Sep 18, 2024

What is crypto? How does cryptocurrency work?

Cryptocurrency, or crypto, is a decentralized digital currency that uses cryptography for secure transactions, without central authority oversight. Join us to discover how Web3 and blockchain are transforming authentication and securing online interactions! 👇

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1. What is cryptocurrency?

Cryptocurrency operates on a peer-to-peer network, allowing individuals to send and receive payments without the need for intermediaries like banks. All transactions are logged in an online database, known as a public ledger, which ensures transparency and security. Unlike physical money, cryptocurrency exists solely in digital form and is stored in digital wallets. Each transaction is recorded in the blockchain, a decentralized system designed to enhance security and trust.

Encryption technology is used to secure the network of cryptocurrency. Advanced cryptography ensures that transactions are safely recorded, preventing fraud and providing data privacy. This encryption is crucial in verifying transactions between wallets and maintaining the integrity of the public ledger.

2. How does cryptocurrency work?

Cryptocurrency operates on a distributed public ledger known as the blockchain, which records all transactions and is continually updated by currency holders. This system ensures transparency and security, as every transaction is verified and permanently logged on the blockchain.

New units of cryptocurrency are created through a process called mining. Mining involves using powerful computers to solve complex mathematical equations, which in turn generate new coins. In addition to mining, users can also acquire cryptocurrencies by purchasing them from brokers and storing them in digital wallets, where they can be securely spent or traded.

Owning cryptocurrency doesn’t mean owning a physical asset. Instead, what you possess is a private cryptographic key, which gives you the authority to transfer a unit of cryptocurrency from one person to another without the need for a trusted third party like a bank.

While Bitcoin has been around since 2009, both cryptocurrencies and blockchain technology are still evolving in the financial world. Many experts predict that blockchain could revolutionize how financial assets like bonds, stocks, and other securities are traded in the future.

3. Cryptocurrency examples

There are thousands of cryptocurrencies in existence today. Some of the most well-known examples of crypto include:

Bitcoin Launched in 2009, Bitcoin is the first and most widely traded cryptocurrency. It was developed by Satoshi Nakamoto, a pseudonym used by an unknown individual or group. Bitcoin remains the dominant cryptocurrency, setting the standard for the market.

Ethereum Developed in 2015, Ethereum is both a blockchain platform and a cryptocurrency known as Ether (ETH). It is the second most popular cryptocurrency after Bitcoin and supports smart contracts, allowing developers to build decentralized applications (dApps).

Polkadot Launched in 2020, Polkadot is a multi-chain platform designed to enable different blockchains to work together seamlessly. Its native cryptocurrency, DOT, powers the network and facilitates governance, staking, and bonding within the Polkadot ecosystem.

Non-Bitcoin cryptocurrencies are collectively referred to as “altcoins” to distinguish them from the original. 0-list-of-crypto-considered-as-securities-by-sec.png

4. How to buy cryptocurrency safely

Buying cryptocurrency securely typically involves three steps. Below, we’ll walk through each step and discuss the differences between centralized exchanges (CEXs) and decentralized exchanges (DEXs) to help you make an informed choice.

Step 1: Choosing a platform

The first step is deciding which platform to use. Generally, you can choose between a traditional broker or dedicated cryptocurrency exchange:

  • Traditional Brokers: These are financial institutions or online platforms that allow users to trade a variety of assets, including stocks, bonds, ETFs, and sometimes cryptocurrencies. They focus on broader financial markets and typically offer limited cryptocurrency options. Examples include E*TRADE, Charles Schwab, and Robinhood. While they do facilitate cryptocurrency transactions, their primary business isn't centered around crypto, and they operate within more regulated financial frameworks.

  • Centralized Exchanges (CEXs): These platforms are run by companies that act as intermediaries, facilitating transactions and maintaining user accounts. Centralized exchanges offer a user-friendly experience, making them popular with beginners. Examples include:

  • Binance: One of the largest global exchanges, offering a vast selection of cryptocurrencies.
  • Coinbase: A popular platform known for its simplicity and educational resources, ideal for beginners.
  • Kraken: A trusted CEX with strong security measures and advanced trading tools.

+** Decentralized Exchanges (DEXs):** These platforms operate without a central authority. Instead, trades occur directly between users (peer-to-peer) via smart contracts on the blockchain. DEXs offer more privacy and control but may be less intuitive for beginners. Examples include:

  • Uniswap: A leading DEX on the Ethereum network, allowing users to trade directly from their wallets.
  • PancakeSwap: A DEX built on Binance Smart Chain (BSC), known for lower fees and fast transactions.
  • SushiSwap: A decentralized exchange with added DeFi features like staking and yield farming.

When comparing platforms, consider factors like the available cryptocurrencies, trading fees, security features, and storage options. Centralized exchanges often provide user-friendly wallets, while decentralized exchanges require you to connect your own wallet, such as MetaMask or Trust Wallet.

Step 2: Funding your account

After selecting your platform, the next step is to fund your account:

  • Using Traditional Brokers: Traditional brokers like Robinhood and eToro allow crypto purchases with fiat via bank transfers or debit cards but offer fewer cryptocurrencies than CEXs. You can’t withdraw crypto to external wallets; it must be traded or held within the platform.

  • On Centralized Exchanges (CEXs): CEXs allow you to deposit fiat currencies (such as USD, EUR) using methods like bank transfers, debit/credit cards, or ACH transfers. For instance, platforms like Coinbase and Binance support direct fiat-to-crypto purchases, making it easy to get started. Some exchanges may not allow credit card transactions due to the volatility of cryptocurrencies and potential high fees.

  • On Decentralized Exchanges (DEXs): DEXs don’t support direct fiat deposits. To trade, first buy cryptocurrency on a CEX like Binance or a traditional broker like Robinhood, then transfer it to your personal wallet (e.g., MetaMask) and connect it to the DEX. For instance, to use Uniswap, buy Ether (ETH) first, then transfer it to your wallet.

It’s crucial to be aware of fees, including deposit/withdrawal fees and trading fees, as they differ depending on the platform and payment method. On traditional brokers, trading fees for crypto may be integrated into the overall fee structure.

Step 3: Placing an order

Each platform has its own advantages. CEXs offer full control and access to your cryptocurrency, while DEXs provide privacy and greater flexibility. Traditional brokers are a simpler option but often lack the full features and control offered by dedicated crypto exchanges.

  • Using Traditional Brokers: Traditional brokers like Robinhood or eToro let you buy or sell cryptocurrencies alongside other assets. Unlike CEXs or DEXs, they usually don’t allow withdrawals to personal wallets. For example, on Robinhood, select Bitcoin (BTC), enter the amount, and confirm your purchase.

  • On Centralized Exchanges (CEXs): CEXs let you place orders via their web or mobile platforms. Choose your cryptocurrency, select "market" or "limit" order, and confirm the amount. For example, on Binance, select Bitcoin (BTC), enter the amount, and confirm your purchase.

  • On Decentralized Exchanges (DEXs): To trade on a DEX, connect your wallet (e.g., MetaMask or Trust Wallet) and swap cryptocurrencies directly. For instance, on Uniswap, exchange ETH for any available token by entering the amount and confirming the transaction. Note that DEX transactions incur gas fees, which can vary with network activity.

  • Additional Ways to Invest in Cryptocurrency

  • Payment Services: Use platforms like PayPal, Cash App, and Venmo to buy, sell, and hold cryptocurrencies directly. These services provide a convenient way to engage with crypto without a dedicated trading platform.
  • Bitcoin Trusts: Invest in Bitcoin trusts through regular brokerage accounts for indirect exposure to Bitcoin via the stock market.
  • Bitcoin Mutual Funds and ETFs: Bitcoin ETFs and mutual funds offer diversified exposure to cryptocurrency assets and are traded on traditional stock exchanges.
  • Blockchain Stocks or ETFs: Invest in companies that develop or use blockchain technology through stocks or ETFs for indirect crypto market exposure.

5. How to store cryptocurrency

After buying cryptocurrency, it's essential to store it securely to protect against hacks and theft. Cryptocurrencies are stored in wallets, which can be physical devices or online software. Some exchanges offer built-in wallets, but not all do.

There are two main types of wallets:

  • Hot Wallets: Online wallets that provide easy access but are more vulnerable to online threats.
  • Cold Wallets: Offline hardware devices that offer enhanced security but often come with a purchase fee.

6. Is cryptocurrency safe?

The safety of cryptocurrency depends on several factors, including how you store it and the platforms you use. While blockchain technology offers strong security, risks such as hacking and fraud still exist. To invest safely, use reputable exchanges and wallets, enable two-factor authentication, and keep your private keys secure. Diversifying your investments and staying informed about security best practices can further protect your assets.

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