What is crypto and how does it work? Everything you need to know

If you've been keeping up with current events, chances are you've found yourself pondering the question, "What is crypto?" It's a common inquiry, especially with Bitcoin's impressive performance. So, what is crypto, and how does it operate? As digital currencies have gained value in recent years, more individuals have become intrigued by them. This guide delves into the details of cryptocurrencies and their mechanics.

What is crypto? 

A cryptocurrency represents a digital form of currency used for online transactions and trade. Today, there exists a multitude of cryptocurrencies, with Bitcoin and Ethereum being among the most well-known. Unlike conventional currencies such as the US dollar, cryptocurrencies employ cryptographic techniques for their financial systems, operating independently from governmental or central authority control.

Secured by blockchain technology, cryptocurrencies utilize a distributed database system where information is stored in blocks. Blockchain facilitates the secure sharing, storage, and verification of valuable data without intermediaries.

Cryptocurrencies offer various advantages over traditional currencies, including rapid transaction speeds, typically within minutes compared to the hours or days often required by traditional banking systems. Furthermore, their operation on decentralized and distributed blockchains enhances security by eliminating single points of failure, making them more resilient to corruption or hacking attempts. Additionally, cryptocurrencies provide users with financial freedom, as transactions cannot be censored or reversed by any government or central authority once completed.

How does crypto work?

Understanding the inner workings of cryptocurrency prompts the question: how does this system operate? To grasp its mechanisms, we delve into three key concepts: blockchain technology, cryptocurrency mining, and cryptocurrency wallets.

Blockchain technology

A blockchain resembles a database but boasts superior features. While databases store vast amounts of electronic data on centralized servers for easy management, blockchains offer a decentralized public ledger. Unlike databases, blockchain networks are not controlled by a single entity, with computers distributed across various locations. Data in blockchains is grouped into 'blocks' with designated storage capacities, forming a sequential chain of data known as the "blockchain." For example, in Bitcoin, every transaction on the network is stored in the blockchain.

Cryptocurrency mining

Before transactions are recorded on the blockchain, they must undergo verification, and the network requires maintenance. This task falls to a group of individuals called "miners." Cryptocurrency mining involves validating transactions and adding them to the network in exchange for crypto rewards. In the case of Bitcoin, miners utilize powerful computers to solve complex mathematical equations in a process known as Proof-of-Work (PoW) consensus. This endeavor consumes significant computational power and energy, making it costly. Successful miners are rewarded with new Bitcoins, currently valued at 6.25 Bitcoins (approximately $262K).

Some cryptocurrencies, such as Solana and Cardano, employ a different consensus mechanism called Proof-of-Stake (PoS). Here, miners secure and maintain the network by 'staking' their coins, with mining power determined by the proportion of coins staked or held by the miner.

Cryptocurrency wallets

Unlike physical currencies like the US Dollar, cryptocurrencies exist solely in digital form. You can't physically possess Bitcoin or Solana; they are transferred exclusively over the internet. A digital or cryptocurrency wallet serves as a repository for your crypto assets.

In essence, cryptocurrency wallets do not hold your crypto funds; instead, they store your private keys. These private keys act as passwords, verifying ownership of your crypto assets and enabling transaction initiation. As your cryptocurrencies reside on the blockchain, access to the digital assets is granted through the use of private keys.

How many crypto exist?

Since Bitcoin's inception in 2009, cryptocurrencies have undergone significant evolution. The success of Bitcoin has catalyzed a proliferation of digital assets.

But just how many cryptocurrencies exist? According to the crypto market aggregator Coinmarketcap, there are over 20,000 crypto assets traded in the market.

Following the remarkable surges of Bitcoin and numerous alternative currencies in 2021, the crypto industry has experienced explosive growth.

Each cryptocurrency belongs to various ecosystems based on its functionality. There are cryptocurrencies like Bitcoin, focusing on fundamental utility, as well as those dedicated to non-fungible tokens (NFTs), decentralized finance (DeFi), play-to-earn (P2E), move-to-earn (M2E), and even the Metaverse.

Is investing in crypto a wise choice?

Investing in cryptocurrency can be highly lucrative but carries significant risk. Cryptocurrencies are known for their extreme volatility, with price fluctuations of up to 35% in a single day being common. While cryptocurrencies have demonstrated considerable success compared to other asset classes, such as stocks, bonds, or gold, they are also prone to rapid price swings.

For example, Bitcoin investors witnessed a remarkable 5,507% return on their investment from 2011 to 2020, with the overall profit reaching approximately six million percent. The cryptocurrency market expanded to a market capitalization of $2.31 trillion, surpassing even the largest companies like Apple Inc., valued at $2.08 trillion at the time. This growth represented an 851% increase from $243 billion in 2020 to the peak of $2.31 trillion in May 2021.

Despite these impressive gains, it's important to note that the cryptocurrency market experiences periodic crashes due to its inherent volatility. However, these downturns are typically short-lived. When selecting cryptocurrencies for investment, it is advisable to focus on assets with strong fundamentals and real-world utility, such as Bitcoin or Ethereum. These assets are more likely to deliver long-term gains despite the market's overall volatility.

What factors contribute to the value appreciation of crypto?

Cryptocurrency derives its value primarily from the principles of supply and demand. When the demand for a particular coin surges, its value increases accordingly, and conversely decreases when demand declines.

This phenomenon explains why slight price discrepancies may exist across different exchanges. For example, while Bitcoin may be priced at $50,500 on one platform like Binance, it could be valued at $50,700 on another exchange such as Coinbase. These variations reflect differences in exchange-specific demand and supply dynamics, which can be aggregated to ascertain Bitcoin's true market value.

Scarcity also plays a significant role in determining a cryptocurrency's value. Cryptocurrencies become more valuable as they become scarcer. For instance, Bitcoin has a predetermined maximum supply of 21 million units, meaning that only this fixed amount of BTC will ever be created. As the supply approaches this limit, Bitcoin becomes increasingly scarce and thus more valuable.

Additionally, the utility of a digital asset influences its value. As the practical applications and use cases for a cryptocurrency expand, its value typically follows suit. Some exchanges incentivize the ownership of their native digital assets by offering discounts on trading fees and cashback rewards to customers.

Is it advisable for me to invest in crypto?

Cryptocurrencies are often hailed as the future of currency, yet the regulatory landscape surrounding them remains largely undefined. In certain nations, cryptocurrency is even prohibited. Are cryptocurrencies legally permissible in your region? These are critical considerations. Moreover, the cryptocurrency market is significantly more volatile than traditional stock markets. Therefore, before delving into cryptocurrency investment, it's prudent to thoroughly grasp market mechanisms, understand the fundamentals of digital assets, and familiarize oneself with cryptocurrency trading practices.

What are the steps for purchasing crypto?

Here are the steps for investors looking to purchase cryptocurrency:

Choose a platform

Cryptocurrencies are traded on crypto exchanges or through multi-asset brokers. Investors can select between brokers offering cryptocurrency trading or dedicated cryptocurrency exchanges. It's essential to research and compare platforms based on supported assets, fees, and overall user experience before making a decision.

Deposit funds

Once a platform is chosen, investors need to fund their account. Each platform has preferred payment methods, such as debit card purchases, bank transfers, or automated clearing house (ACH) transfers. Consider deposit fees and processing times associated with each payment method.

Purchase crypto

After funding the account, investors can buy cryptocurrency. Most platforms allow instant purchases once the deposit is initiated. The buying process varies across platforms, with exchanges offering more features like limit orders or conditional orders. Once the purchase is made, the cryptocurrency will appear in the investor's wallet.

What are the methods for storing crypto?

Cryptocurrencies, much like other financial assets, demand secure storage, particularly in light of the numerous hacks and thefts that have afflicted the burgeoning industry. Investors typically rely on the following services to safeguard their digital assets:

Hot wallets

Hot wallets, also known as online wallets, are digital wallets consistently connected to the internet. They are favored for their user-friendly nature, particularly among beginners. Their constant online presence facilitates easy trading and transfers back to exchanges. Hot wallets are often freely downloadable and usable. However, their perpetual connection to the internet renders them more vulnerable to attacks.

Cold wallets

Cold wallets, also referred to as offline wallets, are typically hardware devices resembling USB drives. They offer heightened security as they operate offline, keeping all assets stored on a device disconnected from the internet. Nevertheless, cold wallets are less suitable for frequent trading due to their slower access speed. Additionally, they tend to be more expensive, with prices starting at $200 and increasing.

What purchases can be made using crypto?

Cryptocurrencies are steadily gaining acceptance in everyday transactions. Apart from serving as a means to store value, investors can utilize cryptocurrencies for:

• Acquiring virtual and physical assets,
• Settling payments for goods and services,
• And even buying airline tickets.

Numerous companies are integrating cryptocurrency payments into their operations, expanding the utility of cryptocurrencies.

Fraudulent activities and scams in the crypto sector

Despite the widespread adoption of cryptocurrency on a global scale, the industry continues to grapple with malicious actors seeking to exploit unsuspecting investors. Common tactics employed by online scammers include phishing websites, virtual Ponzi schemes, dubious celebrity endorsements, and rug pulls. In 2021, the prevalence of rug pulls escalated significantly, with Chainalysis data indicating that approximately 32% of all cryptocurrency scam revenue stemmed from rug pull scams.

Investors can shield themselves from cryptocurrency fraud and scams by storing their funds in secure crypto wallets and implementing two-factor authentication. Additionally, it is imperative for crypto users to conduct thorough research on new projects before investing. It is advisable to steer clear of crypto protocols with anonymous developers, as the market is rife with such entities. As the adage goes, "if it seems too good to be true, it probably is."

For added safety, traders should focus on established and reputable cryptocurrencies such as Bitcoin, Ethereum, and popular large-cap altcoins.

Is crypto considered secure?

Blockchain technology, an exceptionally secure and unchangeable public ledger, underpins cryptocurrency. Transactions are validated through a complex mathematical system, ensuring the integrity of the blockchain. However, investing in cryptocurrencies carries inherent risks.

Cryptocurrency protocols have experienced breaches in the past, and the industry is susceptible to sophisticated scams. Additionally, crypto assets are highly volatile, with prices fluctuating between bearish and bullish trends rapidly.

Despite these challenges and their relatively recent emergence as an investment avenue, cryptocurrencies are generally considered safe.

Cryptocurrencies are revolutionizing the financial landscape, capturing the interest of major players on Wall Street and garnering increasing attention worldwide. Whether viewed as an investment opportunity or a functional asset, cryptocurrency ownership is on the rise daily. Moreover, long-term investment in cryptocurrencies can yield significant profits. However, it is crucial to exercise caution and avoid investing more than one can afford to lose as you embark on this journey.