A Beginner-Friendly Introduction to Cryptocurrency and How it Works

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Trading and investing in cryptocurrencies gained popularity in the past few years  as more people look for alternative ways to grow their incomes or trade for goods without relying on traditional currencies.

This beginner-friendly introduction to cryptocurrency explains what cryptocurrency is and how it works. If you’re new to cryptocurrencies and are keen to take the leap, this guide is for you.

• What is cryptocurrency?
• Understanding cryptocurrency and blockchain technology
• What are the different types of cryptocurrency?
• How do you buy cryptocurrency?
• Are cryptocurrencies legal?
• Should you invest in cryptourrencies?
• Are cryptocurrencies real money?

What is cryptocurrency?

Cryptocurrency is a digital or virtual form of money secured by cryptography, a method of encoding information so only the intended recipient can access it. This technology makes it nearly impossible to double-spend or counterfeit cryptocurrencies.

Using blockchain technology, users securely store cryptocurrencies on decentralised networks spread across numerous computers. Unlike traditional currencies, they are not issued by any central authority, theoretically making them resistant to government interference or manipulation.

A major advantage of cryptocurrencies is they are faster and cheaper when it comes to money transfers, thanks to decentralised systems without single points of failure. However, their value can be highly volatile, presenting risks for investors and users alike.

Understanding cryptocurrency and blockchain technology

As a virtual currency underpinned by a cryptographic system, a cryptocurrency enables secure online payments that don’t rely on third-parties. The word “crypto” relates to the use of cryptographic techniques and various encryption algorithms to secure cryptocurrency transactions and entries on the blockchain ledger.

Blockchain, the backbone of cryptocurrency, is a distributed ledger that uses a set of interconnected blocks of information. Each block contains records of cryptocurrency transactions, which are validated by participants in the network. New blocks are added only after thorough verification, making it virtually impossible to alter or forge the transaction history. This ensures both security and transparency in the system.

What are the different types of cryptocurrency?

There are numerous cryptocurrencies today, so it’s important to understand the different types. This helps you know which currencies are worth investing in and which are not. Some cryptocurrencies have a purpose while others do not. Additionally, it’s important to distinguish between coin names (or tokens) and coin types, as they are not the same.

Here’s an overview of the main types:

1. Transactional cryptocurrencies

These are designed to function as payment methods. Bitcoin (BTC) is a prime example, created specifically for peer-to-peer transactions.

2. Utility tokens

Utility tokens serve specific functions on their blockchains. Examples include Ethereum (ETH), which powers smart contracts, and XRP, used for cross-border payments.

3. Security tokens

Security tokens allow users to invest in assets like stocks by tokenising them. When a user tokenises a stock, its value transfers to the blockchain.

4. Platform tokens

These tokens, such as Solana (SOL), support applications built on a blockchain, facilitating the creation and operation of decentralised apps.

5. Governance tokens

Governance tokens, like Uniswap (UNI), provide holders with voting rights and other forms of participation in blockchain governance decisions.

How do you buy cryptocurrency?

Cryptocurrencies can be purchased for investment purposes or to pay for goods and services. To buy digital currencies, you’ll need to use a cryptocurrency exchange or broker. Here’s how it works:

1. Using a Cryptocurrency Exchange
   Cryptocurrency exchanges are platforms where you can buy and sell cryptocurrencies at their current market value. Essentially, you’re purchasing tokens from other users who are selling them. After purchasing, you can transfer your coins to a digital wallet for safekeeping. Alternatively, some exchanges, like Coinbase, offer integrated storage solutions for convenience.
2. Using a Cryptocurrency Broker
   If your goal is strictly to invest in cryptocurrencies without managing wallets or tokens, a cryptocurrency broker may be a better option. Platforms like Robinhood allow you to buy and hold cryptocurrencies as part of your investment portfolio.

Whether you’re buying for practical use or investment, understanding these options will help you get started with cryptocurrency.

Are cryptocurrencies legal?

Traditional currencies are Fiat currencies, and they get their authority from governments or monetary authorities. For example, everyone globally considers the US dollar legal tender because the US government issues it.

Cryptocurrencies, on the other hand, are not issued by any public or private entity, placing them in a legal grey area. Their status varies significantly across financial jurisdictions worldwide, with some countries embracing them, others regulating them heavily, and a few banning them outright.

In Australia, cryptocurrencies are legal and regulated by the Australian Transaction Reports and Analysis Centre (AUSTRAC). Australians can trade and use cryptocurrencies, but it’s essential to comply with local taxation and anti-money laundering laws.

Should you invest in cryptocurrencies?

Many people classify cryptocurrencies as unstable or risky investments due to the number of crypto scams proliferating globally. There are also issues like hacking, bugs in the system, and high volatility in the cryptocurrency market. Many investors suffer high losses because of these potential issues.

Despite these known hazards, cryptocurrencies continue to attract widespread interest. Many investors have built substantial fortunes by taking calculated risks on new and early-stage cryptocurrencies.

If you’re drawn to the excitement of speculative investing and have the financial capacity to withstand the possibility of losing your entire investment, cryptocurrencies could be a worthwhile venture. However, it’s essential to approach such investments with caution and thorough research.

Are cryptocurrencies real money?

Money is typically defined as something that can be exchanged for goods or services, serving as a medium of barter and exchange with an assigned value. Cryptocurrencies meet these criteria because they hold value and can be used to trade for goods and services.

In this sense, cryptocurrencies qualify as real money. However, their acceptance as a payment method varies, depending on the merchant or service provider. While some businesses embrace crypto transactions, others do not, highlighting the evolving nature of cryptocurrencies in the financial world.