Cryptocurrency Concepts Explained : A Beginner’s Guide to Virtual Coins

Cryptocurrency, for almost a decade now, has turned into a buzzword in both financial and technological realms. From Bitcoin’s rise in 2009 to the sudden increase of thousands of digital coins, these virtual assets are reshaping the future of investment, banking, and even payments. Yet, many still find the concept a tad confusing and quite difficult to comprehend. 

In this article, we will be taking a look at what a cryptocurrency is, how it works, and how these digital coins gain popularity within a short period of time. 

What is a Cryptocurrency?

A digital payment system, cryptocurrency is any form of virtually existing currency used for secure transactions online. These coins are issued by a decentralized system that works on the principles of blockchain, which records the production of new units. It does not require any financial institutions to verify the transactions. Each transfer of crypto funds will be recorded in a public ledger. 

The crypto can be accessed through a cryptocurrency wallet, which is essentially a cloud-based software service. These wallets are the means through which an encrypted key is stored. Crypto’s worth is based on what people are willing to pay for these coins and does not have any legislated or intrinsic value. 

Cryptocurrencies are fungible in nature, meaning that their value remains the same regardless of buying, selling, or trading. Popular crypto coins you can consider investing in are Bitcoin, Litecoin, and Ethereum. The options are not limited to these, and there are thousands of crypto coins you can go for. 

What is Blockchain?

Blockchain is a decentralized, uneditable digital ledger that stores transactions across blocks chained together through cryptography. A network of computers verifies and validates the transactions taking place, making them secure and transparent.

How is a Cryptocurrency Different from a Traditional Currency?

Cryptocurrency is a type of digital currency that works on cryptographic and blockchain technology. One of the notable features of cryptocurrency is that it operates on a decentralized platform and is not controlled by any financial body. They can be used across the globe and offer faster transactions, regardless of geographical distance. 

On the other hand, traditional currency, known as fiat currency, is government-issued money and is issued by the central bank of each country. They are operated by a centralized institution, and regulations vary according to the issuing regions. 

How Does a Cryptocurrency Work?

The cryptocurrency works on a decentralized, peer-to-peer network, operated and secured by cryptography and blockchain technology. The transactions are validated by nodes and then are added to the blockchain in a cryptographically linked chain of blocks, making the transactions secure and transparent, without the interference of a central authority. 

Each validated transaction will be bundled into a new block and will be added to the end of the blockchain, making the transaction public and permanent. The cryptographic hash, which is a continuation of the previous block, makes it impossible to change or alter the past transactions without invalidating the entire chain. 

What is Mining or Staking?

The process of validating transactions and adding them to the blockchain is known as mining. Miners use specialized computers to solve complex mathematical puzzles, and the first one to solve them gets to add the next block of transactions to the chain. For this, miners will receive a reward in the form of new crypto coins and transaction fees. 

Types of Cryptocurrencies

The cryptocurrency ecosystem includes different types of cryptocurrencies, many of them created to facilitate work done on the blockchain they are built on. Because there are different types of cryptocurrencies available, it is important to know whether the crypto you are investing in is worth the investment. Here are some of the common categories of cryptocurrencies:

• Utility Tokens: These tokens have a specific function on their respective blockchain. For example, ETH, the native coin of Ethereum, was created to validate payment transactions and open the blocks. Another example of utility tokens is XRP, the native coin of the XRP Ledger was designed to facilitate transfer between different geographies. 
• Transactional Tokens: These tokens are used as a payment method in the blockchain network. One of the most popular transactional tokens is Bitcoin, which was created as an efficient and cost-effective way to transfer money. 
• Governance Tokens: These tokens allow the investors to vote and make decisions regarding a particular blockchain, such as UniSwap. These are mostly used by blockchain developers in decentralized finance (DeFi) projects or Decentralized Autonomous Organizations (DAOs). A common example is MakerDAO’s MKR token. 
• Platform Tokens: These tokens utilize blockchain technology to enable decentralized applications (dApps) for various purposes. An example of a platform token is Cosmos, a decentralized platform that lets apps or services communicate with others across various blockchains, and ATOM is the platform token that helps the network operate. 
• Security Tokens: Also known as asset-backed tokens, represent the ownership of an asset, such as a stock, whose value has been transferred to the blockchain. An example of a security token is the MS Token, through which one can gain partial ownership of Millennium Sapphire. 

Getting Started With Cryptocurrency

Choosing between an Investor and a Broker

Investing in crypto starts with selecting the right broker or crypto exchange. An exchange is an online platform that allows you to trade cryptocurrencies without the involvement of a third party. However, you will need to find buyers if you decide to sell your coins through an exchange. On the other hand, a broker makes use of interfaces that interact with the exchange and will find a buyer if you are selling your crypto. 

Creating and Funding Your Account

Once you have decided whether to go with a broker or an exchange, open your account. Some platforms require verification of your identity. Once the account is verified, you can add your funds or deposit them into the account. The mode of funding decides the duration it may take to clear the funds into the crypto account. 

Buying Crypto Coins

Once you have set up and verified your account, you can make crypto purchases. There is a plethora of options to buy from, and you can buy according to your financial capability. Some of the most popular crypto coins people tend to purchase include Bitcoin (BTC), Ethereum (ETH), Binance Coin (BNB), Solana (SOL), Ripple (XRP), and Dogecoin (DOGE).

There are different investment vehicles you can opt for, such as a Bitcoin trust, Bitcoin mutual funds, and Blockchain stocks or ETFs. The choice will depend on your investment goals and the extent of risk you are willing to take. 

Selecting the Storage Option

Once the purchase is made, you need to store them in wallets, available as both physical and online software, to protect them from theft or loss. However, trading through exchanges or brokers often limits the storage options. Usually, the storage options are classified into two categories:

• Hot Wallet Storage: These are the wallets or crypto storage methods that use online software to store your private keys to your digital assets. These are more susceptible to cyber attacks as they are connected to the internet.

• Cold Wallet Storage: Also called hardware wallets, the cold storage depends on offline electronic devices to safeguard your private keys. The hardware wallets are considered to be much safer as they don’t rely on the internet. 

The Legal Side of Cryptocurrency

Since cryptocurrencies are not issued by any governmental entity, it is rather difficult to make a case for their legal status, as it varies with jurisdiction. In June 2019, the Financial Action Task Force (FATF) suggested that crypto transfers require AML compliance. 

Regardless of their digital currency format, the IRS treats them as a form of financial assets. In July 2023, the US government declared that cryptocurrencies can be considered securities when purchased by an institutional investor. 

Risks and Challenges of Cryptocurrencies

Besides the market risks that come attached to speculative assets, there are certain other risks that an investor should consider before making the purchase.

• User Risk: Once a crypto transaction is made, there’s no way to reverse or cancel it. And according to Ledger, about 11% to 18% of bitcoins are lost due to various reasons. So, you are advised to take cautious steps while making a crypto transaction.
• Regulatory Risk: In many regions, the regulatory status of cryptocurrencies is still ambiguous. A sudden change in the regulations could make it difficult to sell the crypto or could even result in a market-wide drop in the price. 
• Counterparty Risks: Theft or hacking that might happen to the third-party custodians, like exchanges or brokers, could result in losing one’s entire portfolio. 
• Management Risks: With its decentralized nature and lack of strict regulations, protection against any unethical or deceptive management practices is minimal. The inefficiency caused by the managing team has resulted in scenarios where the investors have lost huge sums. 
• Programming Bugs: Bugs or exploits in the programming of the platform’s automated smart contracts can cause the investors to lose their investments. 
• Market Exploitation: Influential people, organizations, and exchanges promoting tokens favored by them remains a huge issue faced by the investors. 

Tips for a Safe Crypto Investment

• Before getting started with the investment decision, make sure you learn thoroughly about crypto concepts.
• Research the exchange or broker you are selecting before finalizing the decision.
• Decide on your crypto storage method before making the purchase. Know the benefits, requirements, and security offered by different wallets. 
• Diversify your portfolio, as it is a good investment strategy. 
• Be prepared for the ups and downs that follow the crypto investments. 

The Future of Cryptocurrency

Crypto analysts believe that despite the challenges, cryptocurrency will continue to evolve and will find its place in the realm of global finance. With advancements in blockchain technology, cryptocurrencies could become as common as online banking and might be used for everything from global payments to digital identities.

Conclusion

Cryptocurrencies, more than just a digital trend, have turned into a technological revolution. Understanding the basic concepts of cryptocurrencies can help beginners make informed decisions before making an investment. 

Since crypto continues to evolve, it is highly essential that you stay updated with the changing regulations.