Cryptocurrency has been popular for years, but many still don’t understand it. If you’re curious about Bitcoin, Ethereum, or other digital currencies and thinking of investing, this post will clarify the basics. Let’s get started!
What Is Cryptocurrency
Cryptocurrency, or crypto, is a form of digital or virtual money. But what gives it value? Its value comes from the trust and usage by people, which is the foundation of any currency. The main distinctions of cryptocurrency are that it is digital, independent, and global.
To understand how cryptocurrency works, it’s essential to first grasp what currency is. Currencies represent value, and their worth is not determined by their physical form—whether material or digital—but by the people who use and rely on them.
For example, consider using a shiny rock as currency in a village. If someone is willing to trade it for goods like water, food, or services, the shiny rock gains value. However, for it to be considered a true currency, others must also recognize and trust its worth. If only one or two people value it, the shiny rock is not widely accepted. Historically, salt was once used as currency, illustrating this concept.
The same principle applies to paper money; if no one acknowledges its value, it’s just paper. Therefore, cryptocurrency is considered a currency because people believe in and accept its value. However, its classification as currency differs across jurisdictions, with some viewing them as assets or commodities rather than traditional currencies.
By the way, as cryptocurrency has become a global phenomenon and gained widespread acceptance, the factors influencing its value have become more diverse and complex. Some of these factors include scarcity, demand, and the security of its underlying technology.
Anyway, you might wonder how something intangible can be considered currency. Digital money has inherent challenges, such as its intangibility. When cryptocurrency emerged, it addressed these issues—allowing it to become what it is today. In the next section, we will explore how cryptocurrency works and answer this question.
How Does Cryptocurrency Work
To see why cryptocurrency matters and how it works, you first need to understand the problems it solved with the old concept of digital money:
- Intangibility: Digital money cannot be physically owned or secured like cash. How can you keep your money safe?
- Transactability: Digital money requires a secure platform for transactions. Who controls this platform?
- Vulnerability: Digital money can be erased or corrupted like any file. What happens if your digital money file is deleted or damaged?
- Acceptability: For digital money to have value, it must be accepted by stores and individuals. If it isn’t accepted, how can you use it?
- Duplicity: Digital money can be easily copied, similar to duplicating a file. How would this affect the value of your digital money?
Although the first cryptocurrency wasn’t explicitly designed to solve all these issues, it effectively did so through its underlying technologies: modern cryptography and blockchain technology.
Cryptography encrypts data, ensuring that only authorized users can access it. This enhances security by preventing duplication, corruption, and deletion. By the way, encryption means turning readable information into code so that only authorized users can read it.
Blockchain technology serves as a decentralized digital ledger that records every transaction made with a specific cryptocurrency. This ledger is shared across a global network of computers, known as nodes, which work together to verify and store each transaction. This ensures that the data is accurate and resistant to tampering.
While cryptography enhances security by addressing vulnerabilities, blockchain’s decentralized architecture provides data redundancy and security; however, it also introduces storage scalability challenges as the ledger grows over time.
Together, these technologies enable the storage of digital currency in cryptocurrency wallets, which keep track of the currency units. The blockchain network verifies the validity of these units. This combination prevents the duplication of cryptocurrency units and allows users to truly own their cryptocurrency.
If this explanation is confusing, think of cryptocurrency like a cash box. This box contains your cash, the names of all its previous owners, and the transactions it has been used for. Right now, you are the only one who can use it as you have its key. If someone else gets hold of it, it becomes worthless because they don’t have the key—unless they stole it from you.
If that person initiates a transaction using that cash box, the blockchain will see that their key doesn’t match. Even if someone tries to copy or modify the box and its contents, it will be useless to them as long as they don’t have the key.
The blockchain network acts like a middleman for cryptocurrency transactions. It is the only entity that can read and validate the information on the cash boxes, and it also remembers this information because it maintains a ledger. Additionally, the blockchain can record new information on the boxes themselves.
Since this network is global, imagine having this middleman present everywhere there is internet access. That’s essentially how cryptocurrency works in a nutshell.
With many of these challenges addressed, cryptocurrency has gained acceptance as a viable form of currency. The transparency and permanence of blockchain records, spread across numerous computers, make cryptocurrency difficult to hack—but still possible—and easy to trust.
Before moving on to the next section, it’s important to understand the three main ways to invest in and profit from cryptocurrency:
- Buy Low, Sell High: Purchase a cryptocurrency when its price is low and sell it when the price increases.
Currency Trading: Treat cryptocurrency like a foreign currency. Trade it against various currencies, again buying low and selling high.
Hold and Wait: Buy cryptocurrency and hold onto it without using it. Allow its value to increase over time, then sell or use it later for profit.
With this in mind, let’s explore the types of cryptocurrencies you will encounter when you start trading and buying crypto.
What Are The Types Of Cryptocurrency
Currently, there are over 9,000 cryptocurrencies available, some of which have real value while others are essentially useless. Each cryptocurrency was created for specific reasons, and to help you understand the different types, they can be grouped into five main categories:
- Bitcoin (BTC):
Bitcoin is the very first cryptocurrency and the most recognized. It’s often referred to as digital gold because, like gold, you can use it to store value. BTC remains the largest cryptocurrency by market capitalization. - Altcoins: Any cryptocurrency other than Bitcoin is considered an altcoin. Some popular altcoins include: Ethereum (ETH), Ripple (XRP), and Litecoin (LTC).
- Stablecoins: These are cryptocurrencies designed to maintain a stable value by pegging them to a reserve of assets, such as fiat currencies like the US Dollar (USD) or commodities like gold. Examples include: Tether (USDT) and USD Coin (USDC).
- Memecoins: These are typically created as a joke or parody, often inspired by internet memes or popular culture. While they may not have serious use cases or underlying technology like more established cryptocurrencies, they can gain popularity and value through community engagement and social media. Some well-known examples of memecoins include: Dogecoin (DOGE), Shiba Inu (SHIB), and PepeCoin (PEPE).
- Privacy Coins: These cryptocurrencies focus on providing enhanced privacy and anonymity for users. They use advanced cryptographic techniques to obscure transaction details, making it difficult to trace the flow of funds. Examples include Monero (XMR) and Zcash (ZEC).
While there are other types of cryptocurrencies with unique use cases and purposes, these five categories are the most common ones you will encounter when it comes to investing and trading.
Where To Invest In Crypto
Before you can invest in crypto, you need to find a place to buy, sell, and trade them. Here are the most common options:
- Cryptocurrency Exchanges: Cryptocurrency exchanges are websites or apps that allow users to buy, sell, and trade digital currencies. They serve as user-friendly online marketplaces with features such as secure wallets and transaction tracking.
- Peer-to-Peer (P2P) Platforms: P2P platforms enable individuals to buy, sell, or trade digital currencies directly with one another. Users can exchange cryptocurrencies using various payment methods, while the platform ensures transaction obligations are met without holding the assets.
- Crypto ATMs: Crypto ATMs are physical machines that allow users to buy and sell crypto using cash or credit cards. They function like regular ATMs but dispense digital coins instead of cash, and are available in select cities and public spaces.
For newcomers, cryptocurrency exchanges are accessible platforms for buying and selling digital assets. However, it’s essential to research and choose reputable exchanges with strong security measures, as not all platforms provide the same level of protection.
Why Invest In Cryptocurrency
Cryptocurrency has gained significant attention in recent years, and for good reason. Here are several benefits that make it appealing to investors, especially those looking to diversify their portfolios:
- High Returns: Cryptocurrencies, particularly Bitcoin, have seen dramatic increases in value, rising from just a few cents to thousands of dollars. While this presents opportunities for substantial profits, it also comes with high risks due to the rapid fluctuations in prices.
- Decentralization: Cryptocurrencies operate independently of governments and banks, meaning they are not heavily influenced or controlled by any central authority. This lack of oversight can be appealing to those seeking financial autonomy.
- Diversification: Investing in cryptocurrencies provides exposure to a new asset class that behaves differently from traditional stocks and bonds, allowing for greater portfolio diversification.
However, these benefits come with inherent risks. Cryptocurrency prices are extremely volatile and are not influenced by traditional factors like a country’s economic performance, making them difficult to predict—even for seasoned investors.
Additionally, there have been recent scandals involving cryptocurrency creators, including rug pulls that can defraud investors. It’s important to be cautious, especially when trading lesser-known cryptocurrencies outside of Bitcoin and popular altcoins, as this can be particularly risky.
By the way, a crypto rug pull occurs when the founder or developer of a cryptocurrency withdraws the funds that support and give value to the project. Without this financial backing, the cryptocurrency that users and investors hold becomes worthless.
When Is The Best Time To Invest In Crypto
There is no specific best time to invest in cryptocurrency because of its risky and volatile nature. Many investors adopt a strategy of buying a small amount of cryptocurrency and holding onto it, waiting for its value to increase over time, even if it takes a while. This approach helps minimize potential losses and allows investors to focus on long-term gains rather than short-term price fluctuations.
Conclusion
The world of cryptocurrency can feel overwhelming, but you don’t have to navigate it alone. Stay curious, stay cautious, and let knowledge be your best investment.
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Source
- Photo: Unsplash: Traxer
