What is Cryptocurrency and How Does it Work

KEY TAKEAWAYS

• Cryptocurrency is very volatile - it has its own charm and risk.
• The fluctuations caused by supply and demand allow traders to profit from it.
• Experts are ambivalent about investing in cryptocurrency. Because cryptocurrency is a highly speculative investment with the potential for large price fluctuations.
• To prevent fraud, each transaction is verified using one of two main verification methods: proof of work or proof of stake.

What is Cryptocurrency

Cryptocurrency is not a mystery any more… keep reading.

Cryptocurrency is decentralized digital money based on blockchain technology. You are probably familiar with the most popular cryptocurrencies, Bitcoin and Ethereum, but there are over 5,000 different cryptocurrencies in circulation. The distinguishing feature of cryptocurrencies is that they are not issued by any central authority, making them theoretically immune to government interference or manipulation.

Cryptocurrencies can be mined or bought on cryptocurrency exchanges. With the rapid growth in the value of cryptocurrencies they become popular as trading tools. Cryptocurrencies are also used to a limited extent for cross-border transfers.

People can use cryptocurrencies both to buy ordinary goods and services and to invest in the same way as in other assets such as stocks or precious metals. While cryptocurrency is a new and exciting asset class, buying it can be risky as traders have to do enough research to fully understand how each system works.

A few words about Blockchain…

… Since it’s the most misunderstood part of cryptocurrencies.

Blockchain is an open distributed ledger that records transactions in code. It's a bit like a checkbook distributed across countless computers around the world. Transactions are recorded in "blocks", which are then combined into a "chain" of previous cryptocurrency transactions. Thanks to the blockchain, everyone who uses cryptocurrency has their own copy of this book to create a single record of transactions. The software logs each new transaction as it occurs, and each copy of the blockchain is updated simultaneously with the new information, keeping all records identical and accurate.

To prevent fraud, each transaction is verified using one of two main verification methods: proof of work or proof of stake.

• Proof of work - Each participating computer - a "miner" - solves a mathematical puzzle that helps validate a group of transactions, called a block, and then adds them to the blockchain. The first computer to do this successfully is rewarded with a small amount of cryptocurrency for their efforts.
• Proof of stake - To reduce the amount of energy needed to verify transactions, some cryptocurrencies use a proof-of-stake method. With proof of stake, the number of transactions each person can verify is limited to the amount of cryptocurrency they are willing to “stake” or temporarily lock into a shared vault to be able to participate in the process. Every person who stakes on cryptocurrencies has the right to confirm transactions, but the chances that you will be selected to do so increase with the amount you deposit.

What is Cryptocurrency Trading

Investors like to trade cryptocurrency, because it is very volatile and if a trader is able to time the market right, cryptocurrency trading can bring much higher returns than traditional investments.

Cryptocurrency trading is the exchange of digital currency between traders. The fluctuations caused by supply and demand allow traders to profit from it. Cryptocurrency trading is both risky and rewarding due to its volatile nature.

Like any financial market, the cryptocurrency market is subject to fluctuations in supply and demand.

• When demand exceeds supply, the price of an asset moves up.
• When supply exceeds demand, the price of a cryptocurrency tends to fall.

Cryptocurrency trading can be done through a CFD trading account or buying and selling base coins through an exchange.

• CFD trading on cryptocurrencies lets traders speculate on cryptocurrency price movements without taking ownership of the underlying coins. Traders can go either long or short, if they think a cryptocurrency will rise or fall in value. CFD trading on cryptocurrencies can be leveraged, meaning traders only need to put up a small deposit, margin, to gain full exposure to the underlying market. Profit or loss are still calculated according to the full size of your position, so leverage will magnify both profits and losses.
• While when traders buy cryptocurrencies via an exchange, they purchase the coins themselves and will need to create an exchange account, put up the full value of the asset to open a position, and store the cryptocurrency tokens in their own wallet until they are ready to sell. Exchanges bring their own learning curve; many exchanges also have limits on how much traders can deposit, while accounts can be very expensive to maintain.

Trading cryptocurrency, as you can see, is quite tricky, from the perspective of unpredictability, but there are also many advantages. Let’s take a look at Pros and Cons of cryptocurrencies trading, sum up yeas and nays.

Pros and Cons of Cryptocurrency

Cryptocurrencies promise a revolution in financial infrastructure and at this stage in the development of cryptocurrencies, there are differences between the theoretical ideal of a decentralized system with cryptocurrencies and its practical implementation.

Advantages

• Cryptocurrencies promise to facilitate the transfer of funds directly between two parties without the need for a trusted third party such as a bank or credit card company. These transfers are secured using public and private keys, as well as various forms of reward systems such as proof of work or proof of stake.
• Since cryptocurrencies do not use third-party intermediaries, cryptocurrency transfers between the two parties to the transaction are faster compared to standard money transfers.
• Cryptocurrency investments can generate profits. And as of December 2021 Cryptocurrency skyrocketed in value reaching almost $2 trillion.
• Cryptocurrencies such as bitcoin serve as intermediate currencies to facilitate money transfers across borders. Thus, the fiat currency is converted to bitcoin and then transferred across borders, and subsequently converted to the destination fiat currency. This method simplifies the money transfer process and makes it cheaper.

Disadvantages

• Although they claim to be anonymous, they leave a digital trail that the FBI can decipher. This opens up the possibility for governments or federal authorities to track the financial transactions of ordinary citizens.
• Cryptocurrencies become hackers' favorite to use them for ransomware activities. And for other criminal activity.
• Although cryptocurrency blockchains are very secure, unfortunately, exchanges and wallets are vulnerable to hacking.
• Some economists consider cryptocurrencies a speculative bubble, because of sudden value sharp climbing and dropping.
• Although anyone can mine them using a computer with an internet connection. However, mining popular cryptocurrencies requires significant energy, sometimes as much energy as entire countries consume. Expensive energy costs, combined with the unpredictability of mining, have resulted in mining being concentrated among large firms with billions of dollars in revenue.

What is Cryptocurrency Market

Cryptocurrency is a form of decentralized currency. It’s a totally digital asset. At its core, cryptocurrency uses blockchain technology to generate segments of code, unique to each transaction as if serial numbers. Each time cryptocurrencies exchange hands, segments of code get recorded in a decentralized ledger. Ledgers are public, with every transaction recorded in real-time. It’s impossible to fake segments of code across every distributed version of the ledger, which means crypto transactions are extremely safe.

Crypto derives its value from deficit and demand. Because cryptocurrencies aren’t tied to a country, their value is set by investors.

Bitcoin is the most prominent example of a cryptocurrency, but there are hundreds of other coins out there. There’s a growing demand for coins as “tokens,” for specific uses. That traders can use to pay, let's say, phone bills with a crypto token 50 years from now (if cryptocurrency will still be around)!

How does Cryptocurrency Market Work

Cryptocurrency is more than an investment tool. Since its inception, the cryptocurrency market has become the main market for investors. Those who have not been afraid to deal with the volatility of a decentralized currency have found gigantic profits in assets such as bitcoin and other similar crypto assets. However, for many, cryptocurrency is still a mystery.

If you are interested in cryptocurrencies, it is important to understand the market as a whole, not just the currency. Same way, if you don't know what a cryptocurrency is or why it is so highly valued, with the help of a brief overview of the cryptocurrency market and its popularity over the past decade. To make the learning process less overwhelming, you can start with basic info like cryptocurrency abbreviations, market cap, trading volume and more.

Is Cryptocurrency Safe

From a technical point of view, cryptocurrency is as reliable as a house. Currencies like Bitcoin or Ethereum are considered "safe" cryptocurrencies. However, they are very unpredictable assets.

Experts are ambivalent about investing in cryptocurrency. Because cryptocurrency is a highly speculative investment with the potential for large price fluctuations, some financial advisors discourage people from investing at all.

For example, Bitcoin nearly quadrupled in value during 2020, ending the year above $28,900. By April 2021, the price of BTC had more than doubled since the beginning of the year, but by July, all these gains were lost. BTC then more than doubled again, hitting an intraday high above $68,990 on November 10, 2021 before dropping to around $46,000 at the end of 2021. As you can see, cryptocurrency trading can be very risky.

For traders interested in cryptocurrency trading, CFP Ian Harvey's advice is: "The weight in a client's portfolio should be large enough to feel meaningful, while at the same time not violating their long-term plan if the investment drops to zero."

Bottom Line on Cryptocurrency Trading

What we’ve learned

• Cryptocurrency is decentralized digital money based on blockchain technology.
• Cryptocurrencies can be mined or bought on cryptocurrency exchanges.
• People can use cryptocurrencies both to buy ordinary goods and services.
• Blockchain is a bit like a checkbook distributed across countless computers around the world. Transactions are recorded in "blocks", which are then combined into a "chain" of previous cryptocurrency transactions.
• At its core, cryptocurrency uses blockchain technology to generate segments of code, unique to each transaction as if serial numbers. (Bitcoin and other popular currencies in mind).
• Some economists consider cryptocurrencies a speculative bubble, because of sudden value sharp climbing and dropping.
• Mining popular cryptocurrencies requires significant energy, sometimes as much energy as entire countries consume. Expensive energy costs, combined with the unpredictability of mining, have resulted in mining being concentrated among large firms with billions of dollars in revenue.

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