Digital currencies were an innovative financial tool back in 2009 when Bitcoin (BTC), the first cryptocurrency was launched. People didn’t really know what to expect from this new type of digital asset and it was totally unpredictable whether cryptos stood a chance to evolve into a widely accepted, “real” sort of digital money.

In the meantime, Bitcoin has achieved immense popularity and a surge in price from several US dollars value per coin, to several tens of thousands of USD per unit. All of this was followed by the launch of a plethora of new coins and new cryptocurrencies, so-called altcoins, that aimed to offer people worldwide a new means for trading, making payments, storing value, and facilitating complex computational operations in a simple and fast manner.

In other words, the crypto market has evolved into a network of multi-billion dollar crypto exchange platforms, developer teams, and thousands of crypto assets which all have their specific advantages and disadvantages.

Let’s take a look at all the key aspects of how cryptocurrencies actually work and the basics you need to know about them

Five litecoins in colorful stones

What Are Cryptocurrencies?

Cryptocurrencies were initially a type of asset reserved for the relatively small number of crypto enthusiasts back in the early 2010s because hardly anyone else took these currencies seriously. The idea of decentralized, digital cash that isn’t tied to any central bank or government was so revolutionary in 2009 when BTC was launched, that it was unimaginable that such an asset could achieve any widespread use.

The idea behind cryptocurrencies, especially Bitcoin as the pioneer, was to offer people worldwide, regardless of their geographical location, a new financial asset, a sort of digital cash that can be used for any type of transaction, payment, or simply as a means of storing value. Digital currencies were presented as assets that will create a payment system immune to the inflation that is a constant threat for traditional currencies like USD or EUR. 

The fact that cryptos aren’t tied to governments or banks made it possible for them to attain value in a totally different way, based on their popularity and the readiness of people to use them and accept them as a sort of money. This is why developer teams tend to constantly improve cryptocurrencies they create, with software and network updates – so they can become more popular and widely accepted, which would in turn create more value for their currency.

Nowadays, more and more corporate investors, multinational companies, and funds invest in cryptocurrencies exactly because some of them, like BTC and Ethereum (ETH), have become very popular and highly traded due to their functionalities. The more people accept a certain crypto as a financial tool, the higher the value added to it.

Cryptocurrency and Blockchain Technology

Most cryptocurrencies are based on blockchain technology. Some have their own closed networks, but the most popular ones are blockchain-based. Blockchain technology is a type of data storage network that was first pioneered by Bitcoin, which had the first blockchain. This data storage network consists of blocks of data that contain information about transactions and other information that varies depending on the cryptocurrency in question.      

Utility

For example, Ethereum blocks contain much more than just transaction data. They can carry smart contract data and valuable programming code for the development of decentralized applications. Blockchain data blocks are set in chronological order and this network acts as a decentralized, distributed ledger that can be accessed by anyone using the appropriate block explorer platform to check on a certain transaction’s status.

Speed

This technology is lightning fast compared to traditional bank transfers, wire transfers, as well as debit card and credit card transactions since, depending on the cryptocurrency you use, a transfer can take anywhere from a couple of minutes (BTC) to a couple of seconds (ETH). This feature of blockchain technology is one of the key reasons for the increasing popularity of cryptocurrencies as a means for payment and the transferring of funds.

Security

Blockchain technology also provides top-of-the-line security solutions for transactions, as each transfer requires multiple verifications by independent system nodes using the proof-of-work (PoW) method, which makes sure that no one can double-spend the same assets or pull any other sort of scam or fraud.

This is all possible thanks to the first blockchain, by BTC, which was later used as an inspiration and basis for the development of new blockchains that were further improved and made to provide additional services. A great example is Stellar Lumens (XLM), whose blockchain enables international transfers of large sums regardless of the currency. Another example is the Monero (XMR) blockchain that effectively hides all sender and receiver information.

Cryptocurrency Volatility

There is often news in the media about high rises and falls in the prices of Bitcoin, Ethereum, Ripple (XRP), and other cryptocurrencies. This is because cryptocurrencies are a highly volatile type of asset and enormous price fluctuations are possible depending on their popularity and real-world events that can influence people to buy or sell a certain crypto.

This is why community feedback is extremely important for the price of cryptocurrencies. If you have influential entrepreneurs such as Elon Musk praising or criticizing a crypto like Bitcoin, you can expect that to influence the coin’s price. Likewise, if a cryptocurrency’s blockchain has bugs that are left unchecked by developers, people will quickly begin to abandon the crypto in question, causing a drop in its price. 

Crypto volatility is real and this is something everyone who plans on investing in cryptos needs to take into consideration.

Cryptocurrency Transactions

Cryptocurrencies rely on their blockchains to facilitate transfers between users. We mentioned that these transactions are far faster than traditional bank transfers. An important characteristic of crypto transactions is that if more people use a certain crypto, the developer teams behind the blockchain can make transactions work even faster and speed up the verification process.

We should note that these types of software upgrades to blockchains also depend on the block size. For example, Bitcoin may be the most popular cryptocurrency in the world with the largest trading volumes, but each block can contain only 1MB of data. When a large portion of the community disagrees with such data limitations and wants to improve the block size, a hard fork can happen. That actually did happen with BTC and it gave birth to Bitcoin Cash (BCH)—a new crypto with a larger block size.

In any case, crypto transfers leave bank transfers far behind not only in speed but also in terms of paperwork, since traditional transactions require extensive bureaucracy, while cryptocurrency transactions can be initiated without any paperwork. This characteristic makes digital currency a handy tool for business transactions that need to be quick and secure.

Cryptocurrency Mining

Cryptocurrency mining is one of the ways popular digital assets are produced, above all Bitcoin and Ethereum. There are many other cryptos that aren’t generated by miners but put into circulation by developer teams behind a certain crypto project.

In the case of BTC and ETH, mining is the main source of producing new units of the currency. This has become a very attractive business venture for entrepreneurs since Ethereum and Bitcoin mining can be done with the computing power of mining rigs. Rigs are specialized computers that have two or more graphics processing units (GPUs), which are programmed to solely mine cryptocurrency by solving complex mathematical problems and verifying transactions on the BTC or ETH blockchain.

Miners constitute a peer network of system nodes behind the blockchain that verify your transfers. In return, they get rewarded in new units of cryptocurrency for processing transactions and creating new blocks on the chain.

You can put together a mining rig if you are prepared to invest a considerable sum and start mining cryptocurrency yourself like thousands of individual miners worldwide, but there are also specialized mining companies with so-called crypto mining farms that have hundreds of mining rigs.

Mining cryptocurrencies spends a lot of electricity, though, so if you’re thinking about starting mining, you should carefully calculate how much you can earn from this business depending on the money you’d invest, your rig’s hashing power, and the cost of electricity bills.

Cryptocurrency Storage

Since cryptocurrencies don’t physically exist and can’t be stored in wallets or banks, there has to be a specific method of storing them safely. This is why cryptocurrency wallets were invented as a solution for keeping your digital assets safe. Cryptos don’t exist beyond their blockchains or networks and the only way to access them is with your private keys that act as proof that a certain amount of some currency is actually yours.

You need to tie these private keys to crypto wallets that will keep them safe. This means that you don’t really store the cryptos themselves in your wallet, but rather the public keys and what is even more important the private keys to your assets on their specific blockchain.

There are two types of wallets for storing cryptos: hot wallets and cold wallets.

Hot Wallets

Hot wallets are all crypto wallets that have a constant connection to the internet. They are also often called online or digital wallets. These wallets use different types of encrypted software solutions to store and protect your private keys. The most popular types of hot wallets are:

  • Web wallets are crypto wallets that can only be accessed through their online web platforms and they usually store your keys on their platform server.
  • Desktop wallets are downloadable programs that you install on your PC or laptop and they usually store the private keys on your device, just like mobile wallets.
  • Mobile wallets are wallet apps designed for smartphones and tablets. They are usually compatible with both Android and iOS operated smartphones.

These types of wallets are generally very safe, depending on how you use them. This means that you should take full advantage of the encryption they use by storing your passwords and seed phrases outside of the device that you use to access your wallet. This way, even if your device gets hacked, your passwords and seed phrases won’t get compromised and your cryptos will remain safe.

However, it is advised not to store large sums of cryptocurrency in hot wallets, in case they do get compromised by a cyber attack. It is generally recommended to connect your hot wallet with a hardware wallet that stores your private keys safely and securely but is easy to access. This way even if your hot wallet is compromised, the private keys still remain safe on your hardware wallet.

Some of the most popular hot wallets are Coinomi and Atomic wallet.

Cold Wallets

Cold wallets are divided into hardware wallets and paper wallets.

Paper wallets are basically pieces of paper with printed private keys and public keys for accessing and sending cryptocurrency. They also have printed QR codes for the keys and are totally safe from any type of security breach because they aren’t connected to the internet. However, it is important to keep them safely stored and make sure you don’t tear them up, spill liquid over them, or physically damage them in any way.

Hardware wallets are specialized USB devices with top-notch encryption designed to protect your private keys no matter what. These wallets have no internet connection, therefore they can’t get hacked and your keys are totally safe from cyber attacks. Several layers of encryption protect the data stored on them, so in case your hardware wallet gets lost or stolen, the keys to your assets will still remain safe.

The best hardware wallets available are Ledger Nano S and Trezor, which are used by millions of users worldwide. These devices boast great security and compatibility with all of the most popular hot wallets on the market. This means that you can connect your hardware wallet with a hot wallet app and access your cryptos with just a few clicks while keeping your private keys (and thus, assets) safe from cyber attacks.

Cryptocurrency Trading

One of the main reasons why millions of people are joining the crypto market is cryptocurrency trading. Just as company stocks are being traded on classic stock markets, cryptocurrencies are also being traded on cryptocurrency exchange platforms, over-the-counter (OTR) exchanges, and in the form of peer-to-peer transactions.

There is a lot of profit to be made from cryptocurrency trading, thanks to the high volatility of the market and the constantly increasing crypto market cap, along with numerous crypto use cases that are emerging daily. For instance, the ETH network can be used for smart contracts and DApp development.

Crypto traders monitor dozens of exchange platforms using crypto price monitoring apps such as Blockfolio and Stormgain to closely follow the fluctuation of prices and buy or sell certain crypto at the right time to make a profit.

There are numerous crypto trading strategies, such as crypto arbitrage, that are often used to make profits from buying certain cryptos on one exchange platform for a lower price and then immediately selling them at another platform for a higher price. 

If you want to try cryptocurrency trading there is a lot of money that can be made that way. However, you definitely want to learn about the market and how crypto trading works before investing funds in trading.

Cryptocurrency Exchanges

Cryptocurrency exchange platforms are one of the most popular methods, and surely the easiest, to buy and sell cryptocurrency. In the early days of cryptocurrencies, when there was only Bitcoin, buying some BTC wasn’t easy at all. You had to find someone on the web who had some coins and was willing to sell a certain amount to you. You didn’t have any guarantee that that person would uphold their end of the deal and arranging a purchase was a big hassle.

This is why cryptocurrency exchange platforms were soon developed: in order to make it possible for people to buy and trade cryptos quickly, through a reliable service with high security and liquidity. With crypto exchanges, you don’t have to search for someone who wants to trade with you – this part is done by the exchange platforms. You just have to top up your account with cash and select how much of a certain crypto you want to buy. The rest is up to the exchange platform.

There are two types of crypto exchange platforms: centralized and decentralized.

Centralized Exchange Platforms

Centralized exchange platforms are some of the most popular and widely-used platforms on the web that provide their users with several feature plans that range from free to premium services. These exchanges are owned by single companies that control the platform along with all the flowing assets. They provide high-quality, reliable services for reasonable fees that depend on the amount of cryptos you are buying or trading. Some of the most popular centralized crypto exchanges are Kraken, Coinbase, and Binance.

Decentralized Exchange Platforms

Decentralized exchange platforms don’t have a central authority that controls the flow of funds and all the transactions. These exchanges also have lower fees and don’t require nearly as much personal ID and data for verification as the centralized exchanges. You can quickly exchange assets on decentralized platforms thanks to the direct connection of two interested parties by the platform’s algorithm. Some of the most popular decentralized exchanges are Uniswap and Pancake Swap.

Most Popular Cryptocurrencies

Let’s take a quick overview of some of the most popular cryptos on the market. There are thousands of different types of cryptocurrency coins and it is highly advised to carefully study the crypto exchange charts with asset listings.

Bitcoin

Bitcoin is regarded as the king of cryptos. It was the first digital currency and it remains the most valuable one. It’s maintained the largest market cap and trading volume for years. BTC started out as solely digital cash meant for facilitating payments between people, but it soon became a widely accepted store of value and increasing numbers of companies and services (such as Paypal) have begun accepting BTC transactions.

Ethereum

Ethereum was launched in 2015 with its own blockchain that is far more versatile than that of BTC. This is because the Ethereum network can facilitate smart contracts between parties. These contracts are quick agreements and automated processes that are great for creating decentralized applications (DApps) that don’t depend on any central authority. This ability to create smart contracts and build DApps using the Ethereum programming languages has earned widespread sympathy for ETH, especially from developer teams.

Litecoin

Litecoin (LTC) was launched just two years after BTC as another form of decentralized cash. Its open-source code functions in a decentralized global payment network, which is ideal for facilitating money transfers between people in a quick and secure way. The main perk of LTC is that its blockchain creates new blocks faster than the BTC blockchain.

Ripple

Ripple (XRP) uses a distributed consensus ledger with a network of servers that act as validation points for transactions. This cryptocurrency is a powerful transaction tool for enterprise transfers between companies and corporations that need to carry out quick international fund transfers. One of the main advantages of Ripple is that its network can handle up to 1,500 transactions per second.

Bitcoin Cash

Bitcoin Cash (BCH) was borne out of a hard fork of the BTC blockchain because a part of the community wanted to increase the block size from 1 MB to 8 MB. This enabled BCH to process a far larger number of transactions than the original Bitcoin blockchain, but it hasn’t succeeded in surpassing the popularity and value of the original Bitcoin.

A Few Words Before You Go…

Cryptocurrencies are here to stay, which is clear from the total market cap of the cryptocurrency market that has surpassed two trillion US dollars. It is pretty much unimaginable that the cryptocurrency market, with its multi-million dollar daily trading volumes, could just disappear.

This doesn’t mean that virtual currencies aren’t evolving. On the contrary, new developer teams are constantly creating innovative projects that aim to utilize blockchain technology in more advanced ways, bringing crypto assets into the economic focus of the world. This is why you should definitely learn the basics about cryptocurrencies: they are becoming a widely accepted financial tool, and even fiat money was considered innovative when it first appeared.