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                                             The Basics of Cryptocurrency and How it Works
                                                                                      The Basics of Cryptocurrency and How it Works

The Basics of Cryptocurrency and How it Works

11 Dec 2020

Reading Time: 3 minutes

The recent Bitcoin price surge introduced many people to the idea of cryptocurrency. But to beginners, it may seem like a complicated technical whirlwind that can have them thinking twice about joining in the hype. After all, there’s nothing scarier than jumping into an investment that you don’t completely understand. 

Don’t worry: in this cryptocurrency 101 article, we’ll cover the basics and debunk how cryptocurrency works and how it can help you.

What is cryptocurrency?

In its simplest form, cryptocurrency is a decentralised currency that lives in the digital sphere. But in most cases, it can be accessed both online and offline through dedicated wallets. You can use it the same way as regular money, whether buying, selling, or trading for another currency. However, its transactional usage is currently limited to a very small number of merchants. For now, most people see cryptocurrency as an investment, but countries like Venezuela have embraced its usage as actual currency. 

Like fiat money, you can also “earn” cryptocurrency in a process called crypto mining. But more on that later! 

What are cryptocurrencies used for?

Cryptocurrency has plenty of uses. First, it’s a form of digital currency that can be used for transactions–albeit for limited instances as of now. Second, most people invest in crypto as the market can be rather lucrative, as seen with the Bitcoin price hike. Finally, cryptocurrency can also be used to power the blockchain behind the particular coin. For example, on the Ethereum network, Ether (ETH) is used to back up the creation of decentralized applications. 

  • Safety 

Because cryptocurrency lives on a blockchain, all data is secured within each block. It’s important to know how blockchain works. It’s a string of code that can’t be accessed or edited, so any outside influence is unable to make changes to the code to create fraudulent data. 

Blockchains and cryptocurrency go hand-in-hand with anonymity. You can own a cryptocurrency address (which stores coins) without revealing any personal information. Transactions are also completely anonymous because your information doesn’t exist in the address in the first place. 

  • Trust 

Due to the decentralised nature of cryptocurrency, there is no single authority in control of a coin’s circulation or movement. Its maximum capacity and other key features are predetermined and coded onto the blockchain before being rolled out to the public. Cryptocurrency is the direct answer to the general distrust for banks. People are looking for a currency that the government or financial institutions don’t regulate–and that’s why crypto has a huge following. 

Where does cryptocurrency come from?

Fiat money–the money we use in everyday transactions–is printed by the government and then handled by banks. Its value is tied to the import and export of goods. So if a country has a high gold export rate, its currency will naturally be worth more than others. Generally, places with more resources and smart export systems can enjoy higher currency valuation. 

However, in understanding cryptocurrency, it’s important to know that it isn’t produced the same way as fiat money. There are multiple ways coins and tokens can come about. 

  1. They are rewarded to miners. 

  2. They are pre-mined and released under certain conditions. 

  3. A fixed number is released per year. 

All of these are tied to a maximum supply–which all cryptocurrencies are limited to. For instance, there can only be 21 million BTC in the world. Each blockchain gets creative with limiting supply to ensure that new coins can be released for as long as possible. For instance, Bitcoin does a halving event every 4 years, which reduces the number of tokens awarded to miners by 50%. 

What is mining?

Some blockchains allow users to earn cryptocurrency in a process called mining. If you’ve been following crypto trends for a while now, you may have heard of Bitcoin mining, because it was the first and most popular of its kind. While it initially may seem like a complicated process, it’s actually a lot more straightforward than it seems. 

The most basic form of mining, the Proof-of-Work (PoW) model, entails an exchange. You use computer processing power (through a GPU or a dedicated ASIC mining rig) to solve complex mathematical equations. The first miner to successfully solve the puzzle–essentially creating a new block on the network–wins the token reward. This is how Litecoin and Bitcoin mining works. 

Others are a little more complicated. You may need to stake a certain number of coins (through the Proof-of-Stake model) and increase your chances of winning by leveraging a larger pool. The mechanism is often tied to how the specific cryptocurrency works, so it’s important to first familiarize yourself with the basics of cryptocurrency before heading out to the minefield. 

What is a blockchain?

A blockchain is like a ledger where all data and transactions for a particular cryptocurrency are logged and recorded. It’s essentially the “home base” for a particular coin. For the most part, it’s an open-source where anyone can suggest developments or verify payments. But some coins are a little less decentralised than others, which means that not everyone may be granted access to these privileges. 

How do you collect the cryptocurrency you mine?

There are “wallets” dedicated to storing cryptocurrency. They can either be digital, physical (in the form of a USB-like device), or a mix of both. They’re encrypted and key-protected to ensure your safety while storing coins and transacting online. 

When you engage in crypto mining, you can link a compatible wallet to the program you’re running. Anything you win or receive will immediately transfer there. 

How do you sell your cryptocurrency?

You can sell cryptocurrency in a dedicated exchange. Exchange sites act like virtual markets. They broadcast the current running prices of all cryptos and how much has been traded that day. Here’s a tip for investing in cryptocurrency 101: it’s extremely important to watch the exchanges if you’re closing in on a specific coin to buy or sell. As each coin’s price is updated live, you can get a quick overview of what’s doing well and what has risen or fallen in X amount of time. 

In a cryptocurrency exchange, you can buy, sell, and trade your crypto for another kind of currency. 

When I sell my cryptocurrency, who am I selling to?

Exchanges are like markets, except the transaction isn’t necessarily peer-to-peer. They’re like middlemen in the sense that they help you purchase or get rid of cryptocurrency by trading from their supply. Instead of person A selling coins to person B, person A sells coins to the exchange, who will then sell those coins to person B. That way, you don’t have to wait days or weeks for a buyer or seller. 

The instant availability of transactions will allow you to sell when the altcoin or Bitcoin price is highest and buy when it’s at its lowest–with no delays. It’s extremely helpful for investors as the market can be extremely volatile. It’s not rare for prices to rise or drop by 20% overnight, so this functionality is crucial. 

Exchanges will also purchase cryptocurrency to keep in storage for use at a later date. They may sell for profit or use their coins to stimulate the market when the supply is low. 

How are cryptocurrency prices decided on?

Like the rest of the investment market, the altcoin and Bitcoin price comes down to two important things: supply and demand. Naturally, if there’s a massive supply of a particular coin but not enough market interest, its value will go down. But if the supply is low and the demand is high, prices may increase rapidly. 

Several other factors influence the value of cryptocurrencies. For one, you may be wondering how cryptocurrency obtains value in the first place. That value is, at its core, perceived by the public. If people believe that a shirt is worth $1, they’ll be inclined to purchase it for that much. The same goes for crypto. Because people believe that coins are worth something–based on news, mainstream media, and demand–a specific numerical value is aligned to the coin. 

What is a "stablecoin"?

A stablecoin is a type of cryptocurrency with a value pegged to an external asset, such as gold or the American dollar. People use them as a safety net against the volatile crypto market, as they don’t fluctuate in price at the same rate. 

For instance, an investor may own 100 ETH but believe that its value may fall in the near future. They can decide to exchange those ETH for Tether, a form of stablecoin, to avoid losing money without leaving the token ecosystem. It’s quicker than exchanging for fiat money and makes for easy cryptocurrency trades in the future. 

The world of cryptocurrency is constantly moving, so it’s important to stay up-to-date with all the goings of the industry. The above covers the basics of cryptocurrency–and there’s much more to know to guide you in your journey. Check out our edit for more news and trading tips. 

Ronnie A. Rahman

Written by Ronnie A. Rahman
on 11 Dec 2020

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