Cryptocurrency, Personal Finances

What Is Cryptocurrency and How Does It Work? 5 Things to Know

If you’ve been watching the news lately, you must have heard a few things about cryptocurrency. With big brands such as Tesla investing in Bitcoin, which is among the top five cryptocurrencies, this subject’s buzz is not dying down soon.

However, like most individuals, you probably don’t know many details about cryptocurrency. So what is cryptocurrency and how does it work? Our guide below provides all the information you need to know.

What Is Cryptocurrency and How Does It Work?

Also known as crypto, a cryptocurrency is a form of digital money used to purchase goods and services online. Cryptocurrencies are unregulated, and most people trade them for profits. Some companies have developed their own forms of digital currencies that can be traded for their goods and services.

These currencies work like casino chips or tokens. You have to exchange real money for the cryptocurrency amount of your choice.

Cryptocurrencies work using a technology known as the blockchain. The technology records and manages cryptocurrency transactions, and it is spread across numerous computers. 

Below are five things you should know about cryptocurrencies and how they work:

1. How Many Cryptocurrencies Do We Have?

There are over 6,700 types of digital currencies trading publicly in the market today. Cryptocurrencies keep increasing in value by raising money through initial coin offerings (ICO) offerings.

All cryptocurrencies were valued at over $1.6 trillion on February 18th, 2021. Bitcoin, being the most popular among them, was valued at $969.8 billion. Below are the ten largest cryptocurrencies by market capitalization:

  • Bitcoin- $969.6 billion
  • Etherum– $222.3 billion
  • Tether- $33.1 billion
  • Binance Coin- $30.5 billion
  • Cardano- $28.1 billion
  • Polkadot $28.1 billion
  • XRP- $24.4 billion
  • Litecoin- $15 billion
  • Chainlink- $13.3 billion
  • Bitcoin Cash- $13.1 billion

Bitcoin was the first cryptocurrency to be traded on public markets. However, governments don’t consider cryptocurrencies legal tenders such as the U.S. dollar and coins.

2. What Made Cryptocurrencies So Popular?

Different people like different digital currencies. Each currency has different characteristics. Below are the most common reasons why people like cryptocurrencies:

  • People consider cryptocurrencies the currency of the future
  • Everyone is rushing to buy digital currencies now before they increase in value
  • Digital currencies cut out central banks that increase inflation, reducing the value of money
  • The blockchain technology behind digital currencies attracts some supporters

Everyone is attracted to cryptocurrencies for their own reasons. Thanks to their continuous increase in value, some people view them as an ideal form of investment.

3. Are Digital Currencies an Ideal Investment?

While cryptocurrencies increase in value with time, most people consider them as speculations instead of real investments. That’s because they operate like real currencies and don’t generate any real cash flow.  Thus, for you to get returns, someone else has to buy your cryptocurrency at a higher rate than you did.

Investors call this type of venture The Greater Fool investment theory. A real investment guarantees cash flow and an increase in value by growing its profitability over time. 

So, is cryptocurrency safe?

Financial experts have raised concerns about cryptocurrencies’ safety and stability in the market. Some have even advised potential investors against purchasing cryptocurrencies. Digital currencies lack stability; thus consumers and sellers can’t use them to determine the fair price of a product.   

Cryptocurrencies haven’t been stable throughout their lifespan. For example, in Dec 2017, the value of Bitcoin was $20,000, and one year later, it was valued at $3,200. This shows how inconsistent and unstable cryptocurrencies can be.

4. How Does One Purchase Cryptocurrency?

Some cryptocurrencies such as Bitcoin can be purchased using U.S dollars. However, others need consumers to pay with another cryptocurrency using an online wallet. 

You can create the wallet by opening an account using an online application, then use real money to buy cryptocurrency, which is held in the wallet.

5. Is It Legal to Use Cryptocurrencies?

The legal status of cryptocurrencies depends on the country. While Bitcoin is legal in Canada, they are illegal and banned in China. Click to learn more about regulations governing Bitcoin taxes in Canada.  

Most countries have banned the use of cryptocurrencies due to the increased incidents of fraud. Fraudsters and con artists view cryptocurrency as an opportunity to steal from unsuspecting investors. When buying or selling Bitcoin, remember to protect yourself from such fraudsters.

Below are ways you can protect yourself when trading cryptocurrency online:

  • Use platforms with multi-signature and multiple independent approvals for the transaction
  • Always remember to update your software
  • Use a strong password to secure your online wallet
  • Encrypt and backup your online wallet
  • Conduct a background check before buying or selling Bitcoin online

With many hackers penetrating online wallets, always be careful when dealing with online services. Digital currency wallets don’t provide the same security and assurance that banks do.

Pros and Cons of Cryptocurrency

Today, most online services have integrated cryptocurrencies into numerous parts of our lives. This has resulted in the increased awareness that’s driving today’s financial revolution. However, digital currencies have both negatives and positives that consumers should know before investing.

Below are the cons of cryptocurrencies:

  • It’s not easy to understand how digital currencies work
  • They face market fluctuation challenges
  • No security or insurance in case of loss

Every growing technology, including digital currency, will be associated with a degree of uncertainty. However, there are many benefits of adopting new technology. Some benefits of cryptocurrency include:

  • Offer unparalleled transparency of the transactions
  • Offer 24-hour instant accessibility
  • Offers consumers absolute anonymity
  • Authorities or banks can’t manipulate digital currencies 

Cryptocurrencies are not bound by changing political climate and fluctuating custom adjustments. However, this is both a positive and negative quality. While anonymity is great for privacy, it has also opened a door for fraudsters to rob unsuspecting individuals without getting caught.

Are You Ready to Invest in Cryptocurrency?

Everyone today is asking “What is cryptocurrency and how does it work?” As a digital currency, most people don’t know much about cryptocurrencies. Fortunately, this guide will help you better understand cryptocurrencies and how they work.

Check out other posts on our blog for more tips.


About Author