What is cryptocurrency and how does it work?
Cryptocurrency – meaning and definition
Cryptocurrency, also known as just crypto, is any type of currency that exists digitally or virtually and uses encryption to make transactions secure. Cryptocurrencies have no central authority that issues or regulates them, instead using a decentralized system to record transactions and issue new units.
What is cryptocurrency?
Cryptocurrency is a digital payment system that does not rely on banks to verify transactions. It is a peer to peer system that allows anyone, anywhere to send and receive payments. Rather than physical money being carried around and exchanged in real life, cryptocurrency payments are merely digital records in an online database that describe specific transactions. When payments are transferred in cryptocurrency, the transactions are recorded in a public registry. Cryptocurrency is stored in digital wallets.
The name cryptocurrency arose because encryption is used to verify transactions. Advanced programming is thus involved in the storage and transfer of cryptocurrency data between wallets and to public records. The purpose of encryption is to provide security and safety.
The first cryptocurrency was Bitcoin, which was founded in 2009 and is still today the most famous. Much of the interest in cryptocurrencies is based on the fact that they are traded for profit, and speculators sometimes drive prices through the roof.
How does cryptocurrency work?
Cryptocurrency runs on a distributed public ledger called the blockchain, a record of all transactions that is updated and held by everyone who owns the currency.
Cryptocurrency units are created through a process called mining or mining, and involves using computing power to solve complex mathematical problems that generate coins. Users can also buy the currencies from brokers, and then save and spend them using cryptographic wallets.
If you own cryptocurrency, you don’t own anything tangible. What you own is a key that allows you to move a record or a unit of measure from one person to another without a trusted third party.
Although Bitcoin has been around since 2009, cryptocurrency and applications of blockchain technology are still new in the financial world, and more uses are expected to come in the future. Transactions in stocks, bonds and other financial assets can ultimately be traded using this technology.
Examples of cryptocurrencies
There are thousands of cryptocurrencies. Some of the most famous are:
Bitcoin
Bitcoin was launched in 2009. It was the first cryptocurrency and is still the most traded. The currency was developed by Satoshi Nakamoto – widely believed to be a pseudonym for an individual or group whose identity is unknown.
Ethereum
Launched in 2015, Ethereum is a blockchain platform with 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 moved faster to develop new innovations, including faster payments and processes that allow more transactions.
Ripple
Ripple is a distributed ledger system founded in 2012. Ripple can be used to track various types of transactions, not just cryptocurrency. The company behind it has worked with various banks and financial institutions.
Non-Bitcoin cryptocurrencies are sometimes collectively called “altcoins” to distinguish them from the original.
How to buy cryptocurrency
You may be wondering how to buy cryptocurrency safely. It normally involves three steps. These are:
Step 1: choose a platform
The first step is to decide which platform you want to use. In general, you can choose between a traditional broker or a dedicated cryptocurrency exchange:
- Traditional brokers: These are online brokers that offer ways to buy and sell cryptocurrency, and also other financial assets such as stocks, bonds and mutual funds. These platforms usually offer lower brokerage, but fewer crypto features.
- Cryptocurrency exchanges: There are many cryptocurrency exchanges to choose from, offering different cryptocurrencies, digital wallets, interest bearing account options and more. Many exchanges charge balance-based fees.
When comparing different platforms, consider what cryptocurrencies they offer, what fees they charge, their security features, deposit and withdrawal options, and any educational resources.
Step 2: deposit money into the account
Once you’ve chosen your platform, the next step is to deposit funds so you can start trading. Most cryptocurrency exchanges allow users to buy cryptocurrency with fiat currencies (that is, currencies issued by governments), such as US dollars, British pounds and Euros, with their credit or debit cards – although this varies between platforms.
Credit card cryptocurrency purchases are considered risky, and some exchanges do not accept this. Some credit card companies also do not allow cryptocurrency transactions. This is because cryptocurrencies fluctuate greatly in value, and it is not recommended to take on debt — or potentially pay high credit card transaction fees — for certain assets.
Some platforms also accept bank giro payments and bank transfers. Which payment methods are accepted and how long it takes for the deposit to arrive differ between the platforms. The time it takes for deposits to arrive also varies by payment method.
An important factor to consider is fees. These include potential transaction fees for deposits and withdrawals as well as brokerage. Fees differ between payment methods and platforms, and this is something to research from the start.
Step 3: place an order
You can place an order via your broker’s or exchange’s web or mobile platform. If you plan to buy cryptocurrencies, do so by selecting “Buy”, selecting the order type, entering the amount you want to run off the cryptocurrency and confirming the order. The same process applies to sales orders.
There are also other ways to invest in cryptocurrencies. This includes payment services such as PayPal, Cash App and Venmo, which allow users to buy, sell and hold cryptocurrencies. In addition, there are the following investment instruments:
- Bitcoin mutual funds: you can buy shares of Bitcoin mutual funds with a regular brokerage account. These instruments expose institutional investors to cryptocurrencies via the stock market.
- Bitcoin funds: there are exchange-traded Bitcoin funds and regular Bitcoin funds to choose from.
- Blockchain stocks and exchange-traded funds: you can also invest in cryptocurrencies indirectly through blockchain companies that specialize in the technology behind cryptocurrencies and crypto transactions. Alternatively, you can buy stocks or exchange-traded funds in companies that use blockchain technology.
How to save cryptocurrency
Once you have purchased cryptocurrency, you need to store it securely to protect it from hackers and thieves. Most commonly, cryptocurrency is stored in crypto wallets, which are physical devices or online programs used to securely store the private keys of your cryptocurrency. Some exchanges provide wallet services, making it easy for you to store directly through the platform. But not all exchanges and brokers automatically provide wallet services.
There are different wallet providers to choose from. The terms “hot wallet” and “cold wallet” are commonly used:
- Hot wallet: refers to cryptocurrency storage that uses online software to protect the private keys of your assets.
- Cold wallet: unlike a warm wallet, a cold wallet (also called a commodity wallet) relies on electronic devices that are offline to securely store your private keys.
What can you buy with cryptocurrency?
When Bitcoin was first launched, it was intended to be a means of everyday transactions, which would make it possible to buy anything from a cup of coffee to a computer, and also carry out larger transactions such as grocery purchases. This has not really taken off, and although the number of institutions accepting cryptocurrencies is increasing, large transactions are rare. But it is still possible to buy a wide selection of products from online e-commerce sites with cryptocurrency. Here are some examples:
Technology and e-commerce websites:
Several companies that sell technology products accept cryptocurrency on their websites, such as newegg.com, AT&T, and Microsoft. Overstock, an e-commerce platform, was one of the first sites to accept Bitcoin. Shopify, Rakuten and Home Depot also accept it.
Luxury goods:
Some luxury goods retailers accept cryptocurrency as a means of payment. For example, the online store Bitdials offers Rolex, Patek Philippe and other luxury wristwatches for Bitcoin.
Cars:
Some car dealers – from mass market brands to luxury cars – already accept cryptocurrency as payment.
Insurance:
In April 2021, the Swiss insurance company AXA announced that it had started accepting Bitcoin as payment for all types of insurance except life insurance (for regulatory reasons). Premier Shield Insurance, which sells home and auto insurance in the US, also accepts premium payments in Bitcoin.
If you want to spend cryptocurrency at a vendor that doesn’t accept it directly, you can use a cryptocurrency card, such as BitPay in the US.
Cryptocurrency scams
Unfortunately, the number of crimes involving cryptocurrency is increasing. Cryptocurrency scams include:
- Fake websites: Fake websites with fake customer stories and crypto jargon that promise huge, guaranteed returns, as long as you keep investing.
- Virtual pyramid schemes: criminals exploiting cryptocurrency advertise counterfeit opportunities to invest in digital currencies and create the illusion of high returns by paying old investors with money from new investors. One such scam, BitClub Network, raked in over $700 million before the perpetrators were arrested in December 2019.
- “Celebrity” endorsements: the scammers online pretend to be billionaires or well-known names promising that your investment in a virtual currency will multiply, but instead they steal the money you send. They can also use messaging apps or chat rooms to start rumors that a famous businessman is backing a specific cryptocurrency. Once they have encouraged investors to buy to drive up the price, the fraudsters sell their holdings, and the value of the currency falls.
- Romance scams: The FBI is warning of a trend in online dating scams, where fraudsters persuade people they meet through dating apps or social media to invest in or trade virtual currencies. The FBI’s Internet Crime Complaint Center received more than 1,800 reports of cryptocurrency romance scams in the first seven months of 2021, with losses totaling $133 million.
- Fraudsters posing as legitimate virtual currency traders: or setting up fake exchanges to trick people into giving them money. Another cryptocurrency scam involves false advertising of individual retirement savings in cryptocurrency. Then there is direct cryptocurrency hacking, where criminals break into people’s digital wallets and steal their virtual currency.
Is cryptocurrency safe?
Cryptocurrencies are normally built using blockchain technology. The blockchain describes how transactions are recorded in “blocks” and time-stamped. It is a rather complex technical process. The result is a digital record of cryptocurrency transactions that hackers find difficult to manipulate.
In addition, two-factor authentication is required for transactions. For example, you may be asked to enter a username and password to initiate a transaction. Then you may have to enter an authentication code sent via SMS to your personal mobile phone.
Security measures exist, but that doesn’t mean cryptocurrencies can’t be hacked. Hacks involving large amounts of money have cost cryptocurrency startups heavily. Hackers attacked Coincheck at a cost of $534 million and BitGrail at a cost of $195 million, making these two of the biggest cryptocurrency hacks of 2018.
Unlike money backed by a government, the value of virtual currencies is driven entirely by supply and demand. This can create sharp swings that can result in both big gains and big losses for investors. And there is significantly less regulatory protection for cryptocurrency investments than for traditional financial products such as stocks, bonds and mutual funds.
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