What is cryptocurrency and how does it work
Cryptocurrency refers to any form of currency that exists digitally or virtually and uses cryptography to ensure the execution of transactions. Cryptocurrencies don't have a central issuing or regulating authority. Instead, they utilize a decentralized system to record transactions and issue new units.
Photo: Bitcoin logo. Allbreaknews.com
What is Cryptocurrency?
Cryptocurrency is a digital payment system that doesn't rely on banks to verify and confirm transactions. It's a peer-to-peer system that allows anyone to send and receive payments from anywhere. Instead of physical money being transported and exchanged in the real world, cryptocurrency payments exist solely as digital values in an online database that documents specific transactions. When transferring cryptocurrency funds, transactions are recorded in a public ledger. Cryptocurrency is stored in digital wallets.
Cryptocurrency gets its name from the use of encryption to verify transactions. This means advanced coding is involved in storing and transmitting cryptocurrency data between wallets and public ledgers. The aim of encryption is to provide security and protection.
The first cryptocurrency was Bitcoin, created in 2009 and still the most well-known today. Much of the interest in cryptocurrencies involves market trading for profit, with speculators sometimes driving prices to new heights.
How Cryptocurrency Works?
Cryptocurrencies run on a distributed public ledger called a blockchain, a record of all transactions updated and maintained by coin holders.
Cryptocurrency units are created through a process called mining, involving the use of computing power to solve complex mathematical problems that generate coins. Users can also buy coins through exchanges, then store and spend them using cryptographic wallets.
If you hold cryptocurrency, you don't possess anything physical but a key that enables the transfer of a record or unit from one person to another without the need for a trusted third party.
Though Bitcoin has been around since 2009, cryptocurrencies and blockchain technology applications are still in their financial infancy, with more uses expected in the future. Transactions including securities, stocks, and other financial assets could eventually be traded using this technology.
Examples of Cryptocurrencies
There are thousands of cryptocurrencies in the world. Some of the most well-known include:
Bitcoin: Founded in 2009, Bitcoin was the first cryptocurrency and remains the most traded. It was developed by Satoshi Nakamoto, believed to be a pseudonym for an individual or group whose exact identity remains unknown.
Ethereum: Created in 2015, Ethereum is a blockchain platform with its own cryptocurrency called Ether (ETH) or Ethereum. It's the second most popular cryptocurrency after Bitcoin.
Litecoin: Similar to Bitcoin but evolving more rapidly to develop innovations, including faster payments to enable more transactions.
Ripple: Founded in 2012, Ripple is a distributed ledger system. It can be used to track various types of transactions, not just cryptocurrencies. The company behind it has cooperated with various banks and financial institutions.
Non-Bitcoin cryptocurrencies are collectively known as “altcoins” to distinguish them from the original.
Acquiring Cryptocurrencies
You might be wondering how to securely buy cryptocurrencies. Typically, there are three steps to take:
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Step 1
Choose a Platform
The first step is deciding which platform to use. Generally, you can choose between a traditional brokerage or a dedicated cryptocurrency exchange:
Traditional brokerages. These are online platforms offering ways to buy and sell cryptocurrencies, along with other financial assets like stocks, bonds, and ETFs. These platforms tend to offer lower trading costs but fewer crypto features.
Cryptocurrency exchange. There are numerous crypto exchanges to choose from, each offering different cryptocurrencies, wallet storages, interest-bearing account options, and more. Many exchanges charge asset-based fees.
When comparing platforms, consider the offered cryptocurrencies, fees, security features, storage and withdrawal options, and any educational resources.
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Step 2
Transfer Funds to Your Account
After choosing your platform, the next step is funding your account so you can start trading. Most cryptocurrency exchanges allow users to purchase cryptocurrencies using fiat currencies (government-issued currencies) like the US Dollar, British Pound, or Euro, using debit or credit cards. The regulations vary by platform.
Buying cryptocurrency with credit cards is considered risky, and some exchanges don't accept this type of transaction. Some credit card companies also don't allow cryptocurrency transactions. This is due to cryptocurrencies' high volatility. It's not advisable to risk going into debt or potentially paying high credit card fees for certain assets.
Some platforms will also accept bank transfers. The accepted payment methods and the time needed for deposits or withdrawals differ by platform. Similarly, the time it takes for deposits to be processed varies by the payment method.
An important factor to consider is fees. This involves potential deposit and withdrawal transaction fees, as well as trading fees. Fees vary by payment method and platform, something you should research upfront.
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Step 3
Place Your Order
You can place an order through the broker's or exchange's web or mobile platform. If you're planning to buy cryptocurrencies, you can do so by selecting “buy,” choosing the type of order, entering the desired amount of cryptocurrency, and confirming the order. The same process applies to “sell” orders.
There are also other ways to invest in cryptocurrencies. These include payment services like PayPal, Cash App, and Venmo, allowing users to buy, sell, or hold cryptocurrencies. Additionally, there are the following investment vehicles:
Bitcoin trusts: You can buy shares of Bitcoin trusts through a regular brokerage account. These vehicles give retail investors access to cryptocurrencies through the stock market.
Bitcoin mutual funds: There are Bitcoin ETFs and Bitcoin mutual funds available.
Blockchain stocks or ETFs: You can also indirectly invest in cryptocurrencies through companies specialized in blockchain technology that carry out cryptocurrency transactions. Alternatively, you can buy shares or ETFs of companies using blockchain technology.
The best option will depend on your investment goals and risk appetite.
Storing Cryptocurrencies
After purchasing cryptocurrency, you need to store it securely to protect it from hackers or theft. Typically, cryptocurrency is stored in crypto wallets, which are physical devices or online software used to securely store cryptocurrency private keys. Some exchanges provide wallet services, making it possible to store directly on the platform. However, not all exchanges or brokers automatically offer wallet services.
Different wallet providers are available on the market. The terms “hot wallet” and “cold wallet” are used:
Hot wallet storage: “Hot wallets” refer to storing cryptocurrency that uses online software to protect the private keys of the assets.
Cold wallet storage: In contrast to hot wallets, cold wallets (also known as hardware wallets) rely on offline electronic devices to securely store private keys.
What Can You Buy with Cryptocurrency?
When first launched, Bitcoin aimed to be a means for daily transactions, making it possible to buy anything from a coffee to a computer, or even high-value items like real estate. This hasn't yet fully materialized, and although the number of institutions accepting cryptocurrencies is growing, high-value transactions in this currency are still rare. Nonetheless, it's possible to buy a wide range of products from e-commerce websites using cryptocurrency. Here are some examples:
Tech and E-commerce Sites: Several companies selling tech products accept cryptocurrencies for purchase on their websites, such as newegg.com, AT&T, and Microsoft. Online e-commerce platform Overstock was one of the first sites to accept Bitcoin. Shopify, Rakuten, and Home Depot also accept it.
Luxury Items: Some luxury product retailers accept cryptocurrency as a form of payment. For instance, online luxury retailer Bitdials sells high-quality watches like Rolex and Patek Philippe in exchange for Bitcoin.
Cars: Some dealerships for popular and luxury car brands now accept cryptocurrency as payment.
Insurance: In April 2021, Swiss insurance company AXA announced it had started accepting Bitcoin as payment for all its insurance lines except life insurance (due to regulatory issues). US-based Premier Shield Insurance, which sells home and auto insurance policies, also accepts Bitcoin for premium payments.
If you want to use cryptocurrency with a retailer that doesn't directly accept it, you can use a cryptocurrency debit card like BitPay in the US.
Cryptocurrency Frauds and Scams
Unfortunately, cryptocurrency-related crime is on the rise. Cryptocurrency scams include:
Fake Websites: Fraudulent websites featuring fake testimonials and cryptocurrency jargon, promising massive and guaranteed returns as long as you keep investing.
Virtual Ponzi Schemes: Cryptocurrency criminals promote false investment opportunities in digital coins and create the illusion of significant returns, paying early investors with money from new investors. A fraudulent operation like BitClub Network raised over $700 million before its perpetrators were indicted in December 2019.
“Celebrity” Endorsements: Scammers pose online as billionaires or well-known people promising to multiply your digital currency investment but instead steal the received money. They can also use messaging apps or chat rooms to spread rumors that a famous entrepreneur is endorsing a particular cryptocurrency. After engaging investors in buying and driving up the price, the fraudsters sell their holdings, causing the currency to lose value.
Romance Scams: The FBI has been warning about an emerging trend of online romance scams, where scammers convince individuals to meet through dating apps or social media, leading them to invest or trade in virtual currencies. The FBI's Internet Crime Complaint Center recorded over 1,800 reports of romance scams focused on cryptocurrencies in the first seven months of 2021, resulting in losses of up to $133 million.
Fraudsters can also pose as legitimate virtual currency traders or create fake transactions to trick people into giving them money. Another cryptocurrency scam involves fraudulent sales promotions to individual retirement accounts in cryptocurrencies. There's also direct cryptocurrency breach, where criminals invade people's digital wallets to steal virtual currency.
Is Cryptocurrency Secure?
In general, cryptocurrencies are created using blockchain technology. The blockchain refers to how transactions are recorded in “blocks” and timestamped. It's a quite technical and complex process, but the result is a digital ledger of cryptocurrency transactions that's hard for hackers to tamper with.
Furthermore, transactions require a two-factor authentication process. For instance, you might need to enter a username and password to initiate a transaction. Then, you might be required to enter an authentication code sent via SMS to your personal cellphone.
While there are security measures in place, this doesn't mean cryptocurrencies can't be hacked. Several high-profile breaches have cost cryptocurrency startups dearly. Hackers managed to penetrate Coincheck and steal $534 million, and also BitGrail, from which they took $195 million, making these two of the largest cryptocurrency breaches of 2018.
Unlike nation-managed currencies, the value of virtual coins is entirely driven by supply and demand. This can create radical swings that produce astronomical gains or losses for investors. Cryptocurrency investments are also subject to far less regulatory protection than traditional financial products like stocks, bonds, and mutual funds.
