What is Cryptocurrency and how does it work?

Cryptocurrency – meaning and definition

Cryptocurrencysometimes called crypto-currency or cryptois any form of currency that exists digitally or virtually and uses cryptography to secure transactions. Cryptocurrencies don't have a central issuing or regulating authorityinstead using a decentralized system to record transactions and issue new units.

What is cryptocurrency?

Cryptocurrency is a digital payment system that doesn't rely on banks to verify transactions. It’s a peer-to-peer system that can enable anyone anywhere to send and receive payments. Instead of being physical money carried around and exchanged in the real worldcryptocurrency payments exist purely as digital entries to an online database describing specific transactions. When you transfer cryptocurrency fundsthe transactions are recorded in a public ledger. Cryptocurrency is stored in digital wallets.

Cryptocurrency received its name because it uses encryption to verify transactions. This means advanced coding is involved in storing and transmitting cryptocurrency data between wallets and to public ledgers. The aim of encryption is to provide security and safety.

The first cryptocurrency was Bitcoinwhich was founded in 2009 and remains the best known today. Much of the interest in cryptocurrencies is to trade for profitwith speculators at times driving prices skyward.

How does cryptocurrency work?

Cryptocurrencies run on a distributed public ledger called blockchaina record of all transactions updated and held by currency holders.

Units of cryptocurrency are created through a process called miningwhich involves using computer power to solve complicated mathematical problems that generate coins. Users can also buy the currencies from brokersthen store and spend them using cryptographic wallets.

If you own cryptocurrencyyou don’t own anything tangible. What you own is a key that allows you to move a record or a unit of measure from one person to another without a trusted third party.

Although Bitcoin has been around since 2009cryptocurrencies and applications of blockchain technology are still emerging in financial termsand more uses are expected in the future. Transactions including bondsstocksand other financial assets could eventually be traded using the technology.

Cryptocurrency examples

There are thousands of cryptocurrencies. Some of the best known include:

Bitcoin:

Founded in 2009Bitcoin was the first cryptocurrency and is still the most commonly traded. The currency was developed by Satoshi Nakamoto – widely believed to be a pseudonym for an individual or group of people whose precise identity remains unknown.

Ethereum:

Developed in 2015Ethereum is a blockchain platform with its own cryptocurrencycalled Ether (ETH) or Ethereum. It is the most popular cryptocurrency after Bitcoin.

Litecoin:

This currency is most similar to bitcoin but has moved more quickly to develop new innovationsincluding faster payments and processes to allow more transactions.

Ripple:

Ripple is a distributed ledger system that was founded in 2012. Ripple can be used to track different kinds of transactionsnot just cryptocurrency. The company behind it has worked with various banks and financial institutions.

Non-Bitcoin cryptocurrencies are collectively known as “altcoins” to distinguish them from the original.

How to buy cryptocurrency

You may be wondering how to buy cryptocurrency safely. There are typically three steps involved. These are:

Step 1: Choosing a platform

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

• Traditional brokers. These are online brokers who offer ways to buy and sell cryptocurrencyas well as other financial assets like stocks, bondsand ETFs. These platforms tend to offer lower trading costs but fewer crypto features.
• Cryptocurrency exchanges. There are many cryptocurrency exchanges to choose fromeach offering different cryptocurrencieswallet storageinterest-bearing account optionsand more. Many exchanges charge asset-based fees.

When comparing different platformsconsider which cryptocurrencies are on offerwhat fees they chargetheir security featuresstorage and withdrawal optionsand any educational resources.

Step 2: Funding your account

Once you have chosen your platformthe next step is to fund your account so you can begin trading. Most crypto exchanges allow users to purchase crypto using fiat (i.e.government-issued) currencies such as the US Dollarthe British Poundor the Euro using their debit or credit cards – although this varies by platform.

Crypto purchases with credit cards are considered riskyand some exchanges don't support them. Some credit card companies don't allow crypto transactions either. This is because cryptocurrencies are highly volatileand it is not advisable to risk going into debt — or potentially paying high credit card transaction fees — for certain assets.

Some platforms will also accept ACH transfers and wire transfers. The accepted payment methods and time taken for deposits or withdrawals differ per platform. Equallythe time taken for deposits to clear varies by payment method.

An important factor to consider is fees. These include potential deposit and withdrawal transaction fees plus trading fees. Fees will vary by payment method and platformwhich is something to research at the outset.

Step 3: Placing an order

You can place an order via your broker's or exchange's web or mobile platform. If you are planning to buy cryptocurrenciesyou can do so by selecting "buy," choosing the order typeentering the amount of cryptocurrencies you want to purchaseand confirming the order. The same process applies to "sell" orders.

There are also other ways to invest in crypto. These include payment services like PayPalCash Appand Venmowhich allow users to buysellor hold cryptocurrencies. In additionthere are the following investment vehicles:

• Bitcoin trusts: You can buy shares of Bitcoin trusts with a regular brokerage account. These vehicles give retail investors exposure to crypto through the stock market. 
• Bitcoin mutual funds: There are Bitcoin ETFs and Bitcoin mutual funds to choose from. 
• Blockchain stocks or ETFs: You can also indirectly invest in crypto through blockchain companies that specialize in the technology behind crypto and crypto transactions. Alternativelyyou can buy stocks or ETFs of companies that use blockchain technology.

The best option for you will depend on your investment goals and risk appetite.

How to store cryptocurrency

Once you have purchased cryptocurrencyyou need to store it safely to protect it from hacks or theft. Usuallycryptocurrency is stored in crypto walletswhich are physical devices or online software used to store the private keys to your cryptocurrencies securely. Some exchanges provide wallet servicesmaking it easy for you to store directly through the platform. Howevernot all exchanges or brokers automatically provide wallet services for you.

There are different wallet providers to choose from. The terms “hot wallet” and “cold wallet” are used:

• Hot wallet storage: "hot wallets" refer to crypto storage that uses online software to protect the private keys to your assets.
• Cold wallet storage: Unlike hot walletscold wallets (also known as hardware wallets) rely on offline electronic devices to securely store your private keys.

Typicallycold wallets tend to charge feeswhile hot wallets don't.

What can you buy with cryptocurrency?

When it was first launched, Bitcoin was intended to be a medium for daily transactionsmaking it possible to buy everything from a cup of coffee to a computer or even big-ticket items like real estate. That hasn’t quite materialized andwhile the number of institutions accepting cryptocurrencies is growinglarge transactions involving it are rare. Even soit is possible to buy a wide variety of products from e-commerce websites using crypto. Here are some examples:

Technology and e-commerce sites:

Several companies that sell tech products accept crypto on their websitessuch as newegg.comAT&Tand Microsoft. Overstockan e-commerce platformwas among the first sites to accept Bitcoin. ShopifyRakutenand Home Depot also accept it.

Luxury goods:

Some luxury retailers accept crypto as a form of payment. For exampleonline luxury retailer Bitdials offers RolexPatek Philippeand other high-end watches in return for Bitcoin.

Cars:

Some car dealers – from mass-market brands to high-end luxury dealers – already accept cryptocurrency as payment.

Insurance:

In April 2021Swiss insurer AXA announced that it had begun accepting Bitcoin as a mode of payment for all its lines of insurance except life insurance (due to regulatory issues). Premier Shield Insurancewhich sells home and auto insurance policies in the USalso accepts Bitcoin for premium payments.

If you want to spend cryptocurrency at a retailer that doesn’t accept it directlyyou can use a cryptocurrency debit cardsuch as BitPay in the US.

Cryptocurrency fraud and cryptocurrency scams

Unfortunatelycryptocurrency crime is on the rise. Cryptocurrency scams include:

Fake websites: Bogus sites which feature fake testimonials and crypto jargon promising massiveguaranteed returnsprovided you keep investing.

Virtual Ponzi schemes: Cryptocurrency criminals promote non-existent opportunities to invest in digital currencies and create the illusion of huge returns by paying off old investors with new investors’ money. One scam operationBitClub Networkraised more than $700 million before its perpetrators were indicted in December 2019.

"Celebrity" endorsements: Scammers pose online as billionaires or well-known names who promise to multiply your investment in a virtual currency but instead steal what you send. They may also use messaging apps or chat rooms to start rumours that a famous businessperson is backing a specific cryptocurrency. Once they have encouraged investors to buy and driven up the pricethe scammers sell their stakeand the currency reduces in value.

Romance scams: The FBI warns of a trend in online dating scamswhere tricksters persuade people they meet on dating apps or social media to invest or trade in virtual currencies. The FBI’s Internet Crime Complaint Centre fielded more than 1,800 reports of crypto-focused romance scams in the first seven months of 2021with losses reaching $133 million.

Otherwisefraudsters may pose as legitimate virtual currency traders or set up bogus exchanges to trick people into giving them money. Another crypto scam involves fraudulent sales pitches for individual retirement accounts in cryptocurrencies. Then there is straightforward cryptocurrency hackingwhere criminals break into the digital wallets where people store their virtual currency to steal it.

Is cryptocurrency safe?

Cryptocurrencies are usually built using blockchain technology. Blockchain describes the way transactions are recorded into "blocks" and time stamped. It's a fairly complextechnical processbut the result is a digital ledger of cryptocurrency transactions that's hard for hackers to tamper with.

In additiontransactions require a two-factor authentication process. For instanceyou might be asked to enter a username and password to start a transaction. Thenyou might have to enter an authentication code sent via text to your personal cell phone.

While securities are in placethat does not mean cryptocurrencies are un-hackable. Several high-dollar hacks have cost cryptocurrency start-ups heavily. Hackers hit Coincheck to the tune of $534 million and BitGrail for $195 millionmaking them two of the biggest cryptocurrency hacks of 2018.

Unlike government-backed moneythe value of virtual currencies is driven entirely by supply and demand. This can create wild swings that produce significant gains for investors or big losses. And cryptocurrency investments are subject to far less regulatory protection than traditional financial products like stocksbondsand mutual funds.

Four tips to invest in cryptocurrency safely

According to Consumer Reportsall investments carry riskbut some experts consider cryptocurrency to be one of the riskier investment choices out there. If you are planning to invest in cryptocurrenciesthese tips can help you make educated choices.

Research exchanges:

Before you investlearn about cryptocurrency exchanges. It’s estimated that there are over 500 exchanges to choose from. Do your researchread reviewsand talk with more experienced investors before moving forward.

Know how to store your digital currency:

If you buy cryptocurrencyyou have to store it. You can keep it on an exchange or in a digital wallet. While there are different kinds of walletseach has its benefitstechnical requirementsand security. As with exchangesyou should investigate your storage choices before investing.

Diversify your investments:

Diversification is key to any good investment strategyand this holds true when you are investing in cryptocurrency. Don't put all your money in Bitcoinfor examplejust because that's the name you know. There are thousands of optionsand it's better to spread your investment across several currencies.

Prepare for volatility:

The cryptocurrency market is highly volatileso be prepared for ups and downs. You will see dramatic swings in prices. If your investment portfolio or mental wellbeing can't handle thatcryptocurrency might not be a wise choice for you.

Cryptocurrency is all the rage right nowbut rememberit is still in its relative infancy and is considered highly speculative. Investing in something new comes with challengesso be prepared. If you plan to participatedo your researchand invest conservatively to start.

One of the best ways you can stay safe online is by using a comprehensive antivirus. Kaspersky Internet Security defends you from malware infectionsspywaredata theft and protects your online payments using bank-grade encryption.

Related articles:

• What is cryptojacking and how does it work?
• What is Bitcoin?
• Four common cryptocurrency scams
• Scam websites and how to avoid them
• How safe are money e-transfers?