What is Cryptocurrency and How Does It Work

These days, it’s hard to find anyone who doesn’t at least have an opinion about cryptocurrencies. Many people you know might even own some Bitcoin or Ethereum. It’s certainly a hot topic, but some of those people don’t really understand what cryptocurrencies are, how they work, and the pros and cons of this type of investment or financial instrument. Here’s what you need to know.

When Was Crypto Invented

Crypto is actually relatively new. Bitcoin, the first and still most famous cryptocurrency, was only created in 2009, and it was only in the last few years that these kinds of currency really gained mainstream traction. Where it used to be the preserve of computer nerds and traffickers in illicit goods, now you have soccer moms buying and trading crypto on iPhone apps. Things sure did change fast!

How Crypto Works

Crypto is a decentralized currency that does not depend on banks and governments for it’s existence. Essentially, it’s a peer to peer financial system that has no borders or even any laws and regulations. It’s based on blockchain technology, which is a system which requires a series of complex calculations to be completed for each transaction, and when they are completed, the transaction is added to a “block” on the blockchain.

Once the transaction data is on the blockchain, it cannot be accessed, changed, or transferred without the correct key or code. So crypto is a very technically secure system, but because it’s not highly regulated, it’s also often used by less than upstanding people. There have even been cryptocurrencies that were created, gained investors, and then the creators simply vanished – taking all the coin with them. So, it’s a bit of a double edged sword!

How Crypto Mining Works

Cryptocurrencies complete transactions by running complex calculations, which take a lot of computing power. It would be impossible to have one computer system powerful enough to run all the calculations required to complete all the global crypto transactions every day, so the system uses “nodes” or computers that are set up as “mining rigs” to complete them.

These computers are connected to a global network, and whenever there is a new transaction to process, they compete to be the first to complete it. If they are, they are awarded a payment or fee for doing the work. The fee is in the same kind of crypto, and is added to the computer owner’s wallet, along with any other coins they earn.

Of course, this takes a fairly fast computer, and many people have been building large mining operations with several rigs. Which has actually led to a global shortage of certain kinds of computer components, and to concerns about the power consumption of big mining operations. So much that China has outright banned crypto mining in their whole country!

How Crypto Wallets Work

Crypto, being a digital, decentralized currency, is obviously not something you can keep in your regular bank account. So, it needs to be stored somewhere else. That somewhere is called a crypto wallet, and it’s essentially an application that gives you access to the part of the blockchain where your coin is stored. So, you can view and interact with the currency you have there.

Unlike your bank account though, there’s no “forgot password” option for a crypto wallet. So, if you forget your key, your coin is gone for good. So, if you do plan to buy, sell, or trade coin, make sure you store your account information somewhere very safe!

How Crypto Staking Works

Crypto, like stocks, bonds and even property, can be used as an investment, because it can and often does appreciate significantly over time. In fact, when Bitcoin first hit the market in 2009, it was worth just a fraction of a penny per coin. Today, each Bitcoin is worth tens of thousands of dollars.

People who are involved in crypto staking buy or mine coin, and then simply hold on to it, watching it appreciate over time. It’s a bit of a gamble, because the crypto market can be volatile, but people who got involved in Bitcoin early on and kept their coins have made millions off their gamble.

It should be noted that much of Bitcoin’s value is based on supply and demand. So, if there’s ever a sudden drop in interest in buying and owning coin, the value of the currency could drop very far, very fast. So, this really is an investment gamble.

How Crypto Trading Works

Crypto trading is a lot like forex trading, in that it is based on taking advantage of the change in market price of a particular currency – in this case, a digital one.

People who trade crypto currency try to buy it when it is in the process of dropping in value, and then selling it when it increases in value again. If you can catch it at the bottom of the “wave” when it’s decreasing, and sell near the top, you can make a significant profit from doing this. However, since cryptocurrencies are notoriously volatile, and since this usually requires you to use large sums of money, it’s not for the faint of heart!

How Can I Purchase Crypto?

Crypto used to be “dark web” sort of stuff, but these days, you only need a smartphone app to start buying and selling crypto. You could try Coinbase, Robinhood, eToro and other apps. Many allow you to invest very small amounts of money to buy just a fraction of a full Bitcoin or Ethereum coin. As the value of the coin rises or falls, your percentage would increase or decrease proportionately.

How Crypto Earn Works

When cryptocurrency first emerged, there was no such thing as interest on your coin. If the coin you owned became more valuable and you sold it, you made the difference, and that was pretty much it.

These days, however, with banks and financial apps getting in on the crypto game, it’s become a lot more like what you would normally expect from a bank. That includes interest, which in this case is called “crypto earn.”

So, you would keep your “coin” in a particular app or wallet, and over time, you would earn a percentage of simple interest on that value of cryptocurrency.

Can You Use Crypto in the Real World?

That really depends on where you are in the world.

Ecuador made history recently by becoming the first country in the world to recognize Bitcoin as legal tender. At the same time, Turkey has banned the use of crypto to make any purchases. Different countries have different reasons for taking the stance they did.

In the case of Ecuador, they are hoping to attract wealthy Bitcoin investors and traders to their country. In Turkey’s case, they are attempting to stop illegal trade and funding to terror organizations that crypto had been used for in the past.

Some countries and cities are experimenting with crypto ATMs, while in others, you won’t find many places that accept coin, if any. Tesla even accepts payment for their cars in Bitcoin (unless they’ve changed their minds again.)

This is, perhaps, the biggest challenge to crypto. It’s decentralized and democratized, so it’s very much for the people and by the people. But if you want to be able to use currency as a mainstream financial tool, you need government buy in, and they’re not all as enthusiastic about the concept.

Of course, there are plenty of places online where you can use Bitcoin. They’re not all on the most savory or trustworthy parts of the internet, but they are out there if you look for them.

Can Crypto Be Taxed

When it comes to the question of tax, again, it depends on a lot where you are.

Some countries see earnings from crypto as no different to any other investment. Others have no specific rules, and some specifically exclude it from income tax. So, you really want to look at the tax laws in your country of residence to be sure if you will pay tax on your crypto earnings.

Should You Or Shouldn’t You?

It’s really hard to believe that crypto has been around since 2009 – but then, it’s also hard to believe it’s only been here for such a short time.

Some people say that crypto only has value because we all agree that it does. That’s not so different to any other kind of money though. Sure, you can hold a dollar bill in your hand, but it’s still only a piece of paper, and it only has value because we all agree that it does.

Other people say that crypto will come crashing down one day. That might happen, but there’s no sign of it happening any time soon.

Like any investment, if you want to dip a toe (or a little more) into the crypto pool, you should only invest money you don’t need. That way, no matter what happens, you will be okay on the other side.