What is Cryptocurrency and How Does it Work?

A cryptocurrency is an encrypted digital or virtual currency. This is a new form of digital money where users can convert their traditional money like the U.S. dollar digitally and purchase items in the digital economy. In recent years cryptocurrencies like Bitcoin, Ethereum, and Dogecoin have started permeating into mainstream trading with businesses like Microsoft, Home Depot, Starbucks, Whole Foods, AT&T, and Amazon accepting cryptocurrencies.

What Exactly is Cryptocurrency?

What is cryptocurrency? Simply put a cryptocurrency is any form of digital currency that exists digitally or virtually, secured through cryptography making it nearly impossible to counterfeit or double-spend. They do not have a regulating or central body but are distributed digitally across a large number of computers known as blockchains. Like paper money, cryptocurrencies are virtual currencies that can be used for real-world applications such as making payments, transferring funds, or even making speculations on the prices of other cryptocurrencies and Nonfungible Tokens (NFT).

You can even create your own cryptocurrency. Creating a new cryptocurrency does however require some computer coding expertise, but you also can opt to go through the short route by hiring a blockchain developer to create your very own virtual currency. Launching your own cryptocurrency on an existing blockchain platform like Ethereum can be done.

How Cryptocurrency Works

Cryptocurrencies are digital currencies that work outside the banking system and are not controlled by any government or central regulatory authorities. Cryptocurrencies are issued on blockchains where ownership of a particular cryptocurrency is determined by holding a private key and using the private key to make crypto purchases or transfers. At the backend cryptocurrencies like the Bitcoin network relies on miners to maintain their network. Cryptocurrency mining operations entail solving complex computations for providing authentications and verifying transactions that help blockchains to run smoothly. Bitcoin mining helps record current bitcoin transactions in blocks, which are then added to a blockchain. Bitcoin miners use software to solve transaction-related issues such as checking and verifying bitcoin transactions.

Every cryptocurrency has a blockchain supporting it, which is a public ledger made up of blocks of transactions. Bitcoin protocol requires proof of work, where each block of transactions is designated with a specific hash. For the block to be confirmed, a crypto miner must generate a target hash that’s less than or equal to that of the block. Bitcoin miners offer indispensable support to the operations of blockchain and in return are often rewarded with newly created cryptocurrencies and transaction fees.

Blockchain Technology

Blockchains are a form of public ledgers, which is a series (or chain) of blocks on which transactions are recorded after suitable authentication and verification by miners. They are distributed across computers that run using blockchain technology. Here no single entity owns or controls the database, and anyone can access the database, offer proof of ownership, and transfer cryptocurrencies through the use of crypto wallets. The popularity of cryptocurrency has led to the spawning of thousands of cryptocurrencies with a global cryptocurrency market now valued at almost $2 trillion.

How You Can Use Cryptocurrency

Cryptocurrencies help digital payment systems that don’t rely on banks to verify transactions. This peer-to-peer system helps to enable anyone anywhere to send and receive payments electronically. Instead of using physical money by carrying it around and exchanged in the real world, cryptocurrency payments exist purely as digital currencies that can be exchanged through digital wallets or crypto exchanges. When users transfer cryptocurrency funds, the transactions are recorded in public ledgers on blockchains instantly. Like real money cryptocurrencies have their own uses and include:

Use cryptocurrencies for everyday needs: Cryptocurrencies have crossed over into mainstream trade where users can use cryptocurrencies to purchase everyday items both online and in person. Cryptocurrency ecosystems allow for easy transferring of funds across the globe enabling unrestricted global commerce seamlessly. If you want to spend cryptocurrency at a retailer that doesn’t accept it directly, you have the option to use a cryptocurrency debit card. You can also send or receive cryptocurrency as a form of payment as well.

Engage in NFT trading: Cryptocurrencies help users engage in the trading of NFTs which are digital collectibles. They can use NFTs to sustain their hobby, support their idols or speculate in the lucrative NFT market.

Create NFTs: With cryptocurrencies, users can create their unique digital art, music, and in-game collectible to sell. These are limited edition and one-of-a-kind digital art that has disrupted the art world.

Support charities and causes: Cryptocurrencies can help users make donations or support causes that they are passionate about. Charitable organizations such as the Red Cross, UNICEF, and Greenpeace now accept cryptocurrencies.

Pay bills: being able to pay your bills with cryptocurrencies depends on where you live. Some nations are gradually allowing cryptocurrencies to be used as an alternative to their currencies while other nations such as El Salvador have adopted Bitcoin as their legal tender.

Speculate in the cryptocurrency market: With cryptocurrencies being a craze these days many have started speculating on the prices of cryptocurrencies such as Bitcoin as a side hustle. Another savvy investment is to look for initial coin offerings and be part of the action early that can potentially yield some good returns over time.

How to Invest in Cryptocurrency

There are a lot of cryptocurrencies in the market some are universally accepted while others serve specific purposes. Before buying your cryptocurrencies, you will need to do the following:

1. Research: It’s important that you keep yourself abreast with the world of cryptocurrencies. You will need to do extensive research, read reviews, and follow market trends before settling on a particular cryptocurrency.

2. Choose a crypto exchange, payment services, or cryptocurrency brokerage services: These help currency owners to facilitate the purchase of cryptocurrencies. With these, you deposit your US dollar and exchange it for your desired cryptocurrency.

3. Create a cryptocurrency exchange account: For you to trade using cryptocurrencies you will need a cryptocurrency to help you facilitate the authentication and transaction processes. To create an account, you will need to sign up and add a payment method that could be a bank account or a credit or debit card that can be used as a mechanism for deposits and withdrawals for your crypto account.

4. Deposit money into your account: After opening a crypto exchange account, you’ll need to make sure you have funds in your account. You will need to deposit money into your crypto account by linking your bank account, authorizing a wire transfer, or even making a payment through your debit or credit card.

5. Purchase Your Cryptocurrency: Once you have sufficient funds in your crypto account then you can go on to purchase Bitcoin, Dogecoin, Ethereum, or any other crypto.

For a step-by-step guide read our article on How to Buy Cryptocurrency.

Storing Cryptocurrency

Cryptocurrency holders will need a cryptocurrency wallet or digital wallet to store their crypto funds and cryptocurrency data. Cryptocurrency wallets help to secure your cryptocurrency holdings as they keep your private keys or password which is a randomly generated string of alphanumeric characters that act like your bank PIN. Your digital wallet will give you access to your cryptocurrencies and other crypto assets while preventing others from using your crypto or tampering with it. Looking for a crypto wallet? check out our article 8 Best Cryptocurrency Wallet Options.

Pros of Crypto Transactions

Cryptocurrency transactions come with several benefits and include:

1. Speed: cryptocurrency transactions offer you the advantage of trading in real-time making transactions happen within minutes. Once the blockchain has confirmed the authenticity of your account and verifies you have sufficient funds, transactions are automated.

2. Relative low transaction costs: The cost of transacting in cryptocurrency is relatively low compared to other financial services.

3. Easy access to your account: Cryptocurrency transactions offer users the ability to make transactions through their mobile devices or computers. With your computer or smartphone and an internet connection, you can conduct and verify transactions 24/7.

4. Security: Cryptocurrencies are encrypted, meaning it is the users only that have the private keys to their crypto wallets so they are the only ones that can manage their funds. Make sure to keep your private key a secret.

5. Offer privacy: The fact that you don’t have to register for an account at financial institutions to transact with cryptocurrency means you can maintain a level of privacy. A cryptocurrency public ledger keeps users’ identities anonymous along with their cryptocurrency balances, and a record of all transactions executed between network participants. Users can make transactions by using pseudonymous and keeping their anonymity.

Cons of Crypto Transactions

Despite their advantages, cryptocurrencies do also come with risks and these include:

Environment impact: Minting cryptocurrency and cryptocurrency transactions come with a significant computing process requiring massive amounts of energy.

Price volatility: Cryptocurrency prices are subject to volatility potentially exposing you to risks of losing money.

Possible legal ramifications: Because cryptocurrencies are a relatively new phenomenon governments have yet to make any concrete legislation governing their usage. On that latter point, cryptocurrencies run on a decentralized system and as such cannot fall under the domain of a single jurisdiction causing legal quandaries when it comes to taxes and money laundering.

Bitcoin Vs. Cryptocurrency Transactions

Bitcoin is considered the first cryptocurrency and was created in 2009. Today it is by far the most well-known crypto token in the market that you can buy. This popular cryptocurrency started as a peer-to-peer digital currency. It is the largest cryptocurrency in circulation and its blockchain technology handles bitcoin cash transactions through a decentralized network without any third party to facilitate trading. Besides offering relatively low transaction fees and many crypto exchanges accept Bitcoin. In addition, it is inflation-proof as it is capped at 21 million coins and has seen its value increasing exponentially with Bitcoin owners reaping rewards.

If you decide to invest in cryptocurrencies, try to start with a popular cryptocurrency like Bitcoin, as newer ones may not have sufficient liquidity offering when you want to sell the cryptocurrencies off. Another savvy investment is to look for an initial coin offering that can potentially yield some good returns over time.

Is cryptocurrency worth it?

Seeing the popularity of cryptocurrencies many crypto companies have cropped up. With over $91.5 billion in daily transactions across 455 crypto exchanges, 154 counties, and 120 million Bitcoin transactions there is money to be made with cryptocurrencies. As such, many are looking to invest in cryptocurrency.  Some cryptocurrencies held on cryptocurrency exchanges or wallets come with Federal Deposit Insurance Corporation -insurance similar to money deposited in banks helping to ease concerns over losses. For more insights check out our article How to Sell Cryptocurrency.

Is cryptocurrency legal?

Cryptocurrency regulation has been the focus of both the Federal and state governments. The Federal Securities and Exchange Commission, the Internal Revenue Services, and other government bodies have their own modalities when it comes to dealing with cryptocurrencies, particularly Bitcoin.  Determining a central authority when it comes to a specific cryptocurrency transaction can be confusing, however when it comes to what services and exchanges you can use and what you can use it for might depend on the particular state you reside in. Issues regarding, do you have to pay taxes on cryptocurrency or how to accept crypto payments remain in debate.

Is cryptocurrency safe?

Investing in cryptocurrencies can be a risky venture due to their price volatility, crypto data getting lost or stolen, and questions of their legality in certain jurisdictions. However, cryptocurrencies are gaining popularity and are becoming mainstream. Some financial institutions are even offering insurance for crypto while some cryptocurrencies are pegged at par with real currencies such as the US dollar to mitigate volatility issues.

What are cryptocurrency exchanges?

Cryptocurrency exchanges act as a cryptocurrency market. They are platforms where users can sell and buy cryptocurrencies, and trade one crypto for another. You can also buy digital assets such as NFTs, convert Bitcoin to Ethereum and cryptocurrencies back into their dollars or another currency, or buy crypto using standard currency. For more on cryptocurrency, apps check out our article 8 Best Cryptocurrency App Choices.

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This article, "What is Cryptocurrency and How Does it Work?" was first published on Small Business Trends