How Does Cryptocurrency Work? [Essential Guide]

How does cryptocurrency work exactly? That is a question many ask themselves. Cryptocurrency is a complicated topic that I’ll explain to you in this essential guide to cryptocurrencies. 

When you think about cryptocurrency, more questions than answers arise. 

What is cryptocurrency? How does cryptocurrency work? Are cryptocurrencies a good investment? Is it safe to invest in cryptocurrencies? How can I invest in cryptocurrencies? 

In this post, we’ll provide you with a breakdown of the basics of cryptocurrency. You will get all your questions answered and you will learn everything you need to know. 

What Is Cryptocurrency?

For many centuries, people have traded to get the goods they needed. In today’s world, most of the currency is printed by the government or financial institutions. Satoshi Nakamoto, the founder of bitcoin, thought about another way to regulate money. A currency that is regulated by math. Without the government.

Cryptocurrency is a digital or virtual form of money, that is unregulated by any authority and forms a new monetary system. This digital currency is supported by the blockchain, a decentralized peer-to-peer network. The blockchain makes sure that all transactions and wallets are tracked. 

This system has a way of making sure no one can cheat the system. Every transaction is verified by the system for accuracy, while the system stays anonymous and transparent. 

What Is A Ledger & How Does It Work?

All transactions are visible in the ledger, where all transactions are public so everyone is enforced to play fair and be honest. Plus it prevents double spending of your coins. 

A ledger is basically a list of data that nobody owns. It is decentralized on dozens of different computers. This means that the ledger, aka the cryptocurrency blockchain, is self-governed and there are no outside parties involved. 

The computers that are connected to the blockchain, the cryptocurrency miners, need to agree on the transactions. When the miners agree on all the transactions on the blockchain, the block will be accepted and registered. When the block is registered, there is no way back – it is on the ledger forever.  

How does that work? Let’s check it out. 

How Can Transactions Be Verified On The Blockchain?

You have bought Bitcoin and you decide you want to spend it. Now, what happens?

When you spend your Bitcoins, the transaction needs to be confirmed first. When the transaction is unconfirmed, it is not officially on the blockchain yet. Only once the transaction is confirmed, the transaction is part of the blockchain with other transactions that occurred. 

What is that verification process?

The Bitcoins that you spend, go through a verification process. Cryptocurrency miners verify the transactions by solving complex math that is key to verifying a transaction. The thing about cryptocurrency mining is that it is an open-source system. This means anyone can confirm a transaction. The one who solved the problem the fastest adds the block of transactions to their ledger. This is called ‘proof-of-work’. 

When a miner adds a block to the ledger, the miner gets a reward. This reward varies based on the cryptocurrency you’re mining for. Bitcoin used to award 50 BTCs back in the days, at the moment this is only 12.5 BTCs (their award halves at preset times). 

Cryptocurrencies – Where To Buy & Invest?

Cryptocurrencies can be bought on several exchanges, with Binance and Coinbase being the most popular cryptocurrency exchanges. These two exchanges are the best if you want to buy and trade in cryptocurrencies.

Especially for beginners, these platforms are a great start!

If you’re outside the US, Binance is the best trading platform. They are straightforward, easy to use, and cheap.

Man Investing MSN computer working stock market
Image Credit: iwatchwater/Depositphotos.

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If you’re in the US or you want to only trade the few biggest coins, Coinbase is for you. It’s a very reliable platform that gives you $10 in Bitcoin using this link when you trade for a minimum of $100.

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If you decide to buy cryptocurrencies, it’s very important that you sign up with a reputable exchange. After you have signed up, you will be able to buy the cryptocurrency of your choice and store it in your wallet. 

Investing in cryptocurrencies is easier now than it ever was. 

BUT, there are still some problems with cryptocurrencies. For example, they are highly volatile and speculative for the most part. Since December 2017 people have seen their portfolio decrease in value by more than 80% in less than three months. 

You don’t want to be the person who invested their retirement fund in Bitcoin and is now not able to retire when they originally wanted to. 

Bitcoin can go either way. It can double in a few months, or it can lose another 60% of its value.

These types of investments are very high risk. They are highly impacted by things like regulations, new coins, or new developments in technology. Personally, I have around 2% of my net worth invested in cryptocurrencies. It is money that I can afford to lose. 

Is Investing In Cryptocurrencies Safe?

When you want to log into cryptocurrency platforms or exchanges, many security measures are taken. Things like two-factor authentication and encrypted information are the norm. 

Is that enough?

Hacking these platforms is hard, but that doesn’t mean it can’t be done. For example, in 2014, $450 million worth of Bitcoin has been stolen from Mt. Gox. Mt. Gox was a huge cryptocurrency trading platform that has declared bankruptcy shortly after. 

When you’re not planning on trading your cryptocurrencies any time soon, it would be best to take them off the platform in your own wallet. With you taking your assets off the exchange, the risk of you being hacked reduces greatly. 

On the other hand, you should be careful where you store your passwords. When you lose your passwords you can’t access your coins and they are lost. To prevent this, make backups of your keys.

Preferably you would make long and hard-to-guess passwords. The longer you make your passwords, the harder it is to hack them.

Protecting your investments by having them in your own wallet makes for a great first step. Imagine that you have a wallet with thousands of coins from a currency that has been increasing exponentially. Only when you log in, do you realize the wallet got hacked. Noooo!

To keep your coins safe:

  • Use well-known sources for trading and storing your cryptos.
  • Take them off the exchange when you don’t plan on trading them.
  • Make backups of your keys.
  • Use long and hard to guess passwords.

3 Most Popular Cryptocurrencies

There are thousands and thousands of cryptocurrencies out there. At the moment of writing, there are over 5200 cryptocurrencies registered. Every day new cryptocurrencies are joining and other cryptocurrencies will fail. 

There are the free most popular cryptocurrencies:

  1. Bitcoin – Bitcoin (BTC) is the first cryptocurrency and is dominating the market. At the time of writing, Bitcoin trading is over 65% with a market cap of $118 billion. 
  2. Ethereum – Ethereum (ETH) was made to be the better version of Bitcoin, with lower transaction speed and smart contracts to increase the security of the Ethereum blockchain. Ethereum is trading at a $14 billion market cap, which is only 10% of Bitcoin. 
  3. Ripple – Ripple (XRP) is created on the Ethereum network. It is also made to increase transaction speed and it is very cheap to trade. You have to buy Ripple at an exchange though because they can’t be mined. 
Stacking Golden Bitcoins
Image Credit: belchonock/Depositphotos.

All In All – How Does Cryptocurrency Work?

I enjoy learning about the technology that is behind cryptocurrencies. Cryptocurrencies are a virtual form of money that is unregulated and supported by the blockchain. The blockchain tracks all the transactions and wallets. To make sure no one can cheat the system, everyone needs to agree before transactions are put on the blockchain.

Investing in cryptocurrencies has two faces. You have the potential to lose all of your money. Or you have the potential of massive returns. 

Check out these 7 lessons that I learned when investing in cryptocurrencies.

If there is one thing I want you to take away from this, it would be this: there is always a high risk associated with high returns. 

What do you think about cryptocurrencies?

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