able to trade a particular asset with your existing crypto funds. Alo the crypto exchanges have different charges depending upon the asset you are looking for. You need to carefully read the trading charges of crypto exchanges to make a profitable purchase.
Selecting The Cryptocurrency
In the crypto marketplace, you will find multiple currencies, and choosing the one that is profitable and future-proof is quite challenging. The choice ultimately boils down to the goals and aims that you want to achieve with this investment. Also, it depends upon the value of the funds you have. Plus you need to look for a currency that is secure, and stable and its value is likely to increase in the future. Here are the top five cryptocurrencies:
Bitcoin
Bitcoin is the first and most valuable cryptocurrency. The transactions are made over a blockchain ledger and all its transactions are secured by various methods. To mine the bitcoins or add a block to the chain, it uses various cryptographic techniques like puzzle solving or stake-authorization to keep the currency safe from fraudsters. From May 2016 to March 2022 the value of Bitcoin increased up to 7800% and today you can buy 1 bitcoin for $44000.
Ethereum
Ethereum is the second most valuable cryptocurrency that is among the favorites of developers in the blockchain. This protocol supports a so-called smart contract that is automatically processed once the conditions are met. Also, it supports complex financial transaction that is usually not supported by Bitcoin. From 2016 to 2022 the value of Ethereum is grown up to 27000%. The market cap of Ethereum is $361.
Tether Stablecoins
This is the most stable form of cryptocurrency. If you want to make a safe and future-proof investment, Stabecoins is an excellent choice. The value of stable coins is backed by fiat currencies like US dollars or Euros and their value is much more stable compared to other types of cryptocurrencies.
Binance Coin
This protocol is mainly used to do trading and pay feeses over one of the largest crypto exchanges Binance. This currency was launched in 2017 and is among the best-growing cryptocurrencies these days. You can use this currency to buy other cryptocurrencies like Ethereum or Bitcoin.
Polkadot
This cryptocurrency protocol allows interoperability among different networks and blockchains. This is an open portal that allows the miners to add or create a new blockchain. This protocol is designed to create a connection between permission and permissionless blockchains. The total market cap for Polkadot is around 50 billion US dollars.
FAQs
Is investing in cryptocurrency a good idea?
If you believe in blockchain technology and understand how cryptocurrency works then it is a good idea to invest in a cryptocurrency. It is a long-term yet risky investment and many people believe that cryptocurrency is going to see an immense value rise in the future.
Can cryptocurrency be converted to cash?
Yes, cryptocurrency can be converted to cash in many ways. You can use a broker platform for third-party exchange to convert the cryptocurrency into cash. if you are authorized to make the transactions in the peer-to-peer platform you can convert the crypto into cash by selling it. It helps you save the fees that brokers charge you when you exchange the currency.
How do beginners invest in Bitcoins?
As a beginner, you need to use fiat currency to buy Bitcoins. The best way is to join a certified Cryptocurrency exchange platform and buy the bitcoin by paying real money. They may charge you an extra fee for their services but as a beginner, you should not trust the decentralized exchanges.
Wrapping It Up
If you want to invest in cryptocurrency it is crucial to understand that it is not an easy job. Keeping a track record of the ups and downs in the value of different cryptocurrencies and trading in unstable situations is a demanding job. I’m hopeful that this post will help you learn “How cryptocurrency works”. However, without entering the crypto world you might not be able to learn the skills and abilities that are needed to make a profitable and future-proof investment.