What Is Cryptocurrency, and How Is It Used? A Beginner’s Guide

So, what is cryptocurrency, and how does it work? In simple terms, cryptocurrency is a digital asset that is secured using a process called cryptography, which prevents the currency from counterfeiting and double-spending.

Cryptography uses sophisticated algorithms and encryption techniques to secure data, making it impossible for unauthorized parties to gain access. As a result, cryptocurrency provides users with privacy and security when transferring funds, making it a safe and secure way to make payments online.

Cryptocurrency is also decentralized, meaning it is not controlled by a central authority such as a bank or government but operates on a peer-to-peer network. This means that users can transfer funds without going through a bank or other financial intermediary.

Cryptocurrencies like Bitcoin or Ethereum are created through mining, which involves high-powered computers solving complex mathematical equations to verify transactions and add them to the blockchain a distributed public ledger, confirming all transactions that have occurred on the network.

For each block added, miners are rewarded with a certain amount of cryptocurrency that incentivizes people to participate in mining, thereby producing new coins and increasing the supply of cryptocurrency in circulation.

Mining requires specialized hardware and consumes copious amounts of energy, making it expensive (relative to the current BTC price). Additionally, the difficulty of the equation’s miners need to solve increases over time, meaning that it becomes harder to mine for new coins as more people join the network.

From a technological standpoint, cryptocurrency is safe because transactions are secured with cryptography, making them tamper-proof. The use of blockchain technology, as pioneered by the pseudonymous creator of Bitcoin, Satoshi Nakamoto, also renders cryptocurrency secure. This is because all transactions are recorded on a distributed public ledger (DPL), making them permanent, irrevocable, and immutable.

From an investment standpoint, however, cryptocurrency is considered a volatile asset, especially when compared to more traditional asset types such as stocks and bonds. Cryptocurrency prices can be affected by various macro and microeconomic factors, including social media sentiment, geopolitical events, and regulatory changes, recently some high profile scams and exchange failures have sent crypto prices to a fraction of their previous highs.

If you are just getting started in cryptocurrency, this Coin Hint article presents some essential basic concepts and processes you should know.

To buy, sell, and store cryptocurrency, you will first need to acquire a digital wallet. Think of this as your own bank account. Once you have set up a digital wallet, you can buy and sell cryptocurrency on various cryptocurrency exchanges – or peer to peer. You can also save them in your wallet, like you would fiat currency in a savings account.

Proof-of-Work (PoW) cryptocurrencies, such as Bitcoin, rely on mining to secure and validate transactions. To mine crypto, a miner must expend resources to power a mining rig, which typically consists of a system of powerful graphics cards and computer processing power. The process of mining cryptocurrency has three main objectives:

• To bring new cryptocurrencies into circulation via mining rewards
• To validate ongoing transactions, checking for counterfeiting and double spending

To maintain the decentralization of a particular network

Cryptocurrency trading is a form of investment where traders speculate on the price movements of digital currencies. One way to do this is through contracts for difference (CFDs), typically with leverage (CFDs) or by buying and selling the physical coins through an exchange.

CFDs are derivatives that enable traders to speculate on crypto price movements without owning the underlying digital assets. Unlike buying and selling coins directly, CFDs allow traders to take long (buy) or short (sell) positions depending on how they think an asset’s price will move.

Despite having shared foundations on blockchain technology and infrastructure, there are key differences between the several types of cryptocurrencies available in the market today:

Bitcoin (BTC) is the first and most widely adopted cryptocurrency. It is now considered a legal currency in some countries, specifically El Salvador and the Central African Republic. Bitcoin remains a PoW system, as it depends on miners to create and verify transactions and new blocks. BTC has a limited supply and is synonymous with cryptocurrencies as an asset class to many due to its dominance in market capitalization and trading volume.

Smart contract platforms, such as Ethereum, Corda, Stellar, and Fabric, allow developers to create decentralized applications (DApps) on their blockchains. Smart contracts are self-executing lines of code that carry out certain activities once specific conditions are met. The technology automates tasks and establishes the trustlessness required of blockchains, allowing people to participate in activities such as decentralized loans and other transactions securely and with ease.

Cryptocurrencies whose value is pegged to a fiat currency, commodity, or other financial instrument are called stablecoins. They are named such because their goal is to provide a crypto alternative to high-volatility assets like Bitcoin and Ethereum. Some examples of dollar-backed stablecoins are Tether (USDT) and TrueUSD (TUSD) both are pegged to the USD 1:1 and collateralized either with USD held in trust (as with USDC) or with a basket of other real world assets.

Central Bank Digital Currencies (CBDCs) are digital versions of existing fiat currencies created by a central bank and issued to the public. They function as legal tender and are typically used for purchasing goods and services in the same way that fiat currencies such as the U.S. dollar or Euro would be.

According to recent data, 11 countries have launched CBDCs, including the Bahamas’ Sand Dollar, Jamaica’s Jam-Dex, and the Eastern Caribbean Central Bank DCash. Furthermore, 114 countries, or over 95% of global GDP, are reportedly exploring CBDCs. Some of the world’s largest countries from an economic measure are investigating the possibility of launching their own CBDC’s in the future such as the UK via the bank of England.

The term “tokens” has been used to loosely refer to cryptocurrency, but technically, tokens refer to cryptocurrency assets that do not exist within their own blockchains. Unlike Bitcoin, Ethereum, and other coins with their own blockchains, tokens are assets built on top of other blockchains. Uniswap, Decentraland, and Curve Finance, for instance, were all built on top of Ethereum, making their native assets “tokens” instead of “coins.” Tokens often have a specific utility that confers rights upon the holder other than a means of transferring value, for example governance tokens that allow holders to vote on the development of a specific protocol, like sushi swap.

Meme coins are popular cryptocurrencies typically depicted with animated memes or funny images. Some examples of meme coins include Dogecoin (DOGE) and Shiba Inu (SHIB), and they usually offer more entertainment value than usability. Meme coins are risky investments with no intrinsic value, except for their “meme” factor, so their prices may rise and fall rapidly and unpredictably.

In a word, ‘sentiment’ is the biggest driver of prices. When a coin is rare or is in the news for positive reasons and the demand for it is high, prices tend to surge as buyers clamor to own it. On the other hand, when there is an abundance of cryptocurrency with low demand or a negative news event, its value drops significantly. In addition, other factors that may affect the price of a cryptocurrency include:

• Production costs: This refers to the cost required to create a cryptocurrency. If, like Bitcoin, producing new coins requires significant investment, its price can automatically increase.
• Competition: The presence of other cryptocurrencies in space can also influence the price of a particular coin. If similar coins are available at lower prices without a unique utility, this could reduce demand for any one coin and cause its value to drop.
• Regulatory developments: How different countries plan to regulate or ban specific cryptocurrencies can have a dramatic effect on their price. Positive news and developments typically boost the confidence of investors, resulting in higher demand and prices.

Media coverage: Good or bad press can also affect the price of a cryptocurrency. If it’s receiving favorable coverage from reputable sources, for example speculation about wider adoption for a specific purpose (e.g. Elon Musk, Saturday night live interview when he mentions DOGE) this could drive demand for that coin, pushing up its value. On the other hand, negative press (the fall of the Terra Luna coin) can discourage investors and lead to lower prices.

Theoretically, anyone with a penchant for coding and blockchain technology can launch their own cryptocurrency project, but what makes an asset that will rise in value? Here are some general considerations:

• Technology: Bitcoin, for example, was built on robust coding and revolutionary technology. It has a track record of being reliable and secure and immune from hacks and manipulation, which is why it remains the most popular cryptocurrency.
• Innovation: Decentralized finance (DeFi) projects have taken the crypto world by storm in recent years, offering innovative products that are made possible by blockchain technology. Increasingly new use cases and innovations in the space drive adoption and thus demand and value.
• Adoption: For crypto to gain value, there must be increasing adoption and widespread recognition of its utility and purpose that solves challenges in today’s society. Companies, governments, and institutions that recognize the potential of a cryptocurrency and use it for real-world applications encourage others to join in.

With the growing acceptance of virtual currencies, it is now possible to buy quite a lot with Bitcoin and other cryptocurrencies – from insurance policies to luxury watches, event tickets, consumer staples, and beyond. Examples of companies that currently accept crypto as payment are:

• Microsoft
• AT&T
• Burger King
• KFC
• Twitch
• Virgin Galactic
• Norwegian Air
• Namecheap
• Cheap Air

Investing in cryptocurrency is risky, but not without potential rewards. Below are some pros and cons you should consider before deciding to invest in crypto.

Pros:

• High potential for gains
• Transparent, secure transactions
• Resistant to government control

Cons:

• Volatile prices and markets
• Unpredictable market conditions
• Risk of insecurity, frauds, and hacking attempts when interacting with some protocols and due to users’ poor operational security (op sec)

It is widely thought that cryptocurrency adoption will likely increase as the world continues to shift towards increasingly more digital ways of carrying out transactions. Despite the current political quagmire that is cryptocurrency regulation, more countries may also follow in the footsteps of El Salvador in electing crypto as legal tender, not to mention the development of CBDCs as central governments and banks attempt to participate in the future of money.

That said, there is still much to be improved as the world moves toward Web3 adoption, and the right assets could rise to power as new projects are unveiled and standards in the space continue to evolve.

Since cryptocurrency is yet to be regulated, there are different laws around the world regarding its taxation. In the U.S., the IRS considers cryptocurrency as property and not currency. As such, tax rules for capital gains must be followed by U.S.-based crypto holders and investors instead of income tax.

Cryptocurrencies do not come with a tax obligation; you don’t have to pay any taxes for just having them. However, according to the IRS:

• If you decide to transact with or sell your cryptocurrency, you will need to pay taxes on it. The reason for this is that when its market value changes, capital gains, and losses will be triggered, which in turn requires taxation.
• As a business owner, if you are paid in cryptocurrency for a service or product rendered, it is considered taxable income.

The value of cryptocurrencies can be affected by many distinct factors – from supply and demand dynamics to market sentiment and news. Understanding these factors and staying up to date on the latest information can help you make informed decisions when investing or trading in cryptocurrency.

As with any investment, research is vital. Be aware of the risks, and never invest more than you are willing to lose. Through proper education and understanding, cryptocurrency can be a great way to diversify your portfolio and capture potential gains from fluctuations in the market prices of cryptos.