What is cryptocurrency? A guide for beginners
Cryptocurrency is a digital type of currency that exists only electronically. In this guide, we’ll cover how crypto works and why it may (or may not) revolutionize finance as we know it.
7 min read
The following statements do not constitute investment advice or any other advice on financial services, financial instruments, financial products, or digital assets. They are intended to provide general information. The following statements do not constitute an offer to conclude a contract for the purchase or sale of financial instruments and financial products or an invitation to submit such an offer and to buy or sell any particular digital asset. Cryptocurrencies are subject to high fluctuations in value. A decline in value or a complete loss are possible at any time. The loss of access to data and passwords can also lead to a complete loss.
Right now, there’s a lot of talk in the media about what cryptocurrency is. If you’re still confused, we're here to bring you some answers. In short, cryptocurrency is a form of universal, digital money that can be used to buy goods or services. Cryptocurrencies can also be traded or viewed as investments, but their extreme volatility means that they aren’t for the faint of heart.
So, what makes cryptocurrencies different from traditional currencies like the dollar or euro? It starts with trust. The word “crypto” comes from the cryptographic techniques used to ensure that cryptocurrencies can be transacted securely. These techniques replace the need for a bank or other third party to oversee transactions.
This is a core part of crypto’s appeal. A decentralized financial system—one that doesn’t rely on banks or powerful institutions to work—could be faster, cheaper, fairer, and more transparent. But cryptocurrency also has its own issues to figure out if it’s ever going to fulfill that promise. Let’s take a closer look.
How does cryptocurrency work?
Many cryptocurrencies rely on blockchain technology, which allows for a decentralized network to review and approve any transactions made. Think of a blockchain as a sort of digital ledger—everyone in the network gets a copy of that ledger, so if anyone tries to edit or change it, their version will be rejected by the others.
At its core, blockchain is just a database—a way of storing large amounts of information that doesn’t allow any of that information to be edited. But by using a decentralized, peer-to-peer network to verify any new transactions added to the blockchain, cryptocurrencies take an approach to trust that’s fundamentally different from traditional currencies.
Whereas traditional currencies are issued and regulated by a bank or central authority, there is no central organization that manages a typical cryptocurrency like Bitcoin or Ethereum. There is also no trusted third party (such as a bank) that oversees the transfer of funds between two parties. Again, this is part of crypto’s appeal—but it can complicate things when it comes to actually paying for stuff.
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How to pay for stuff with cryptocurrency
Yes, cryptocurrencies can actually be used to buy stuff—they are currencies, after all. Many websites and online shops have started to accept Bitcoin as payment. And with other cryptocurrencies, you can buy everything from an NFT to a virtual plot of land in an online video game.
In order to make a digital purchase with cryptocurrency, you’ll need a crypto wallet. A crypto wallet is a wallet where you can securely store cryptocurrency. Each wallet comes with public and private keys that can be used for spending and receiving crypto. The public key is a code that is known by everyone on the system. The private key is only known by the user and is used to sign for their transactions.
How many cryptocurrencies are there?
According to statista.com, there are nearly 6,000 different cryptocurrencies in operation. But 90% of the market is made up of only 20 of these.
It’s relatively easy to set up a cryptocurrency, which is why there has been such a big increase in numbers in the past few years (For some context: In 2013 there were fewer than 70 cryptocurrencies). The most popular cryptocurrencies include Bitcoin, Ethereum, and Litecoin.
How are the values of each cryptocurrency determined?
Compared to other financial markets, the cryptocurrency market is relatively unstable. And when we say unstable, we mean really unstable. The value of crypto can rise dramatically in the span of days or even hours—but it can also easily come crashing down.
Many cryptocurrencies like Bitcoin don’t have any intrinsic value. Instead, their value is based on supply and demand. If lots of people want to buy a cryptocurrency but there isn’t much available for sale, the value will rise. Bitcoin and many other cryptocurrencies have a finite number of tokens, which helps keep the supply from outpacing the demand—at least for now.
What is cryptocurrency mining?
Crypto mining refers to how new units of crypto are released onto the market, in exchange for users confirming transactions and adding them to a blockchain.
Through this system, users continue to update and secure the network in exchange for cryptocurrencies like Bitcoin. Anyone with a computer and internet access can mine, but it’s not always profitable. Successfully mining for a profit often depends on which cryptocurrency you’re mining, the power of your computer, and how much electricity you use.
For Bitcoin, the mining process works like a lottery. Any company or individual who wants to take part in cryptocurrency mining will race to be the first to solve a special code. This is the code that confirms the transaction and updates the blockchain with the details. The winner is then rewarded with new Bitcoins.
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How to invest in cryptocurrency
These days, there are cryptocurrency exchange websites where you can buy and sell cryptocurrency. These include companies such as Binance, Coinbase Exchange, and Huobi Global. Many of these exchanges charge fees for facilitating different types of transactions, so be aware of the fees and how they might eat into any potential profits.
Some cryptocurrencies allow you to buy in Euros, while others require payment in cryptos. Bitcoin, to use one example, will let you do both. To start trading, you’ll need to first set up an account on a cryptocurrency exchange. This will allow you to transfer real money so you can buy cryptocurrencies.
Many exchanges will supply you with a “custodial” wallet in which to store any crypto you buy or sell on the exchange. In most cases the exchange holds the private keys to this wallet, so make sure you trust the exchange if you are planning to keep your crypto in that wallet.
Is investing in cryptocurrency risky?
In a word: yes. Investing in cryptocurrency is very risky.
If you invest in just one cryptocurrency, your risk is concentrated in that one cryptocurrency. You can mitigate the risk a bit by purchasing a portfolio of different cryptocurrencies via an exchange traded fund (ETF). This will allow you to invest in a range of currencies, but it’s still by no means “safe.” The entire crypto ecosystem is still volatile and by no means a sure long-term bet, so be aware of what you’re getting into before you invest your life’s savings.
Why are cryptocurrencies so popular?
Different people are attracted to cryptocurrency for different reasons—and crypto certainly has its share of skeptics. Here are some reasons why crypto may be growing in popularity among true believers:
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Lack of fees
A relative lack of fees is part of what makes some cryptocurrencies popular. These fees can be lower compared to traditional banking fees, because there is no central authority managing the payments.
Efficiency
Availability and speed of transactions also makes some cryptocurrencies very appealing. Transactions can be made within minutes—24/7, 365 days a year. There are no opening time restrictions or additional processing through a third party. This makes them easy to use and very accessible.
Security
Blockchain technology is the system that delivers many cryptocurrencies. It makes it very difficult to modify transactional information once it is put onto the system. This is a security feature that has increased the demand for this currency.
Lack of human involvement also helps with this, because the network of computers approves the information going onto the database, and the risk of errors being made is reduced.
Lack of government involvement
The lack of regulation by any world government is also seen as a positive by some. Different cryptocurrencies may be perceived as more stable because of this, and less at risk if a particular region becomes unbalanced.
Speculative profitability
And then, of course, there’s the potential to make profits. The cryptocurrency market is very active and, with banks investing in projects to adopt blockchain technology, it’s easy to imagine that crypto will be a significant part of the financial industry moving forward.
What are cryptocurrencies?
Cryptocurrencies are currencies that exist virtually and are protected by cryptography. Although different coins may have different uses, many coins can be used for trading, storing value, or purchasing certain goods and services. You can learn more about the basics of crypto in our beginner’s guide to cryptocurrency.
How do I trade cryptocurrency?
Cryptocurrencies are traded through a digital currency exchange (DCE), also known as a cryptocurrency exchange. Online companies are set up to do this, and you can use a variety of payment methods—including credit cards and fund transfers—to buy crypto. It’s then possible for you to buy and sell the currency through these exchanges.
Can you make money with cryptocurrency?
Yes, you can—in the same way you make money on the stock market. Purchase a cryptocurrency at a certain price, hold onto it, and sell when the price rises. This method relies on you watching the markets to track performance and assessing when the best price is to buy or sell. There is a level of risk involved, but the amount you want to invest is up to you.
Do you pay taxes on cryptocurrency?
Yes, crypto is subject to capital gains tax. The rules relating to exchange rates and taxation vary by member states, so the exact figure could be as little as 0% and as high as 50%, in terms of tax payable.
Are cryptocurrencies legal and safe?
In general, cryptocurrencies are considered legal throughout Europe. However, they aren't regulated, so there's a risk of market instability and potential losses for investors. Cryptocurrencies utilize blockchain technology, which has several security features. Transactions are stored in a special code with a timestamp, making it difficult for cybercriminals to access. Many banks are exploring the possibility of integrating this system into their own operations.
What is cryptocurrency staking?
Staking is a way to earn rewards by making your crypto available for use in the cryptocurrency's validation process. Not all cryptocurrencies offer this option, but if they do, you can deposit your coins and earn long-term rewards, similar to a fixed-term deposit. The blockchain will use your deposit to verify and secure transactions. This process is called "Proof of Stake" and is part of the overall approval mechanism. Essentially, it's a way to benefit from the currency you already have, while also contributing to the system's security and the efficiency of the blockchain.
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