What is cryptocurrency and how does it work
Cryptocurrency is a mean of payment that exists only on the Internet. It has no paper expression, and its value does not depend on the state.
Usually, to transfer money from one person to another, you need an intermediary - a bank. With cryptocurrency it is different: the bank is not involved in the exchange. Cryptocurrency is built on the blockchain system - a chain of information blocks. They are used to transfer digital money from person to person without an intermediary.
In 2009, the first digital coin, Bitcoin, appeared, and since then the number of cryptocurrencies has been growing.
We tell you what cryptocurrency is, how it works, what its price depends on, how to get it and use it.
What is blockchain
Blockchain is a way of storing information along a chain. Records of transactions of network participants are encoded, distributed among other participants and form interconnected blocks. If someone tries to make changes to obtain currency in an unfair way, such as rewriting an existing transaction or creating a new one without the consent of other participants, the system will compare this information with other databases and block the transaction.
It's like having your own bank branch on your computer.
To be able to carry out transactions, you need to maintain the network in working order - this is what miners do. They donate their computing power to the system to produce new blocks and coins, and receive a percentage of the operations. The creator of the blockchain himself determines how many resources the miner must provide in order to receive the reward. All participants in the issuance of cryptocurrency are endowed with equal rights and opportunities.
The developers include in the system a limitation on the emission of cryptocurrency - for example, only 21 million bitcoins can be produced.
Forms of cryptocurrency
Digital currency is divided into coins and tokens.
Coin. This is a cryptocurrency currency that operates on its own blockchain. It can be obtained through mining - providing the system with the computing power of your computer. Coins can be transferred to other users of the blockchain system and sold for regular currency. Some companies accept them as payment for goods and services. For example, Microsoft sells the Windows operating system and the Xbox game console for bitcoins.
There are coins that run on a rewritten Bitcoin blockchain. They are called altcoins - alternative versions of Bitcoin.
Token. This cryptocurrency currency is created on the basis of an already existing blockchain. They cannot be obtained, but can be purchased or received for activity. Even in theory, tokens cannot be used to pay; they are used to give the user access to the platform’s functions. If a coin is a bill, then a token is a ticket. But if you bring the token to the exchange, it can be exchanged for regular money at the current rate.
Tokens can be used as an investment tool and evidence of business ownership, and can be used to participate in voting or surveys.
Tokens have more capabilities, but coins are more valuable among investors: they are more difficult to create.
How to get cryptocurrency
To store coins or tokens you need an electronic wallet. There are several ways to fill your wallet with cryptocurrency.
Mining. Creation of a new network block for which a reward is awarded. To do this, you need to provide the system with your computing power. If at the beginning of the emergence of cryptocurrencies it was possible to mine from a regular PC, now the network level has become more complicated. Special devices have appeared - mining farms. Individual users combine the power of their computers and create associations of miners.
Staking. If the income in mining depends on the power of the equipment, then in staking it depends on the number of cryptocurrency coins already available. This is a kind of investment: the owner sends coins to maintain the blockchain and receives a reward for this.
Purchase. Cryptocurrency can be bought. For this purpose, there are exchangers where people can sell and buy digital coins for another cryptocurrency or for national currency. You need to pay a commission for the exchange.
A commission-free alternative is p2p exchangers that allow you to transfer money from person to person, without intermediaries. To use them, verification is required - disclosure of your passport data.
Another way you can buy cryptocurrency is to use crypto exchanges.
Trading. Crypto trading is similar to regular trading. It is based on the principle of “buy low and sell high.” The high volatility of the price of cryptocurrencies allows you to conclude quick transactions. Trading is carried out on trading platforms.
The developers of the Dogecoin currency offer several ways to earn cryptocurrency: purchasing, exchanging, mining and providing the power of your computer
Tokens can be purchased on an exchange, in an online exchanger, or directly from a company that offers a portion of the profits from some project for the purchase of a token. They are purchased both for regular money and for cryptocurrency.
How is cryptocurrency used?
There are several ways to use cryptocurrency.
Investments. Cryptocurrency attracts investors with its high return on investment. At the end of the first quarter of 2023, Bitcoin became the leader among other investment instruments - since January 1, 2023, its price has increased by 70%.
Speculation. Cryptocurrency market prices are an easy subject of speculation. The variability in the value of electronic money creates differences in exchange rates. This difference is used by traders and crypto brokers.
Exchange cryptocurrency for goods and services. The exchange is not common everywhere, but it is gaining momentum. Cryptocurrency payments are accepted by Amazon, EBay, and PayPal. ATMs for cashing out funds are appearing, and a unified form of payment with cryptocurrency debit cards is being developed - BitPay.
Why is it safe to use cryptocurrency?
Data that ends up on the Internet can be appropriated and changed, but on the blockchain, fraud with wallets or payments is almost impossible. The high level of security is due to the fact that the information in each block is encrypted, and the blocks are interconnected via a chain. To hack a system, you need too much power, since for the sake of one cell of information you will have to change the code of all the others.
The system has other features that guarantee safe operations:
There are public and private keys. The public key is the user’s electronic wallet address and is publicly available. A private key is a cipher known only to the owner of the wallet. Keys work like this: one user wants to send cryptocurrency to another and encrypts it using a public key, and the recipient uses a private key to open the “letter.”
What determines the price of cryptocurrency?
The price of cryptocurrency is influenced by the supply and demand of network users. It does not depend on the state and national currency.
The more popular a cryptocurrency is, the more users it attracts. This means that the number of operations increases and its value increases. When there are fewer users, the price of the cryptocurrency falls.
At the end of 2020, many bitcoins were withdrawn from exchanges, but the demand remained the same. Because of this, its price increased sixfold in January 2021
For miners, the price is different: it consists of the cost of equipment and electricity costs.
Types of cryptocurrencies
There are three types of cryptocurrencies.
Decentralized.These are cryptocurrencies that are obtained by mining. For example, Bitcoin, Ethereum, Zilliqa, Elastos, IOTA.
Pseudo-decentralized.The issue and circulation of such currencies is controlled by a closed group of people, who can also make decisions to block the owners’ accounts. At the same time, it is impossible to obtain electronic money using mining - they buy pseudo-decentralized currency. Such cryptocurrencies include Bitcoin Cash, Ripple, TRON, EOS.
Stablecoins.The value of such a currency is tied to some value, less often to another cryptocurrency, so its price changes more often than that of other currencies. For example, Gemini Dollar is equal to a US dollar, and DigixDAO is equal to a gram of gold.
Stablecoins, the issue of which is backed by national money, are completely centralized. For example, the company Tether Limited released the Tether cryptocurrency, which is 20% backed by reserves of US dollars from the organization’s accounts. And the Gemini Dollar is fully backed. It is supervised by the New York State Department of Financial Services.
Risks
The peculiarity of cryptocurrency is that it has no government regulation. There are risks associated with using cryptocurrency. Here are the problems that cryptocurrency miners and buyers may encounter:
The use of cryptocurrency is associated with risks due to the fact that it is not regulated by the state. Here are the problems that cryptocurrency miners and buyers may encounter:
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In most countries, cryptocurrency cannot be officially exchanged for goods and services. This is due to the fact that its production and transfer is anonymous, which means that participants in the process can evade paying taxes. Some online stores accept it and can also be traded, but its price directly depends on demand. If demand falls, the currency will depreciate and the owner may lose all the money invested in it.
How is cryptocurrency used?
Cryptocurrencies are processed in a distributed public ledger - a blockchain, where records of all transactions are stored, updated by currency holders.
Cryptocurrency units (coins) are created through the mining process. This is a process in which a computer's processing power is used to solve complex mathematical problems, resulting in the generation of coins. Users can also buy currency from brokers and then store and spend it using crypto wallets.
Cryptocurrency is not a tangible object, it is a key that allows a record or unit of measurement to be moved from one person to another without a trusted third party.
Bitcoin has been around since 2009, but financially, cryptocurrencies and the application of blockchain technology are still in their infancy; Their rapid development is expected in the future. In the future, cryptocurrencies can be used in trading transactions with stocks, bonds and other financial assets.
Examples of cryptocurrencies
There are thousands of cryptocurrencies. The most famous of them are listed below:
Bitcoin
Bitcoin, created in 2009, became the first cryptocurrency and still maintains the highest popularity. The currency was developed by Satoshi Nakamoto - it is believed to be a pseudonym for a person or group of people, and the exact identity of the developer remains unknown.
Ethereum
The Ethereum blockchain platform was developed in 2015. It has its own cryptocurrency Ether (ETH) or Ethereum. It is the most popular cryptocurrency after Bitcoin.
Litecoin
This currency is most similar to Bitcoin, but has faster innovations such as faster payments and processes that allow for more transactions.
Ripple
Ripple is a distributed ledger system founded in 2012. Ripple can be used to track various types of transactions, not just cryptocurrencies. The company behind the Ripple platform has worked with various banks and financial institutions.
Cryptocurrencies other than Bitcoin are collectively referred to as “altcoins” to differentiate them from the original.
How to buy cryptocurrency?
You may wonder how to buy cryptocurrency safely. This usually happens in three stages.
Step 1. Select a platform
The first step is to choose a platform to use. Typically, you can choose between a traditional broker or a specialized cryptocurrency exchange.
·??????? Traditional brokers. These are online brokers offering the purchase and sale of cryptocurrency, as well as other financial assets: stocks, bonds, ETFs. These platforms typically offer lower trading fees but fewer cryptocurrency features.
·??????? Cryptocurrency exchanges. There are many cryptocurrency exchanges, each offering different cryptocurrencies, wallet storage, interest-bearing account options, and more. Many exchanges charge fees based on the assets traded.
When comparing platforms, it is recommended to pay attention to the cryptocurrencies traded, fees, security features, storage and withdrawal options, and the exchange has a crypto license.
Depositing funds into an account
The next step after choosing a platform is to fund your account so that you can start trading. Most cryptocurrency exchanges, depending on the platform, allow users to purchase cryptocurrency using fiduciary (government-issued) currencies such as the US dollar, British pound, euro, or by paying with debit or credit cards.
Cryptocurrency purchases using credit cards are considered risky and are not supported by all exchanges. Some credit card companies also do not allow cryptocurrency transactions. This is due to the extremely high volatility of cryptocurrencies - when trading certain assets, it is not recommended to take risks by making trades in debt or potentially paying high fees for credit card transactions.
Some platforms also accept ACH transfers (automated clearing house transfers) and bank transfers. Acceptable payment methods and timing for deposits and withdrawals vary by platform, and deposit clearing times vary by payment method.
An important factor to pay attention to is the size of the fees, which includes potential deposit and withdrawal fees as well as trading fees. Fees vary depending on payment method and platform. It is recommended to study this issue at the platform selection stage.
Placing an order
Orders can be placed through the website or mobile application of the selected broker or exchange. To buy cryptocurrency, you need to select the “Buy” option, order type, indicate the amount of cryptocurrency to be purchased and confirm the order. A sales order is placed in the same way.
There are other ways to invest in cryptocurrency. These include payment services such as PayPal, Cash App and Venmo, which allow you to buy, sell and store cryptocurrencies. In addition, there are the following investment instruments:
·??????? Bitcoin trusts. Bitcoin trust shares can be purchased through a regular brokerage account. Such instruments provide individual investors with access to cryptocurrency through the stock market.
·??????? Bitcoin Mutual Funds. There are Bitcoin-linked ETFs as well as Bitcoin mutual funds.
·??????? Blockchain Stocks and ETFs. You can invest in cryptocurrency indirectly through blockchain companies that specialize in the technologies behind cryptocurrency mining and cryptocurrency transactions. Alternatively, you can buy shares or ETFs of companies using blockchain technology.
The best option depends on your investment goals and risk appetite.
How to store cryptocurrency?
After acquisition, it is necessary to ensure secure storage of the cryptocurrency, guaranteeing protection from hacking and theft. Cryptocurrency is usually stored in crypto wallets. These are physical devices or online programs used to securely store private keys to cryptocurrencies. Some exchanges provide wallet services, whereby cryptocurrency funds are stored directly on the platform itself, but not all exchanges and brokers provide such services automatically.
There are also different wallet providers. There are two types of storage of funds: “hot wallet” and “cold wallet”.
·??????? Hot wallet is a cryptographic vault that uses online programs to protect private keys to assets.
·??????? Cold wallet (also called a hardware wallet), unlike a hot wallet, uses offline electronic devices to securely store private keys.
Typically, there is a fee for using cold wallets, but no fee for using hot wallets.
Recommendations for safe investing in cryptocurrency
According to Consumer Reports, all investments involve risk, but a number of experts consider cryptocurrency to be one of the riskiest investment options. If you are considering investing in cryptocurrencies, the following tips will help you make an informed choice.
Analyze existing exchanges
Before you start investing, learn as much as you can about cryptocurrency exchanges. It is estimated that there are over 500 exchanges. To get started, do your analysis, read reviews and consult with more experienced investors.
Learn how to store digital currency
The purchased cryptocurrency can be stored either on an exchange or in a digital wallet. There are different types of wallets, each of them has its own advantages, technical requirements and level of security. As with exchanges, it's a good idea to explore different cryptocurrency storage options before you start investing.
Diversify your investments
Diversification is the key to a successful investment strategy. This is also true for cryptocurrency investments. For example, you shouldn't invest everything in Bitcoin just because it's a popular name. There are thousands of investment options, and it's best to spread your funds across multiple currencies.