How Cryptocurrency Works for Beginners: Everything You Need to Know
Each time you turn on the news, read the papers or scroll through your Twitter feed you most likely see stories about the price of Bitcoin. I know I do. You might even have friends who are invested in this flagship cryptocurrency. Or you yourself might already have some skin in the game. Whatever the case, there is much more to the world of cryptocurrency than the original coin that helped kick off the crypto craze. As more and more enthusiasm builds for crypto investment, it’s important that smaller and first-time investors gain some valuable insights about how this revolutionary financial technology works. And here, I’m talking about all versions of this revolutionary technology: from the tried and tested big-hitters like Bitcoin and Ethereum, to the burgeoning market springing up for NFTs.
This article will break down the fundamental concepts of crypto to help you understand this innovative technology.
What Is Cryptocurrency?
Even though it sounds a lot more complicated, cryptocurrency is essentially just digital cash. In response to the Great Financial Crisis of 2008, a programmer or group of programmers (nobody is 100% certain who created Bitcoin) decided to invent a digital currency that would do away with the need for banks or financial institutions. Rather than relying on a 3rd party to oversee financial transactions, the programmer/programmers wanted to design a new peer-to-peer way of exchanging money. Thus Bitcoin, the original cryptocurrency, was born. Cryptocurrency is reliant on blockchain technology, which is essentially like a public Excel spreadsheet that stores cryptocurrency transactions. Everyone can see what transactions are being carried out on the blockchain and the record of these lasts forever. Put simply, cryptocurrency is a digitized way of transacting without the need for a bank.
How Does Cryptocurrency Work?
Everyone in the network has access to an evolving public record called the ledger. A transaction can only be added to the ledger once a complicated cryptographic puzzle is solved and a consensus is reached by other users/computers in the network, and this takes a lot of computing power. So much so that the electricity needed to commit fraud by faking transactions makes fraud uneconomical and, therefore, it does not really happen.
Let’s say you want to buy some Bitcoin. You would connect to the network, and the computers on that network would validate your transaction by having a network user solve a cryptographic puzzle. Once this puzzle is solved, and the work is verified by a consensus of other network users, the transaction is added to a block of data, and that block of data is added to a chain of existing previous transactions, which is called the blockchain. The solving of complex cryptographic puzzles, the consensus of many users/computers in the network, and the energy required to do all that is called “proof of work.” It keeps the blockchain secure.
How Does Blockchain Work?
Put simply, a blockchain is a chain of interconnected blocks of information. It helps to think of these blocks as containers that store transaction records. On average, there are 500 cryptocurrency transactions stored in each block. All the blocks are connected in a way that verifies the chain sequence is correct. What does this mean? Before the latest block of information is added to the chain, it checks the info in the preceding block, which also does the same to the block before it, and so on. The blockchain then, is an unbroken series of stored info. The beauty of this is it makes everything stored in the blockchain traceable, permanent, and unchangeable. Thus, it makes cryptocurrency a profoundly transparent and credible currency.
What Is Cryptocurrency Mining?
Like the “mining” part of its name suggests, Cryptocurrency mining is the process of painstakingly processing bitcoins in the hopes of a financial reward. Bitcoin relies on mining to confirm new transactions and update the blockchain ledger. Bitcoin miners use sophisticated computing systems to audit very complex “blocks” of transactions. If they are the first to process the block of information, bitcoin miners are paid a reward, in the form of bitcoin. And then the process begins over. Essentially, they are getting paid to keep the whole system honest. It is this system of mining, which keeps bitcoin decentralized and peer-to-peer, and independent of third party financial institutions. Not only does cryptocurrency mining help certify the legitimacy of Bitcoin transactions, but it is also the only way to bring new bitcoins into circulation.
The Main Advantages of Cryptocurrencies
Because of their decentralized structure, cryptocurrencies may be able to supply a number of solutions:
Reducing corruption: Cryptocurrencies seek to overcome the problem of absolute power by sharing it across a large number of network participants. That is, after all, the underlying concept of blockchain technology.
Giving people control over their own finances: With cryptocurrencies, there is no central authority, which means you and only you can access your funds.
Eliminating the middlemen: When you transfer traditional money, an intermediary such as your bank or a digital payment service gets a percentage. With cryptocurrencies, all network participants on the blockchain serve as that intermediary; their pay is structured differently from that of fiat money intermediaries, and so is negligible in comparison.
Serving the unbanked: A large section of the world’s population lacks or has limited access to financial institutions such as banks. Cryptocurrencies aim to tackle this problem by bringing decentralized finance to every corner of the globe, allowing anybody with a phone to start participating in the financial system.
Top 3 Cryptocurrencies You Must Know About
1. Bitcoin (BTC)
Market cap: Over $742 billion
Bitcoin is a digital currency that is created, held, and transferred electronically.
It is the first decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen.
2. Ethereum (ETH)
Market cap: Over $308 billion
Ethereum is a decentralized platform that runs smart contracts, which are self-executing contracts with the terms of the agreement between parties written directly into code.
Ethereum is designed to enable peer-to-peer transactions without a middleman, such as banks and other financial institutions. It has been described as “the first practical blockchain application” by Vitalik Buterin, co-founder of Ethereum.
Bitcoin vs. Ethereum: What’s the Difference?
Whilst both are forms of virtual, decentralized currency, also known as cryptocurrency, and both utilize blockchain technology to power financial transactions, there are some major differences between Bitcoin and Ethereum. One of the biggest differences between the two cryptocurrencies is what’s known as “block time” — it takes a few minutes for a Bitcoin transaction to be verified and processed, whereas Ethereum does so in seconds. To differentiate itself, even further, Ethereum will move to a “proof of stake” (POS) protocol in 2022. POS uses staking, rather than mining, to verify transactions. This is different to Bitcoin’s “proof of work” (POW) protocol, which is much more energy and time-intensive.
3. Tether (USDT)
Market cap: Over $80 billion
Tether is the largest stable coin and the third largest cryptocurrency by market cap. You can think of stable coins as a bridge between cryptocurrencies and traditional money. Stable coins are digital currencies that have their value backed by a real-world asset, usually the US dollar. Stable coins get their name from the fact that their value is stabilized via the real-world asset they represent. Besides their relative stability in comparison to the volatility of other forms of crypto, other benefits of stable coins include:
- Easier to understand concept.
- They are a digitized form of an existing fiat-backed currency.
- They can be moved instantly between crypto wallets, unlike traditional real world currencies.
However, unlike traditional crypto, stable coins are heavily regulated and overseen by third party authorities.
Crypto Coins vs. Tokens
Some people might be confused about the difference between cryptocurrency coins and tokens. This is because both terms are often used interchangeably. However, there are some important distinctions between the two.
The main difference between crypto coins and tokens is that crypto coins use their own blockchain, but crypto tokens don’t.
Essentially, a coin is a cryptocurrency that serves as the unit of account on its own blockchain network. For instance, Bitcoin operates on its own blockchain, as does Ether, which operates on its own Ethereum blockchain.
Coins develop their own infrastructure and get to choose how secure they are from attacks, how their supply is managed, how their transactions are processed or recorded, and whom they reward.
Crypto tokens, on the other hand, are usually a representation of an asset rather than a means of trade. A commonly seen token is Tether, a stablecoin originally built on the Ethereum blockchain, and is a crypto representation of the US Dollar. It is used most commonly for trading other cryptocurrencies without having to worry about price volatility. As a result, unlike coins, tokens can opt not to be “tied” to a particular blockchain, giving them more freedom and making trading simpler.
What Are NFTs?
Non-fungible tokens, or NFTs are digital assets that can be created, bought, and sold for real world money. The “non-fungible” part of their name means they are effectively 1 of 1. They are unique, have certified ownership and are irreplaceable. A fungible asset on the other hand is interchangeable with another of the same type. Here’s an example to illustrate this point further. Say I lend you $1 and ask you to pay me back tomorrow. I am not going to expect the exact same $1 bill that I gave you yesterday. Because cash is fungible, you could give me any old $1, and I’d be happy. Not so with NFTs! And this is what makes them a very attractive option for doing business in the Metaverse. They are unique digital assets with an agreed upon value whose ownership is certified. Perfect for a future digital world where in person cash transactions are impossible!
The Metaverse at a Glance
The work of Neal Stephenson, author of “Snow Crash”, which envisions a virtual reality-based successor to the internet, seems far more realistic today. Technology usually provides a new vision for the human race and has always been advancing over time. Many experts point to the Metaverse as the next step we can take in this direction. In layman’s terms, the Metaverse is a shared virtual world where information is constantly simulated. In the future, we will be able to create our own universes with VR tools and have them persist even if we are offline. These worlds would be persistent and would exist independently of our devices. The Metaverse has been predicted to become a part of our everyday lives in the future, as it will offer us an opportunity to socialize with others from all over the world and explore different realities.
The concept is now being developed by companies such as Facebook and Apple, which are in fierce competition with each other to be the first to release a viable product. The metaverse has been predicted to become a trillion dollar industry by 2025.
How to Avoid Getting Fooled by an NFT Scam
Rugpulls. Pump and dump. Plagiarized NFTs. If you don’t know what these are or you haven’t had these things happen to you, consider yourself lucky. NFT scams are a growing reality in the crypto landscape. And some have even raked in millions, fooling a large number of people. In this section, we’ll break down some of the most common examples of NFT scams, as well as how you can avoid them. That way, you can know what to be on the lookout for so you don’t become the next victim of an NFT scam.
Rug pulls
An NFT rug pull is essentially an NFT scam that begins with the developers making a lot of claims and maybe even releasing what looks to be very promising digital assets in the marketplace. As more and more investors come into the scam, the founders simply pull the rug out from underneath their feet by running off with the funds. And the promised project never materializes.
How to avoid this NFT scam
Do your homework before investing! Look into the credentials and reputation of the developers behind the project. Also, look at things like:
- Longish liquidity lock-up time periods.
- A project’s whitepaper.
- A few investors owning most of the NFT assets.
- Suspiciously high staking rewards.
- A dubious website.
Pump and dump
Disappointingly, pump-and-dump schemes are now commonplace in the crypto world. And now they are a lucrative NFT scam for unscrupulous operators. This type of NFT scam works when a group buys up a lot of NFTs to artificially inflate their value and drive up demand. Following this, the scammers will sell off when they know prices are at the peak, leaving investors with worthless assets.
How to avoid this NFT scam
You need to check out the history and inspect the records for the NFT project. OpenSea allows you to find out the total transactions and the number of buyers for an NFT collection. What you are looking for is a lot of investors. This means good liquidity. Follow the NFT project on Facebook, Twitter, Discord, etc. Does it have an engaged and authentic community that will ensure its value grows organically?
Plagiarized NFTs
Unfortunately, this NFT scam is growing in popularity. Artists are increasingly reporting that they are having their work ripped off and turned into NFTs by scammers. This is then sold to investors who believe they are purchasing ownership rights to the real deal. Minting an artwork as an NFT is a very straightforward process. But this does not mean the person owns the intellectual property. Scammers are stealing the IP of artists and creating fake OpenSea accounts to sell their counterfeited NFTs.
How to avoid this NFT scam
Again, this is where doing the necessary background research before buying NFTs is important. Does the artist have a blue checkmark to signal their verification status on OpenSea? You could even “stalk” the artist via Twitter, Instagram, online, etc. to see if you can verify the artwork as belonging to them yourself. Finally, you could even reach out to them directly to inquire if the NFT artwork is theirs.
No one wants to be scammed out of their hard-earned money. At the same time, no one wants to miss out on the next big investment. Scammers are preying upon investors’ hope of striking it rich in the NFT marketplace. That’s why it’s important to do your own research. Only invest when you are 100% certain that it’s an authentic opportunity. Oh, and always protect the security of your private information.
Keeping Your Crypto Safe
What Are Crypto Wallets?
A crypto wallet might seem straightforward at first glance. For the uninitiated, it’s logical to conclude that crypto wallets are digital wallets that store your cryptocurrency. But that wouldn’t be exactly correct because your crypto holdings live on the blockchain. So, what are crypto wallets meant for, then? Well, crypto wallets hold your keys, not cryptocurrency.
At this point, it might be helpful to explain what the keys are. A “key” is a string of alphanumeric characters that is used to receive and send cryptocurrency. It’s like an account number for your bank account, but it doesn’t have any personal information attached to it. They prove your ownership of your digital money and allow you to make transactions. These keys can either be public or private. Public keys allow you to receive cryptocurrency transactions. Anyone can send transactions to the public key, but you need the private key to prove that you are the owner of the cryptocurrency received in the transaction.
Why Are Crypto Wallets Important?
The answer is very simple: security. That’s because your private key proves your ownership, and since there’s no personal information attached, you want to keep this as secure and accessible to you as possible. Always keep in mind that you lose access to your funds if you lose your private keys!
How to Use a Crypto Wallet?
#1: The first step is to find which cryptocurrency wallet, you would like to use.
There are three primary types of cryptocurrency wallets:
Paper wallets: keys are written on paper and stored somewhere secure. This would be the most secure option, but not the most functional, because it makes using your crypto difficult.
Hard wallets: keys are saved on a hardware device and kept in a secure location and are only linked to a computer when you need to utilize crypto. The main goal here is to strike a balance between security and convenience.
Soft wallets: keys are stored in an app or other software. This is less secure than the other two options because it’s more vulnerable to being hacked, but it’s much more user-friendly and you don’t have to worry about misplacing your wallet.
#2: The second step is to follow the provider’s directions and set up your wallet as instructed.
#3: And the third and final step is to start sending and receiving crypto!
Risks of Cryptocurrency
The world of cryptocurrency is full of risks and opportunities. With so many coins and tokens to choose from, it can be hard to know which ones are worth investing in. Doing research before investing is one way to make sure that you are not going to lose your money.
For individuals who see the value of research but are unsure where to begin, I’ve explained my research approach in three simple steps below.
Step #1. Identify what type of information you need.
The first step in researching a crypto coin or token is to determine what you want to find out about it. Do you need a quick overview of the market, or do you need more in-depth information? If you want a quick overview, then CoinDesk and CoinTelegraph are good sources because they have an excellent guide to cryptocurrencies. If you want more in-depth information, then Bitcoin Magazine and the Bitcoin Talk Forum are good places to start.
This is a list to help you with your research on the crypto coin or token that you are interested in.
- Check Coinmarketcap for the coin’s price, trading volume, and market cap.
- Check the GitHub repository for the coin’s code.
- Check the Telegram group for updates on the coin or token.
- Find out what the coin or token does.
- Find out how it works.
- Find out who is behind the project.
- Find out how much money was raised in an ICO (Initial Coin Offering).
- What are some of the things that people say about it?
Step #2. Locate the best sources of information for your research.
There are a lot of places to find information on cryptocurrency. However, not all of them are reliable. So it’s important to know what sources can be trusted and which ones you should avoid.
Here are some good resources for crypto research:
- CoinMarketCap: It has the most up-to-date data on the performance of any given cryptocurrency. It also provides valuable information about market capitalization, trading volume, and more.
- CoinCheckup: This is an online platform that provides in-depth research reports on various cryptocurrencies.
- BitcoinTalk Forum: It is one of the oldest cryptocurrency forums in existence today and has been a hub for discussion among enthusiasts since its inception in 2009.
Step #3. Examine your comfort level when it comes to taking risks.
All investments, including crypto coins and tokens, have some level of risk. If you want to invest in cryptocurrencies, you should be aware that you might lose part or all of your money.
Doing your own research can help to mitigate some of those risks, but it won’t totally protect you. The reward, though, for taking on risk is the potential for a greater investment return.
Final Thoughts
The cryptocurrency market is a volatile one. It is not for the faint-hearted. A lot of people have lost money, and there are many more who have been scared away from the market because of that.
It’s important to do your research before investing in any cryptocurrency and to understand the risks associated with it. You should also be aware that there are no guarantees and you could lose all your money if you don’t take proper precautions.
Recommended Books
If you’d like further resources, I’ve provided links to some of the books that helped me grasp the concepts discussed above. They’re affiliate links, so if you decide to use them and make a purchase, I’ll earn a small commission at no additional cost to you. But in all honesty, I suggest these books because they were helpful in building my knowledge of crypto and are already a part of my personal library.
Money: The True Story of a Made-Up Thing by Jacob Goldstien
Blockchain Bubble or Revolution: The Future of Bitcoin, Blockchains, and Cryptocurrencies by Neel Mehta, Aditya Agashe, et al.
Digital Cash: The Unknown History of the Anarchists, Utopians, and Technologists Who Created Cryptocurrency by Princeton University Press
The Age of Cryptocurrency: How Bitcoin and the Blockchain Are Challenging the Global Economic Order by Paul Vigna and Michael J. Casey
Hype: How Scammers, Grifters, and Con Artists Are Taking Over the Internet―and Why We’re Following by Gabrielle Bluestone
The Bitcoin Standard: The Decentralized Alternative to Central Banking by Saifedean Ammous
The NFT Handbook: How to Create, Sell and Buy Non-Fungible Tokens by QuHarrison Terry and Matt Fortnow
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