What Is Cryptocurrency and How Does It Work?

Cryptocurrency. It’s inflicting a lot of drama within the investing world today. It’s means up! It’s means down! It’s making millionaires throughout.

However what’s crypto actually? Ever heard of Bitcoin, Dogecoin, Litecoin, XRP or Ethereum? Nope—they aren’t embarrassing rock band names from the ’90s. They’re truly sorts of cryptocurrencies. They usually’re trending in all places you look.

It’s all fairly complicated, so right here’s our cryptocurrency for freshmen information, beginning with: What on the earth is crypto?

What Is Cryptocurrency? 

Cryptocurrency is digital cash that exists solely in a pc community. You alternate actual cash, like {dollars}, to purchase “cash” or “tokens” of a sure form of cryptocurrency. You’ll be able to maintain crypto as an funding or you should purchase stuff with it.

Consider it this fashion: Cryptocurrency is form of like swapping out your cash whereas visiting a brand new nation. A Benjamin should purchase you a pleasant dinner within the States, however if you wish to get pleasure from advantageous eating in Italy, you’ll want some euros. We worth {dollars} and euros as a result of we know we are able to buy items or companies with them. The identical goes for cryptocurrency. You alternate your cash for crypto and use it identical to actual cash (at locations that settle for it as a sort of cost). And because the value of crypto goes up and down so much, you may deal with it like an funding—shopping for low and promoting excessive.

So, the place the heck can we get the phrase cryptocurrency from, anyway? We’re glad you requested. It comes from the phrase cryptography—that means the artwork of writing or fixing codes. Sounds just like the setup of an Indiana Jones film, proper? Every coin of cryptocurrency is a novel line of laptop code. And cryptocurrencies can’t be copied, which makes them simple to trace and determine as they’re traded.

How Does Cryptocurrency Work?

Cryptocurrency is exchanged person-to-person on the web with out a intermediary like a financial institution or authorities. It’s just like the Wild West of the digital world—however there’s no marshal to uphold the legislation.

Right here’s what we imply: Have you ever ever employed a child in your neighborhood to mow your garden or watch your canine whilst you have been out of city? Likelihood is, you paid them in money. You didn’t have to go to the financial institution to make an official transaction.

That’s what it’s prefer to alternate cryptocurrencies. Most are decentralized—which suggests no authorities or financial institution controls how they’re made, what their worth is, or how they’re exchanged. Due to that, cryptocurrencies are price no matter persons are keen to pay or alternate for them. Yep, it’s fairly wild.

With us thus far? Okay, good. As a result of we’re about to get into the tech weeds even extra.

What’s the blockchain?

Cryptocurrencies are based mostly on one thing known as blockchain know-how. A blockchain is sort of a actually lengthy receipt that retains rising with every alternate of crypto. It’s a digital database of all of the transactions which have ever occurred with a given kind of cryptocurrency. These information are known as blocks, they usually’re linked and secured utilizing cryptography. (Extra on that subsequent.) Yep, it sounds prefer it’s straight out of The Matrix.

What’s cryptography?

Cryptography is a approach to hold data protected by utilizing advanced laptop codes. So, cryptography retains your crypto transactions personal and makes certain solely you may entry your cash.

Right here’s the way it form of works in actual life. Think about you’ve gotten a particular lock in your digital pockets. This lock has two keys: a non-public key (solely you understand) and a public key (you may share this one). Once you need to ship cryptocurrency to somebody, you employ your personal key to create a novel signature for that transaction. It’s like signing a examine with a secret pen that solely you’ve gotten. This signature proves that you just’re the one making the transaction.

Your signature, together with the transaction particulars, is then locked up utilizing advanced math puzzles. Solely these with the right personal key can unlock and skim the transaction.

As soon as the transaction is locked, it joins a gaggle of different transactions within the blockchain. The blockchain is sort of a shared ledger everybody can see, however they’ll’t see the small print of your transaction as a result of it’s locked together with your secret signature.

How does somebody earn crypto?

The commonest approach to earn crypto is a course of known as mining. It’s utilized by large gamers like Bitcoin and Litecoin. However crypto additionally may be earned by staking. Let’s check out each.

Mining (Proof-of-Work)

You gained’t want a pickaxe and a hat with a bit of flashlight on it to mine crypto. Mining occurs when individuals use their computer systems to resolve tremendous sophisticated math issues that ensure that new crypto transactions are right. Then, these transactions get added to the blockchain (aka the receipt). As a reward for ensuring crypto transactions are legit, miners are paid in newly minted cryptocurrency cash (referred to as the block reward).

Mining (additionally known as proof-of-work) consumes tons of computational energy and electrical energy, and it turns into progressively more difficult as extra miners be a part of the community.

Staking (Proof-of-Stake)

Some cryptocurrencies use a system known as proof-of-stake (additionally known as staking) to create cash. With this method, validators (typically known as minters) put up (or stake) cash as collateral for the best to examine transactions and add them to the blockchain.

Validators are rewarded for his or her service with newly minted cash. But when they do shady stuff, they may lose their stake. Proof-of-stake programs have develop into extra well-liked just lately as a result of they use means much less power than proof-of-work programs. Ethereum is the most important crypto firm to make use of proof-of-stake.

Each kind of crypto has guidelines known as consensus protocols or blockchain protocols that regulate the creation of latest cash so the market doesn’t get flooded with them. Some cash have a most variety of cash coded into their protocol. (Bitcoin is capped at 21 million cash.)

What Sorts of Cryptocurrencies Are There?

Bitcoin is the highest canine that everybody is aware of about, but it surely’s not the one form of cryptocurrency on the market. There’s Litecoin, Polkadot, TRON, Cardano . . . and, oh, nearly 10,000 different kinds of weirdly named cash developing the ranks. Let’s hit on the highest contenders:

Bitcoin 

Yeah, Bitcoin is the family title that most individuals consider while you speak about cryptocurrency. That’s as a result of it was the primary cryptocurrency, and it’s additionally the most important by market cap (round $550 billion—give or take a number of billion). 

Bitcoin was created in 2009 by an unknown one that goes by the alias Satoshi Nakamoto—whoever that’s^.1 And that large secret is a part of its underground really feel that folks like. However there’s no denying the truth that every thing nameless is tremendous shady.

Despite the fact that cryptocurrency is rocky, crypto traders appear to love Bitcoin as a result of they assume it has a bit of extra energy and stability than the remaining. It’s additionally valued a lot increased than its rivals (for now). Whereas some cryptocurrencies commerce for cents, Bitcoin hit $60,000 again in 2021—although it’s price about half of that now.

Ethereum

Ethereum is the subsequent hottest cryptocurrency after Bitcoin. And regardless that Ethereum is like Bitcoin with its crypto cash (known as Ether), it’s a bit of completely different too. Whereas Bitcoin was created to develop into a substitute for conventional currencies just like the greenback, Ethereum has advanced right into a community that can be utilized to do previous issues (like shopping for artwork) in new methods.

For instance, NFTs sparked a cryptocurrency digital artwork craze the place you purchase digital artwork with digital cash—NFT stands for non-fungible token . . . severely, who comes up with these names? NFTs are supported by Ethereum’s blockchain know-how, making a brand-new means for people to get into (digital) advantageous artwork accumulating.    

Tether

Tether is what’s referred to as a stablecoin. It’s pegged (or tethered) to the worth of the U.S. greenback, so it has a secure value—one tether token is price $1. Tether is less complicated to spend than different sorts of crypto as a result of its worth doesn’t go up and down a ton. Crypto traders can commerce Tether for different cryptocurrencies or hold on to it to retailer their cash with out the worry of it dropping worth.

Dogecoin 

Dogecoin (pronounced “dohj-coin”) began as a joke again in 2013 and is now actually well-liked. On the time, there was a meme going round of a Shiba Inu (that’s a form of canine) who was given the nickname “Doge.” The creators of Dogecoin named their cryptocurrency after the Doge meme, it grew to become their mascot, and the remaining is web historical past. Oh, we’re critical. You can’t make these items up.

So, all of that to say, there’s no scarcity of cash to spend money on on the market in cryptocurrency land. And relying on what’s trending that day (Dogecoin, anybody?), you’ll see the worth of those cash go up and down like a kind of swinging pirate ship rides at a carnival. When you chase crypto based mostly on what’s scorching that day, you’ll most likely wind up sick too (identical to you’d from that dang carnival journey).

How Do You Purchase Cryptocurrency?

The most well-liked approach to get your palms on some crypto is to purchase it by a cryptocurrency alternate. Consider it form of like a inventory alternate—however as a substitute of 1000’s of various shares listed, a crypto alternate has sorts of crypto you could purchase and promote. Once you purchase crypto from an alternate, it’s saved in a digital pockets linked to your account.

Coinbase is the most important cryptocurrency alternate within the U.S., however there are tons of others (many aren’t very respected) out in our on-line world. In reality, FTX, one of many largest crypto exchanges, went belly-up final 12 months and clients have been defrauded out of thousands and thousands of {dollars}.

When you don’t need to undergo a crypto alternate, you should purchase a number of the extra well-liked cryptocurrencies straight by a digital pockets.

How Do You Retailer Cryptocurrency?

You retailer your cryptocurrency in one thing known as a digital pockets—normally in an app or by the seller the place you buy your cash. Your pockets provides you a non-public key—a novel code that you just enter to digitally log out on purchases. It’s mathematical proof that the alternate was legit.

What Can You Purchase With Cryptocurrency? 

At this level, most individuals nonetheless see cryptocurrency as an funding. However cryptocurrency is shortly gaining velocity and changing into extra extensively accepted as foreign money. And utilizing crypto on this means might develop into much more well-liked as these cryptocurrencies hold gaining belief.

Some main retailers—like Entire Meals, Walmart, Domino’s Pizza, and Lowe’s—let individuals purchase reward playing cards utilizing crypto. However not many truly take crypto in particular person. And naturally, any two individuals who worth the tokens can alternate them for items or companies with one another.

You too can purchase these NFTs we have been simply speaking about with cryptocurrency, if proudly owning the world’s first digital fragrance or digital bathroom paper with flowers is your factor. Sure, these are “actual”—however that’s a narrative for one more day.

Is Crypto Protected?

We’ll simply come out and say it: Crypto isn’t very protected. Sure, the blockchain and cryptography safe your crypto transactions, however you’re nonetheless vulnerable to getting hacked. And in contrast to when your checking account will get hacked and your financial institution steps in to make issues proper, with crypto, you’re simply out of luck. To not point out, crypto isn’t protected by the Federal Deposit Insurance coverage Company (FDIC) like cash in a standard financial institution is.

Professionals and Cons of Cryptocurrency

Earlier than you say goodbye to your {dollars} and good day to Bitcoin, Ether or Doge, there are some things you should know up entrance.

Professional: Cryptocurrency is personal.

Crypto transactions are nameless and never topic to very a lot authorities regulation. This appeals to individuals who have extra of a hands-off strategy to authorities.

Con: Cryptocurrency is unstable.

Cryptocurrency costs swing up and down like loopy. Bitcoin dropped about half of its worth within the final 12 months. This makes crypto a dangerous funding. Buying and selling in cryptocurrency is form of like playing.

Professional: Cryptocurrency is a worldwide foreign money.

 Individuals all around the world use crypto, so it’s fast and simple to alternate between international locations. And since crypto isn’t linked to the central financial institution of a rustic, a authorities can’t manipulate it.

Con: Cryptocurrency has a lot of unknowns.

Solely a small proportion of individuals on the earth actually perceive the crypto system and know the way to function it. Ignorance makes you susceptible. We all the time inform people who in the event you can’t clarify your investments to a 10-year-old, you haven’t any enterprise investing in them to start with.

Why Do Individuals Spend money on Crypto?

Individuals have made thousands and thousands of {dollars} investing in crypto—in order that makes investing in crypto appear thrilling. However . . . simply as many have misplaced thousands and thousands. And possibly you worry you’re lacking out by not investing in crypto. Pay attention, you may attempt your hand at cryptocurrency if you’d like. If in case you have some cash you’re keen to lose, cash you may need thrown away on a roulette wheel in Vegas as a substitute, knock your self out. However investing in cryptocurrency isn’t a great way to construct wealth in your future.

A Higher Method to Make investments

Backside line? The street to constructing wealth is sluggish and regular, and there are nonetheless means too many unknowns in the case of cryptocurrency.

Get-rich-quick schemes are simply that—schemes. Don’t danger it and pour all of your hopes, desires and cash into them. As an alternative, sit down with a SmartVestor Professional who is aware of what they’re doing. Allow them to stroll you thru a stable technique for investing that doesn’t contain making an attempt to construct wealth by dangerous investments like crypto.