As computers evolved along with network systems, we saw the digitalization of many aspects and technologies of our daily lives and how we use them. The same thing has happened to money: over 97 percent of the money in circulation today in the US is from checking deposits – dollars deposited online and converted into a string of digital codes by a commercial bank.
In 2009, Satoshi Nakamoto, presumably a pseudonymous developer, creates the first decentralized cryptocurrency, Bitcoin. He published a paper entitled “Bitcoin – A Peer-to-Peer Electronic Cash System”, which proposed a system for electronic transactions without relying on trust.
In this guide to cryptocurrency, we’ll give you a gentle introduction to crypto fundamentals and how cryptocurrency works.
This cryptocurrency for beginners guide includes the following:
- What is cryptocurrency?
- How does cryptocurrency work?
- What is a blockchain?
- Why is crypto so popular?
- Are cryptocurrencies legal?
- Advantages and disadvantages of crypto
- History of cryptocurrency
What Is Cryptocurrency and How Does Cryptocurrency Work?
A cryptocurrency is a digital currency (or asset) that can be exchanged among people (or machines) through a computer network, usually through a decentralized, distributed, and public ledger (blockchain). A network user can send and receive digital currencies anywhere in the world, even to the international space station. By using digital wallets, a user can send to or receive money from other users, exchanges, or digital smart contracts. The user that wishes to send money inputs the other user’s address, and, depending on the cryptocurrency technology and network conditions, this can take from milliseconds to hours and cost from fractions of cents to hundreds of dollars.
The user can also use cryptocurrencies to pay and buy goods and services, just as regular money, or use them as a storage value, like gold or any other asset.
Cryptocurrencies like Bitcoin, Ethereum, and BNB are volatile, in the sense that their value fluctuates over fiat money, like gold and shares. Stable coins such as USDT and USDC peg to a fiat currency instead, in this case, the US Dollar.
Cryptocurrency for Beginners: What Is a Blockchain?
A blockchain is a special type of computer network that is the backbone of the vast majority of cryptocurrency projects. It is a secure, distributed, public and decentralized autonomous network made of various nodes that collaborate with one another to write transactions in a public ledger. Once written in the ledger, transactions are immutable.
The transactions are also encrypted, hence the name cryptocurrencies. The network exchanges encryption keys with users so only the ones that own a private key can access and transfer their funds.
One of the biggest innovations about blockchains is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party.
Transactions in a blockchain are groups of blocks that hold sets of information. These blocks have a limited (by convention) storage capacity, that when filled is closed and linked to the previous one, hence the name blockchain. All new information will be added to a new block and the process repeats.
This specific data structure usage mechanism allows data immutability (data can’t change) when implemented in a decentralized manner. Data is added as a timeline since the first block, called the genesis block.
In most networks, like Bitcoin, the transactions are not added directly to the blockchain. All the valid transactions have to enter a waiting area before being accepted in a block. The name of this waiting area mempool. If the size of the mempool is big, it results in longer transaction confirmation times and higher transaction fees.
Why Is Crypto So Popular?
Cryptocurrencies are often hailed as the future of money and have been growing in popularity since their inception in 2009. There are a few reasons for crypto’s popularity:
1. Decentralization: Cryptocurrencies are not subject to government or financial institution control. This appeals to individuals who are distrustful of centralized systems and institutions.
2. Abundance: There are over 5,000 different types of cryptocurrencies, providing users with a wide variety of choices.
3. Security: Cryptocurrencies use cryptography to secure their transactions. This makes them resistant to fraud and theft.
4. Growth: The cryptocurrency market has seen tremendous growth over the past few years, with the total market value of all cryptocurrencies increasing from $12 billion in 2016 to over $2 trillion in 2022.
5. Innovation: Cryptocurrencies are constantly evolving, with new types and applications being developed.
How Do I Buy Cryptocurrencies?
Step 1: Find a reputable exchange. There are many exchanges available, and it is important to do your research to find one that is right for you.
Step 2: You will need to create an account and verify your identity. Once your account is verified, you can link your bank account or credit card to the account to fund your purchase. Most exchanges will allow you to buy Bitcoin, Ethereum, Litecoin, and other major coins. You can typically buy coins with USD, EUR, GBP, or other fiat currencies. Some exchanges also allow you to buy coins with other cryptocurrencies.
Step 3: As soon as you have found the coins you want to buy, you can place an order. You will need to specify the number of coins you want to buy, as well as the price you are willing to pay. Your order will then be matched with someone selling the same coins at the same price, and the trade will be made. Depending on the exchange, you may be required to pay a fee for the trade.
Step 4: After a trade is made, the coins will be deposited into your exchange wallet. You can then hold onto them, sell them, or use them to purchase other goods or services.
Are Cryptocurrencies Legal?
According to a 2021 summary report by the Law Library of Congress published in November, Egypt, Iraq, Qatar, Oman, Morocco, Algeria, Tunisia, Bangladesh, and China have all banned cryptocurrency. 42 countries have banned digital currencies by putting restrictions on the ability of banks to deal with crypto or prohibiting cryptocurrency exchanges.
Some of these governments declared that cryptocurrencies are being used in illegal activities and had the potential to destabilize their financial systems.
While not illegal in most countries, many governments are studying to regulate digital currency. Some countries are also creating central bank digital currencies (CBDC for short), like Brazil, the United States, South Korea, and Sweden.
The main difference between CBDCs and cryptocurrencies is that CDBCs are centralized by a financial regulator instead of being decentralized such as Bitcoin. This can offer advantages, such as legal protection against theft.
Are Cryptocurrencies Safe?
Cryptocurrencies are relatively safe, but there are some risks involved. For example, if you store your cryptos in a digital wallet and lose your private key, you could lose access to your coins.
Additionally, if you store your coins on an exchange, you are trusting that the exchange will not be hacked and your coins will not be stolen. There have been several high-profile hacks of exchanges in recent years. Overall, though, cryptocurrencies are a fairly safe way to store and transfer value.
Types of Cryptocurrencies
Cryptocurrencies are often classified as either utility tokens or security tokens. Utility tokens provide users with a digital good or service and are often used to fund projects within the cryptocurrency ecosystem. Security tokens represent an asset or a utility and are subject to federal and state regulations. Bitcoin is the first and most well-known cryptocurrency, but there are many other types of cryptocurrency available.
Some of the most popular include:
These alternative cryptocurrencies often have different features and purposes than Bitcoin. For example, Ethereum focuses on Smart Contracts and Decentralized Applications (DApps), while Litecoin is designed to be a cheaper and faster alternative to Bitcoin.
Investors can make money by trading cryptocurrencies through a different set of strategies, like day trading and HODL.
In day trading, investors buy and sell cryptocurrencies within a day by taking advantage of short-term movements. This is especially true as cryptocurrencies are highly volatile. So, this is not recommended for beginners due to the risk involved, as the investor can buy at the top and sell at the bottom.
HODL is a term that has originated from a typing mistake on an early Bitcoin forum and got stuck within the cryptocurrency community. It means to strongly hold an asset no matter price fluctuations. It might be a better option for beginners, especially in the long term. But it also has risks as an investor can buy at the top and the asset price could drop and take too long to return to the buy price or even never return.
Crypto Fundamentals: Advantages and Disadvantages of Cryptocurrencies
1. Cryptocurrencies are decentralized, which means that they are not subject to government or central bank control
2. Cryptocurrencies are global, which makes them attractive to investors and users in different parts of the world
3. Cryptocurrencies are often more secure than traditional fiat currencies, due to their decentralized nature and cryptographic algorithms
4. Cryptocurrencies can be used to anonymously purchase goods and services online, which provides a level of privacy and security for users
5. Cryptocurrencies have the potential to become a more efficient and cost-effective way of conducting transactions compared to traditional fiat currencies
1. Cryptocurrencies are highly volatile, which makes them a risky investment
2. Cryptocurrencies are subject to manipulation and fraud, due to their decentralized nature
3. The value of cryptocurrencies is often dependent on the strength of the underlying technology, which is still in its early stages of development
4. Cryptocurrencies are not widely accepted as a form of payment, which limits their utility
5. Cryptocurrencies are not backed by any government or central bank, which makes them a risky investment
History of Cryptocurrency
In 1983, David Chaum proposed the idea of electronic cash, which he called “ecash”. Ecash is a form of digital currency that allows buying goods and services online. Ecash is stored in a digital wallet and can be used just like regular cash.
Although ecash never gained widespread adoption, it was an early example of a digital currency and paved the way for the development of other cryptocurrencies, such as Bitcoin.
In 2008, Bitcoin was created as a peer-to-peer electronic cash system. Its creator, Satoshi Nakamoto, designed it as a way to avoid the double-spending problem inherent in digital currencies. Online payments were fraught with the risk of someone spending the same money twice. Bitcoin quickly gained popularity as a way to make online purchases without having to go through a bank or other third party. In 2009, the first block of Bitcoin transactions was mined. In the following year, version 0.1 of the Bitcoin software was released.
In 2011, Bitcoin experienced its first major price surge. The value of a single Bitcoin rose from around $0.30 to over $30 in just a few months. This price increase was driven by two factors: first, increasing media attention on Bitcoin, and second, the collapse of the Mt. Gox exchange. Mt. Gox was once the largest Bitcoin exchange, but it was forced to declare bankruptcy in 2014 after losing 750,000 Bitcoins to hackers.
In 2013, Bitcoin experienced another price surge, this time reaching over $1,000 per coin by December of that year. The price increase was driven in part by mainstream adoption of Bitcoin, including by businesses such as WordPress and Overstock.com who began accepting Bitcoin as payment for goods and services.
The following year, 2014, was marked by two significant events in the cryptocurrency world: first, the collapse of another major exchange, Mt. Gox; and second, the launch of Ethereum. Ethereum is a decentralized platform that runs smart contracts: programs that can automatically execute transactions on their own if certain conditions are met.
In 2016, Bitcoin reached its highest price point at around $1,000 per coin again. This caused a wave of new investors to enter the market in hopes of making quick profits. Yet, many people were inexperienced and didn’t understand how the market worked. This led to a lot of people losing money as prices suddenly crashed back down to around $300 per coin.
2017 was another big year for cryptocurrency as Bitcoin’s price surged to an all-time high of nearly $20,000 per coin. At the same time, Ethereum’s price also rose significantly as it became the second most valuable cryptocurrency. This caused a wave of new investors to enter the market and spurred the growth of many other altcoins.
2018 was a tough year for cryptocurrency as prices fell sharply from their all-time highs set in 2017. For Bitcoin, this meant prices fell from around $20,000 per coin to below $4,000 per coin while Ethereum’s price also dropped significantly. The total market capitalization also shrank by over 60 percent during this period.
In 2019, Bitcoin, the first and most well-known cryptocurrency, celebrated its 10th anniversary. Cryptocurrencies were still largely unknown to the general public at this point, but some early adopters began to realize their potential as an investment.
In 2020, the COVID-19 pandemic caused a global economic downturn, which led to increased interest in Bitcoin and other cryptocurrencies as a haven asset. The price of Bitcoin surged to new all-time highs, and other cryptocurrencies also saw significant gains.
In 2021, institutional investors began to take notice of cryptocurrencies and started investing in them. This caused another price rally, with Bitcoin reaching $67,000 for the first time. Furthermore, central banks around the world started considering launching their own digital currencies.
Finally, in 2022, crypto assets are expected to go mainstream as more people start using them for everyday transactions. Additionally, new regulations are likely to be put in place that will legitimize cryptocurrencies and make them even more attractive to investors.
Cryptocurrency for Beginners: The Bottom Line
Cryptocurrencies have the potential to disrupt many sectors of our society by being secure, resilient, and censorship-proof. We hope this guide to cryptocurrency has helped you to understand the crypto fundamentals and how cryptocurrency works.
Please note that cryptocurrency investments carry risks and you should speak to your financial advisors before investing. How crypto works can be complex and detailed assistance can be vital for beginners.
How Cryptocurrency Works for Beginners: Frequently Asked Questions
What is Bitcoin and how does crypto work?
Bitcoin is a decentralized cryptocurrency. It was created in 2009 by an unknown person or group of people using the pseudonym Satoshi Nakamoto. Bitcoin is the largest cryptocurrency in terms of market capitalization and has been considered the gold standard in cryptocurrencies.
What is crypto mining?
Crypto mining is the process of verifying and adding transaction records to a blockchain. In most cases, crypto mining requires special-purpose hardware and software to verify and capture new transaction data and then link it to the existing blockchain.
What is a blockchain?
A blockchain is a distributed database that contains a list of all the transaction records that have ever been made with Bitcoin. This public ledger is what sits at the heart of the Bitcoin protocol and allows for trustless payments between two parties without the need for a central authority.
What is an altcoin?
An altcoin is any cryptocurrency that is not Bitcoin. There are currently over 1,000 different altcoins with more being created every day. Many altcoins are simply copies of Bitcoin with slight changes to the code or blockchain structure, while others are completely different. Ethereum, Litecoin, Dogecoin, and Ripple are just a few examples of popular altcoins.
What is an ICO?
An ICO is short for “initial coin offering.” This is a new way to raise funds for digital currency-related projects. In an ICO, a project sells digital tokens in exchange for Bitcoin or other cryptocurrencies. The funds raised are then used to finance the project or invest in other cryptocurrency-related ventures. The tokens sold during an ICO can be traded on exchanges and used to purchase goods or services from the project that conducted the ICO.