What Is Cryptocurrency? The Beginner’s Guide to Digital Currency

Monday, January 10, 2022
   
Cryptocurrency

Cryptocurrency—or crypto—has become a hot commodity these days, periodically stealing headlines as some soar in value or fall in reaction to current events. Financial experts are increasingly viewing it as an alternative to stock market investing—even the new stock market perhaps.

According to Cardify’s Head of Product, “nearly 25 percent of the money that investors are putting away is going to cryptocurrencies, a big jump from 5 percent last year.” However, many of those investors—70 percent—have been trading for less than a year, with only 15 percent claiming a strong understanding of the crypto market. But what is cryptocurrency, and how does cryptocurrency work?

What Is Cryptocurrency?

Cryptocurrency is described as a digital asset. For many of us, we’re left wondering what that even means. Basically, it allows you to invest your money and convert it to a different, digital currency. You buy digital coins, tokens, or stock in the hope that they will become more valuable. Crypto has taken on a life of its own because it comes in several forms that can serve as both investment and currency. You can pay or transfer cryptocurrency to anyone anywhere without the involvement of conventional financial institutions.

How Does Cryptocurrency Work?

Two factors make cryptocurrency work. First, investors believe in a particular cryptocurrency’s worth and what it enables them to do. Investors can buy coins, tokens or futures, for example, in a particular brand or type of cryptocurrency. Some types allow fractional buys—a satoshi, for example, equivalent to 100 millionths of a bitcoin. Some platforms even let participants tie physical assets like property to digital value. Then, investors can use it anywhere around the world as part of financial contracts. Ultimately, the users or investors are the ones who maintain the value of the currency.

Second, cryptocurrencies work on a blockchain network separate from traditional financial institutions. Blockchain technology is different from traditional networks in that it operates on a model of decentralized transparency. Multiple nodes around the globe independently record each new transaction, constantly adding and updating records once they are validated throughout the redundant network. Meanwhile, each user within the blockchain network has a unique blockchain identity. Each of the user’s validated actions or transactions is neatly recorded in a “block” of data and attached to that identity in order, forming a chronological chain of permanent, redundant historical records.

What Are the Most Popular Cryptocurrencies?

As of November 2021, more than 10,000 different cryptocurrencies were in existence. However, some of the more well-known ones demonstrate the variety among them:

Bitcoin is recognized as the original cryptocurrency software system—its decentralized network dating to 2009. With just 21 million coins, the digital currency’s worth has risen in sporadic bouts from a fraction of a penny in 2010 to today’s prices approaching $50,000. Bitcoin remains the largest crypto brand thanks to its high market capitalization and trading volume.

Ethereum is the second-largest cryptocurrency. It uses the ether as its coin and allows users to build and run applications that include everything from financial products or smart contracts to databases or games without any third-party entity.

Litecoin is similar to Bitcoin, also using scrypt algorithms and operating on proof of work—the original crypto method of consensus. But the system offers shorter transaction confirmation times. Similar to mining, proof of work relies on virtual miners racing to solve mathematical puzzles and be the first to verify a transaction and update the blockchain in exchange for a crypto reward.

Cardano, in contrast, operates on proof of stake—as does Ethereum. In proof of stake, transaction validators stake a portion of their own cryptocurrency for the responsibility of validating a transaction, updating the blockchain and earning a crypto reward. Once the primary validator has acted, additional validators attest to the transaction’s validity. Once the number of validations reaches a certain threshold, the entire blockchain updates, and all validators receive their reward. In addition to financial tools, Cardano products include Atala PRISM, an identity management tool, as well as Atala SCAN and Atala Trace, which are supply chain management tools.

USD Coin is a bit different. It offers stablecoins—crypto “dollars” that are pegged to the value of an external fiat currency or commodity. By tying crypto value to the worth of the U.S. dollar or precious metals, the goal is to minimize the cryptocurrency’s volatility and make it more stable and user-friendly.

Other cryptocurrencies include Dogecoin, Polkadot, XRP, SolaceCoin, Tether and Binance Coin—each reportedly worth billions of dollars.

What Is Cryptocurrency Used For?

Crypto transactions are peer to peer and difficult to track beyond the blockchain address. This makes them the perfect vehicle for illegal activities and scams as well as purchases associated with black markets, the dark web and other less-than-savory venues.

However, time, profitability, expansion and development of what cryptocurrency-based platforms can offer have led to a growth in their acceptance, interest, and popularity. Younger investors comfortable operating within a digital, virtual world with global reach are especially drawn to crypto.

At its most basic levels, cryptocurrency is digital currency. It allows holders to buy goods or services, transfer or even donate money as long as the recipient accepts the cryptocurrency you want to use. Since it’s global in reach, it can even be used for travel.

Cryptocurrency is also a vehicle for financial investment. You can purchase or trade into the digital asset in hopes that it will increase in value to yield a significant profit. The development of new applications like secure contracting, treasury or voting systems, for example, for the cryptocurrencies’ blockchain networks lends itself to speculation investment as well. For many, it’s the security of the decentralized technology operating within the cryptocurrency network that is promising.

How Can I Buy Cryptocurrency?

As one Coinbase article points out, “as long as you have a smartphone or another internet-connected device, you have the same crypto access as everyone else.” Coinbase is one of several online exchanges that handle cryptocurrency. Other well-known brokerages and exchanges include Binance.US, eToro, Gemini, Robinhood, SoFi Active Investing, TradeStation, Webull and Kraken. Some platforms like Coinbase and Binance provide access to 100 or more options. Others limit offerings to standards like Bitcoin, Bitcoin Cash, Litecoin and Ethereum.

Exchanges typically let you buy, sell or trade cryptocurrency. You can use standard funds to purchase cryptocurrency or trade one for another. Like more traditional stock-based versions, each crypto exchange or brokerage will have its own security measures, fees, registration and identification requirements, accepted purchase procedures and storage options for purchased currency.

How Can I Protect Myself Against Fraud and Theft?

The volatile and unpredictable nature of cryptocurrency can make investing risky. Advisors recommend thoroughly examining a company’s prospectus so that you understand exactly what you’re buying. Factors to consider include ownership, investors, the currency’s stage of development, and whether your investment gives you an ownership stake or simply the use of your purchased coin.

Check to see if the cryptocurrency you’re considering investing in is recognized by and listed on major exchanges like Coinbase, Binance, or Kraken. Do reputable sites like CoinMarketCap recognize and track its performance? You’ll want to see the current price and metrics like price history, the company’s market capitalization, its trading volume, and circulating supply.

Keep in mind that if you work with a centralized exchange, the security of your investment depends on the effectiveness of the centralized exchange’s security measures. If the centralized exchange’s databases are compromised, your information and investments will be at risk. Some exchanges may offer insurance, but it typically applies only if the centralized exchange is clearly at fault.

A decentralized exchange operates much like the cryptocurrency itself—with no one point of control. However, while hacking or attacking a decentralized exchange is not likely to succeed, decentralized exchanges are also rather immune to regulation. With little to no vetting or control, players may choose to use platforms for illegitimate purposes without identification or repercussion.

Minimize Risk Through Education

Because of all of these factors, experts advise monitoring digital assets closely and observing proper due diligence and security practices. If you would like to know more about safe ways of investing money and making your money work for you, La Cap is committed to providing financial education services to the community we serve. With new technologies emerging every day, staying one step ahead can help keep your money secure.

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