What Are Cryptocurrencies? A Complete Guide to Crypto

In the last few years, cryptocurrencies have gone from being a niche concept in the world of technology enthusiasts to a global phenomenon. People from all walks of life have now at least heard of Bitcoin, Ethereum, mining, and blockchain. Even then, most of the mainstream audience is still in the dark, asking the simple question—“What are cryptocurrencies?”

So, how exactly do cryptocurrencies work? What made Bitcoin go from a fraction of a cent to being worth tens of thousands of dollars? Is cryptocurrency changing the financial landscape, and is it worth investing in?

Join us as we explain everything from what cryptocurrencies are in simple words to how you can use them.

What Are Cryptocurrencies?

Simply put, cryptocurrencies are a form of digital currency that uses cryptography for security. Compared to fiat money issued by a central governing authority, cryptocurrency operates in a decentralized manner. This means that there’s a decentralized ledger that contains all transactions, and every participant has access to it.

The concept of digital currencies has existed for many years, but it wasn’t put into practice until 2008. That’s when a person or an entity under the pseudonym Satoshi Nakamoto released a whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”

Satoshi Nakamoto developed blockchain and cryptocurrency mining as a solution to the double-spending problem digital currencies faced up until that point. Their vision was to create a peer-to-peer transaction system that would operate without the need for banks and other intermediaries.

Bitcoin’s advances inspired the creation of many alternative cryptocurrencies, aptly called “altcoins.” Nowadays, there are tens of thousands of different altcoins, with some of the most popular being Ethereum, Ripple (XRP), Litecoin, Cardano, Solana, and many others.

While the primary purpose of Bitcoin is to represent a P2P transaction system, other cryptocurrencies have various uses, including:

• Investment opportunities
• Platforms for decentralized applications
• Store of value
• Online purchases
• Remittance
• Collateral for loans

How Do Cryptocurrencies Work?

While complex, the technology behind cryptocurrencies is based on several simple principles, such as:

• Decentralization. Most cryptocurrencies operate on decentralized platforms, where no single entity has complete control over the entire network. Instead, every participant takes part in facilitating and verifying transactions.
• Transparency. The open-source nature of blockchain technology allows anyone to view transactions on it. While the participants' identities are encrypted, the rest of the information about transactions (such as the amounts and wallet addresses) is visible.
• Immutability. The blockchain is designed to be unchangeable. Once a transaction is confirmed and added to a block, it cannot be changed, which adds to the system’s stability and security.
• Cryptography. Cryptocurrencies use cryptographic techniques to secure transactions. That makes the system especially secure and nearly unhackable.
• Limited supply. Most cryptocurrencies are programmed to have a limited supply, which is a mechanism to combat inflation. Some cryptocurrencies even burn tokens, which makes them deflationary.
• Globality. The digital nature of cryptocurrencies implies that anyone with an internet connection has access to them, regardless of the policies of a single country. Still, that doesn’t mean there aren’t legal and tax implications to using cryptocurrencies.
• Consensus mechanisms. To validate and confirm transactions, most blockchains require their users to reach a consensus. Two of the most popular consensus mechanisms are proof of work (PoW) and proof of stake (PoS).

What is Blockchain?

Blockchain is the fundamental technology behind cryptocurrencies. In essence, it’s a public ledger with all transactions written on it. It operates based on three key components:

1. Blocks, which are made out of groups of validated transactions
2. Chain, which is created out of blocks and is unchangeable
3. Consensus algorithms, which are mechanisms used by network participants to validate and confirm transactions

Proof of Work vs. Proof of Stake

Proof of work and proof of stake are both consensus mechanisms designed to ensure the security, stability, and decentralization of cryptocurrency networks. However, they operate in vastly different ways. Here are the key differences between them:

Types of Cryptocurrencies

All cryptocurrencies can be broadly divided into two different categories:

1. Crypto coins
2. Crypto tokens

While many use these terms interchangeably, they each have distinct characteristics and purposes, so let’s explore the differences.

Coins

Every cryptocurrency that has an independent blockchain of its own is called a coin. Not only that, but coins are necessary for their network to operate correctly. Bitcoin (BTC) is the most popular coin in the crypto sphere. Other prominent coins include:

• Ether (ETH)
• Litecoin (LTC)
• Binance Coin (BNB)

The primary purposes of crypto coins are to be digital currencies and stores of value.

Tokens

Crypto tokens are more utility-oriented than coins. They reside on top of existing blockchains and can be used for various purposes. For instance, utility tokens, like Filecoin, allow holders to use decentralized cloud storage. On the other hand, stablecoins like USDT and USDC act as dollar counterparts to fiat money.

Ethereum’s ERC-20 network is the most popular platform for the creation of crypto tokens. Some of the most popular ERC-20 tokens are:

• SHIBA INU (SHIB)
• Dai (DAI)
• Wrapped Bitcoin (WBTC)
• Chainlink (LINK)
• Uniswap (UNI)

Examples of Cryptocurrencies

Now that we know the basics, let’s answer the “What are cryptocurrencies?” question by taking a look at some examples:

• Bitcoin (BTC) is considered the pioneer in the world of cryptocurrency. It paved the way for a decentralized monetary system and the thousands of other cryptocurrencies that we have today. While BTC was initially designed to be a replacement for traditional money, its store-of-value characteristics made it better known as “digital gold.”
• Ethereum (ETH) was launched in 2015 by Vitalik Buterin. It’s conceptualized as a decentralized platform for dApps and smart contracts. If Bitcoin is considered “digital gold,” Ethereum is considered “digital oil” meant to run the DeFi system.
• Ripple (XRP) was created to make up for some of Bitcoin’s shortcomings. Ripple Labs created the network called XRP Ledger (XRPL) and its native token, XRP. Its purpose is to allow for much faster and more energy-efficient transactions than with Bitcoin.
• Binance Coin (BNB) was initially created as the utility token for the Binance exchange. Users could’ve used BNB to pay for the trading fees. The use-case for the token grew over time, especially with the launch of Binance Smart Chain.
• Cardano (ADA) was developed by an Ethereum co-founder, Charles Hoskinson. It’s a research-oriented cryptocurrency with the goal of being a faster and more scalable version of Ethereum.
• Polkadot (DOT) is another cryptocurrency developed by an Ethereum co-founder, Dr. Gavin Wood. Its purpose is to interconnect different blockchains.
• Litecoin (LTC) is often referred to as “silver to Bitcoin’s gold.” It was developed in 2011 to have faster transaction times than Bitcoin.

Pros And Cons of Cryptocurrencies

Cryptocurrencies offer many advantages compared to the traditional financial system. However, there are several disadvantages to consider as well. Keep reading to find out what those are.

Pros of Cryptocurrencies

Let’s start with some of the most notable pros of cryptocurrencies:

• Decentralization is one of the biggest reasons why cryptocurrencies have gained such popularity among vast global audiences. They allow for increased freedom and autonomy in transactions between individuals without the need for a central authority.
• Transparency and immutability ensure that cryptocurrency transactions cannot be altered once they’ve been performed, which adds another layer of security.
• Financial inclusion and accessibility are big perks of cryptocurrencies. Anyone with an internet connection can buy and hold cryptocurrencies or participate in the blockchain and transactions.
• Potential for growth is one of the biggest reasons why many investors try to acquire as many assets as possible. As the cryptocurrency market gains popularity, its value is expected to grow significantly.
• Low fees and quick transactions make cryptocurrencies a great alternative to traditional transactional systems.

Cons of Cryptocurrencies

Now we’ll explore some cryptocurrency drawbacks:

• Irreversible transactions leave little to no room for error. Since there’s no governing authority, the chances of retrieving assets lost due to mistakes or fraud are very small.
• The volatility of the market can result in quick and large gains on your investment but also rapid and unexpected losses.
• Lack of understanding among beginner cryptocurrency participants can result in risky investments and poor asset management.
• Environmental concerns are prevalent with proof-of-work cryptocurrencies, such as Bitcoin. Mining cryptocurrencies requires a lot of electric power, which is why many currencies feature other consensus mechanisms, such as proof of stake.
• No underlying value. Unlike stocks and traditional assets, cryptocurrencies don’t have physical value, which makes some investors skeptical about their future.

Are Cryptocurrencies Safe and Legal?

The safety and legality of cryptocurrencies are complex and multifaceted topics. That’s because the cryptocurrency market is not only new and not fully defined; it also represents an intersection of the financial and technological spheres.

First off, the legality of cryptocurrencies varies by country. For example, El Salvador adopted Bitcoin as a legal tender in 2021. On the other hand, in 2019, China officially made cryptocurrency transactions illegal.

Cryptocurrency investors should keep in mind that there can be tax implications in countries that permit investing, holding, and trading them. Even then, these implications vary between jurisdictions. Not only that, but the regulations keep changing as governments work on finding the best way to ensure the stability of the financial system.

So, is cryptocurrency safe? There are risks involved with participating in the cryptocurrency market, including:

• Market risks and price volatility
• Technology risks, such as hacks and security breaches
• Regulatory risks due to sudden governing changes
• Management risks that stem from the individual’s ability to control their assets
• Cryptocurrency scams and frauds

Familiarizing yourself with all the risks is the best way to avoid them safely.

Cryptocurrency Scams

Cryptocurrency scams are one of the biggest risks in this emerging financial market. Many investors looking for high profits enter the market before learning how to safely invest in cryptocurrencies or how cryptocurrencies work. Let’s take a brief look at some of the most prominent crypto scams:

• Ponzi schemes are rampant in the crypto sphere and are much like traditional Ponzi schemes, where early investors see big returns, but most participants lose money.
• Pump and dump (P&D) frauds are orchestrated by organized groups that artificially inflate the price of a coin or a token (“pump”) before selling their holdings (“dump”), causing the price to crash.
• Cloud mining scams involve some companies taking payment in advance to rent mining equipment to participants. While there are some legitimate businesses operating in this manner, others don’t have the infrastructure that they claim to possess.

Besides these, there are many other cryptocurrency scams to be aware of, such as:

• Fake wallets
• Fake exchanges
• Rug pulls
• Phishing scams
• Pyramid schemes
• Malware and ransomware

How to Buy Cryptocurrency

Here’s a step-by-step guide on how to quickly and securely buy cryptocurrency on centralized exchanges:

1. Choose a cryptocurrency exchange based on your needs and preferences. Some of the most popular CEXs include Binance, Coinbase, and Kraken.
2. Sign up for an account using your phone number or email address. You can further secure your assets by using security features such as two-factor authentication.
3. Perform a KYC check to verify your identity and unlock the exchange’s features.
4. Use fiat currency to buy crypto. You can deposit currency in various ways, including wire transfers. Also, you can buy crypto directly using money transfer services, credit cards, and debit cards.
5. (Optional) Get a private wallet and withdraw your funds from an exchange for more secure safekeeping.

It’s vital to thoroughly research the exchange and cryptocurrency before purchasing. Furthermore, once you buy assets, you should stay informed about market conditions. The volatility of the crypto market can result in swift changes—a single news story can drastically alter the value of your holdings.

What Can You Buy With Cryptocurrency?

Just a few years ago, cryptocurrency was still a niche form of payment. Fortunately, we’ve come a long way since the first recorded payment with Bitcoin on May 22, 2010, when Laszlo Hanyecz bought pizza with 10,000 BTC.

Here is what cryptocurrencies are used for and what you can buy with them, both online and offline:

• Goods and services
• Travel arrangements
• Food and beverage
• Gift cards
• Entertainment (games, movies, apps)
• Cars
• Real estate

How to Store Cryptocurrency

There are many ways to store cryptocurrency, but they all fall into two distinct categories:

• Hot storage
• Cold storage

Hot storage is a type of cryptocurrency storage that is connected to the internet. The upside is that it allows you to trade, transfer, and manage your assets quickly. On the other hand, your cryptocurrency is more susceptible to hacking. Some hot storage options include:

• Exchange wallets (Binance, Coinbase, KuCoin)
• Mobile and desktop wallets (Trust Wallet, Coinomi)
• Browser extensions (MetaMask)

Cold storage refers to the offline depository. Cold wallets are some of the safest ways to store your crypto assets. Notable cold wallets include:

• Hardware wallets (Trezor, Ledger)
• Paper wallets
• USB drives (an affordable substitute for dedicated hardware wallets)

Hardware wallets require a bit more know-how to use properly, and they are less versatile than hot wallets. However, they are usually the best solution for long-term crypto holdings.

Is Cryptocurrency a Good Investment?

Whether cryptocurrency can be a good investment depends on multiple factors, such as your financial goals, risk tolerance, and current market conditions.

First off, there’s the potential for high returns. For instance, Bitcoin was worth a fraction of a cent when people started mining it, only to reach an all-time high value of almost $70,000. The cryptocurrency market also represents a hedge against traditional markets and other assets. That allows you to diversify your portfolio and lower the risk of big losses.

As a result, cryptocurrency is a good investment if you have a long-term belief in technology and a high risk tolerance.

However, you should be aware of market volatility and regulatory risks when investing in cryptocurrencies. Additionally, there’s the question of security and self-governance that investors need to be aware of.

5 Tips on How to Invest in Crypto

Here’s a list of five tips that can increase your chances of successfully investing in cryptocurrencies as a beginner:

1. Educate yourself to learn as much as you can about cryptocurrencies in general and about specific coins or tokens that you want to invest in.
2. Start small and never invest more than you’re willing to lose. The volatility of the crypto market can result in significant gains and massive losses in short periods.
3. Diversify your portfolio and minimize the risk by investing in multiple different assets.
4. Avoid FOMO and don’t make impulsive decisions to invest in cryptocurrencies that have already seen price surges due to hype.
5. Consult a financial advisor, especially if you’re serious about investing but aren’t sure what to do.

Key Takeaways

Hopefully, this comprehensive guide on cryptocurrencies for beginners has demystified this intricate world, giving you a strong starting point to continue researching.

We’ve seen that the value of cryptocurrencies extends beyond them just being a new form of money. They offer a revolutionary approach to the current financial system based on trust and security in combination with decentralization.

So, whether you’re an eager investor, a tech enthusiast, or somewhere in between, you’re about to enter the world of possibilities. Proceed with curiosity and caution, and best of luck in the crypto world!

What Are Cryptocurrencies FAQ

• What is cryptocurrency and how does it work?

  Cryptocurrency is a form of digital currency secured by cryptography. Its purpose is to enable peer-to-peer transactions using a decentralized network. Transactions are facilitated and verified by network participants, ensuring transparency and security without the need for a central governing authority.

• What is blockchain?

  The blockchain is a digital ledger that holds information about all cryptocurrency transactions. In essence, a bunch of confirmed transactions are bundled together and stored in blocks. These blocks form a chronological chain that makes tampering with the information in it impossible.

• How do you mine cryptocurrency?

  You mine cryptocurrency by using specialized computer equipment to solve complex mathematical problems. This process represents the foundation of the proof-of-work system. Successful mining rewards miners with new cryptocurrency tokens. Mining is also used to confirm network transactions.

• How is cryptocurrency taxed?

  Cryptocurrency is taxed differently depending on your location. In many jurisdictions, cryptocurrency is considered property. As a result, investors need to report capital gains or losses associated with using their crypto assets.

• How to stake cryptocurrency?

  You can stake your cryptocurrency by using a digital wallet to lock up your assets. The purpose of staking is to support the activities of a decentralized network. Staking is possible with proof-of-stake cryptocurrencies, where participants use their coins or tokens as a guarantee of their trustworthiness.