Key takeaways

  • Cryptocurrency is digital money, like euros or United States dollars, but operates independently from governments and banks, using a decentralized technology called blockchain.
  • Transactions are securely recorded on a public ledger (blockchain) visible to all users, ensuring transparency and preventing fraud through cryptography.
  • Cryptocurrencies come in many different shapes and sizes, from Bitcoin (the first and most famous) to altcoins, stablecoins and tokens used for specific purposes like governance or gaming.
  • Cryptocurrencies can offer lower transaction fees, faster transactions, enhanced privacy and accessibility to financial services for unbanked populations, but they also have risks, such as volatility and regulatory concerns.

Cryptocurrency has been a hot topic in the financial technology industry for over a decade. But what exactly is it, and why should you care? 

Imagine cryptocurrency as digital money, similar to the euros or US dollars (fiat currencies) people use daily, but with a few significant differences. Some cryptocurrencies have properties similar to gold, other commodities and stocks. Many people buy specific cryptocurrencies to hold on to them and hopefully see their value increase over time. 

Unlike traditional currencies issued by governments, cryptocurrencies are decentralized, meaning that a single person or entity does not govern them. Instead, they run on a technology called blockchain, which is like a public ledger that documents or records each transaction. 

Cryptocurrencies also often aim for a high level of decentralization, taking away the operation of the network from one point and distributing it to many. They function like a massive online community where members collectively monitor one another to ensure no one engages in dishonest behavior. 

This is achieved through secure communication called cryptography, which ensures that transactions are both irreversible and secure.

This article provides a comprehensive introduction to cryptocurrency, covering the basics, including the definition of cryptocurrency, the history of cryptocurrency, how cryptocurrency works, its benefits and risks and its future.

Cryptocurrency for beginners, explained

Suppose everyone has a notebook where they keep track of their financial transactions. This means that every time money is spent or received, it is recorded in the notebook, similar to how a bank keeps track of customers’ transactions.

Now, there’s a catch. Instead of one person or bank keeping this record, millions of people worldwide have copies of this notebook. Everyone updates their notebook to reflect a change whenever a transaction occurs. This implies that all parties possess the same information and can view and agree on the transactions that have occurred. 

So, how can they ensure that all the records match and that no one cheats if everyone uses the same notebook and updates it simultaneously? This comes down to the blockchain technology at the heart of cryptocurrency.

Did you know? The concept of digital cash predates Bitcoin. David Chaum, a computer scientist, is often credited with pioneering early work in digital currencies.

How does cryptocurrency work?

The shared record-keeping system (as discussed above) defines how cryptocurrencies work, but it uses blockchain technology rather than physical notebooks. 

Here are the key elements involved in the process:

  • Transaction recording: Just like you would write in a notebook that you gave $20 to a friend, this transaction is recorded digitally in the cryptocurrency world. This means you are not writing it by hand; computers create and record it.
  • Shared notebooks and same information: Each participant in the crypto network has a copy of the same digital ledger. This ensures that everyone involved can independently check transactions and has access to the same information. 
  • Verification: When a transaction occurs, it must be verified to ensure its legitimacy. In the context of cryptocurrencies, miners or network nodes review the transaction information to verify that the sender has sufficient funds to complete the transaction. 
  • Consensus: To maintain the system’s integrity, all participants must agree on the recorded transactions. This agreement process is called consensus. It ensures that a transaction becomes part of the permanent, unchangeable record as soon as it is validated and added to the blockchain. 
  • Blockchain technology: Cryptocurrencies utilize blockchain technology instead of physical notebooks. A blockchain is an electronic ledger that keeps track of every transaction made through a computer network. The term “blockchain” refers to the arrangement of all transactions into a single “block,” which is then connected to other blocks in a “chain.”  It is decentralized because all network nodes have access to this digital ledger.

How blockchain technology works

Blockchain is the foundation of cryptocurrencies. A decentralized ledger keeps track of every transaction made over a computer network. Each block in the chain contains a list of transactions. Once a block is full, it is added to the chain in chronological, linear order. 

A full block indicates that it has reached its maximum capacity to store transactions. At this point, the block is added to the blockchain, akin to an electronic ledger, in the chronological order in which the transactions happened. This ensures that all transactions are documented consecutively, allowing users to know which ones occurred first. 

How transactions are processed in a blockchain network

  • Transaction initiation: A user starts a transaction by sending another user a specific quantity of cryptocurrency.
  • Broadcasting: For verification, the transaction is sent to a network of computers or nodes.
  • Verification: Nodes use algorithms to validate the transaction’s legitimacy.
  • Recording: The transaction is recorded in a block when verified.
  • Adding to blockchain: The transaction becomes permanent and immutable when the block is added to the existing blockchain.
Types of cryptocurrencies

Types of cryptocurrencies

Beyond Bitcoin, there are many other types of cryptocurrencies, each with its own unique characteristics and purposes.

Bitcoin

Bitcoin (BTC) is the first cryptocurrency known for its decentralized nature and limited supply of 21 million coins. Think of a limited supply like this: with US dollars, the government can print more whenever it wants. This can sometimes lead to too many dollars in circulation, raising prices (inflation).

With Bitcoin, the number of BTC that can ever exist is limited, much like a digital goldmine with a finite supply of gold. 

Did you know? The name “Bitcoin” is a combination of “bit,” the smallest unit of data, and “coin,” referring to traditional currency.

Altcoins

Any cryptocurrency other than Bitcoin, including Ether (ETH) and Litecoin (LTC), is called an altcoin. These alternative coins offer various improvements or different features compared to Bitcoin, ranging from faster transaction times to low transaction fees.

Stablecoins

Stablecoins are cryptocurrencies pegged to stable assets like fiat currencies or commodities to minimize price volatility. They are commonly used for trading or remittances. Examples of stablecoins include Tether (USDT), USD Coin (USDC) and Dai (DAI).

Privacy coins

Users who respect privacy are drawn to privacy coins like Monero (XMR) and Zcash (ZEC), which aim to hide transaction details, including who sent or received the money. 

Utility tokens

They are used within a specific blockchain to access services or to perform tasks, like paying gas fees or gaining rewards within decentralized applications (DApps). 

Security tokens

Security tokens allow users to purchase fractional shares of an underlying asset, such as property. Thus, buying and selling shares of real-world assets becomes more accessible and quick and ensures security on the blockchain.

For example, if your property is worth $100,000, you could create 100,000 tokens, each worth $1. Each token represents a fraction (1/100,000th) of the property’s total value.

Governance tokens

Governance tokens are like voting shares in a club. For instance, MKR governance tokenholders in a decentralized autonomous organization (DAO) like MakerDAO can vote on significant decisions like new projects or rule modifications. 

Since every token represents a voting right, the more tokens you own, the more influence you will have to shape the direction of the project. 

Memecoins

Memecoins are internet-based currencies created for community-driven causes or fun. For example, Dogecoin (DOGE) began as a joke of the well-known “Doge” meme, which featured a Shiba Inu dog. 

Despite its lighthearted beginnings, Dogecoin has gained a sizable fan base and is frequently used to tip online content creators or raise money for charitable causes.

DeFi tokens

DeFi tokens are the backbone of decentralized finance (DeFi) applications. They allow users to lend cryptocurrencies and earn interest or borrow against them. For instance, the Ethereum-based lending platform Compound’s (COMP) token is a DeFi token that is used for these purposes.

NFT tokens

Non-fungible tokens (NFTs) represent unique digital items like collectibles or art that can’t be replaced with something else. For example, an artist could create a digital painting of a castle and sell it as an NFT on a platform like OpenSea. In this case, a digital ID representing the castle is called an NFT token.

This digital ID is a unique alphanumeric code, often a lengthy string of letters and numbers, stored on the blockchain to ensure the verifiable ownership and legitimacy of the artwork. 

AI tokens

In artificial intelligence networks, these tokens are used to pay for services. SingularityNET, for instance, employs AGI tokens to gain access to data services and AI algorithms. That said, users can use AGIX tokens within the network to pay for AI services like data analysis.

Gaming tokens

Currencies used in online games to buy in-game assets like virtual land are called gaming tokens. Players can trade, purchase and sell in-game assets using these tokens, creating a real economy within the game. 

History of cryptocurrency

Have you ever wondered where the whole crypto mania originated from? Cryptocurrencies have a longer history than you might imagine. Here’s a brief overview:

Early concepts and precursors

  • 1980s to 1990s: With inventions like David Chaum’s eCash, which popularized the idea of anonymous online transactions, the concept of digital money started to emerge. Cryptographic protocols developed in the 1990s, such as Adam Back’s Hashcash and Wei Dai’s B-money, set the foundation for decentralized digital currencies. 

Birth of Bitcoin

  • 2008: In 2008, The mysterious figure (or group) known as Satoshi Nakamoto published a groundbreaking paper on Bitcoin. This was no ordinary paper. It introduced the blockchain technology that powers these digital currencies, laying the groundwork for the entire cryptocurrency industry. 
  • 2009: Bitcoin was formally launched when Satoshi mined the first block, referred to as the Genesis Block. And the rest, as they say, is history.

Early adoption and growth

  • 2010: A programmer named Laszlo Hanyecz spent 10,000 Bitcoin on two pizzas, marking the first real-world Bitcoin transaction, now famously known as Bitcoin Pizza Day.
  • 2011: Altcoins like Namecoin (NMC) and Litecoin began to take off and outperform Bitcoin in terms of functionality and design. 

Rise of Ethereum and smart contract-powered blockchains

  • 2013: Vitalik Buterin proposed Ethereum, a new platform for DApps that uses smart contracts, which are self-executing agreements with all their conditions encoded.
  • 2015: Ethereum debuted in 2015, introducing a new era of cryptocurrency innovation, including using initial coin offerings (ICOs) to finance startup initiatives.

Mainstream attention and regulation

  • 2017: The value and popularity of cryptocurrencies, including Bitcoin, skyrocketed, with BTC hitting an all-time high of about $20,000 in December. ICOs also surged around this time, raising billions of dollars for various projects.
  • 2018: Governments around the world began paying closer attention to cryptocurrencies, leading to increased regulations.

Continued innovation and expansion

  • 2020: With the advent of DeFi, lending, borrowing and trading without traditional intermediaries was made possible by new financial apps developed on blockchain platforms like Ethereum.
  • 2021: The market for NFTs exploded, enabling creators and artists to sell their original digital works on blockchain networks. Bitcoin surged to a record high of more than $60,000.
  • 2022 to present: Blockchain technology breakthroughs, growing institutional acceptance, and continuous legislative changes are all contributing to the continued evolution of cryptocurrencies. Blockchain interoperability, DAOs and advancements in sustainability and scalability are examples of emerging developments. 

Did you know? El Salvador was the first country to adopt Bitcoin as legal tender, which sparked global debate and interest in cryptocurrencies.

Cryptocurrency vs. traditional currency

To understand the differences between cryptocurrencies and traditional currencies, imagine regular fiat money, such as US dollars and euros, but entirely digital and independent of banks or governments — that’s cryptocurrency.

Although it offers advantages like faster transactions and cheaper fees, it can be volatile. Traditional currency, on the other hand, is generally accepted and reliable, but it can be costly and slow for international transactions. 

Here’s a quick comparison between the two:

Cryptocurrency vs. traditional currency

How to use cryptocurrency

Using cryptocurrency may sound exciting, but one must approach it carefully and with some preparation. Here’s a step-by-step guide to help you navigate the process.

Step 1: Getting started with a digital wallet

First, you need a cryptocurrency wallet, which is a digital wallet similar to a digital bank account, allowing you to receive, send and store cryptocurrencies. There are various wallets to choose from:

Each type of wallet has advantages and disadvantages, so choosing one that fits your needs, is convenient and meets your security requirements is important.

Step 2: Acquiring cryptocurrencies

After your wallet is set up, you can acquire cryptocurrencies using the following methods:

  • Cryptocurrency exchanges: Platforms like Coinbase, Binance and Kraken, which allow users to buy cryptocurrencies using traditional currencies, are called cryptocurrency exchanges. You must create an account and complete the verification process to buy crypto on these exchanges.
  • Peer-to-peer transactions: You can buy cryptocurrency directly from other individuals, such as a friend or relative, through platforms like Paxful.
  • ATMs: You can buy Bitcoin and other cryptocurrencies with cash at cryptocurrency ATMs, which resemble bank ATMs. 

Did you know? Mt. Gox, once the largest Bitcoin exchange, suffered a catastrophic hack in 2014, leading to the loss of hundreds of millions of dollars worth of Bitcoin.

Step 3:  Using cryptocurrency

It is straightforward to conduct transactions with cryptocurrencies. Typically, you’ll follow the below steps when sending money to someone else or making a payment for goods or services:

  • Get the recipient’s address: Ensure you have the recipient’s correct wallet address. Double-check the address, as crypto transactions are irreversible.
  • Enter the amount: Specify how much cryptocurrency you want to send.
  • Confirm and send: Before confirming the transaction, carefully review the details. Depending on how busy the network is, also called network congestion, processing the transaction could take some time.

Step 4: Staying informed and secure

The cryptocurrency market is still evolving and highly volatile. Keep yourself updated by engaging in community forums, such as those on Reddit or X, and subscribe to credible news sources. 

Additionally, ensure that two-factor authentication (2FA) is enabled on all your accounts, watch out for phishing scams, and never share your private keys. 

2FA is like adding an extra lock in addition to a regular password. The second secret key to your online account is a special code sent to your phone or email. It means someone knowing your password won’t be granted access to your account, as they will need the second code.

Your private key is the secret password to your cryptocurrency wallet, which allows you to access and control your funds.

Benefits of cryptocurrencies

Cryptocurrency benefits have made it an attractive option for many users and investors. These include:

  • Decentralization: Unlike traditional currencies, cryptocurrencies are not governed by a central body. This lowers the possibility of corruption and centralized control.
  • Transparency: Every transaction is visible to the public and documented on the blockchain. Because of this transparency, accountability is ensured, and fraud is prevented.
  • Lower transaction fees: Compared to traditional banking systems, cryptocurrency transactions frequently offer reduced transaction fees, particularly for international payments.
  • Security: Cryptocurrencies employ cryptographic algorithms to protect transactions and regulate the generation of new units. They are, therefore, extremely safe and challenging to counterfeit.

Risks and challenges associated with cryptocurrencies

Despite various benefits, cryptocurrencies also come with risks, including:

  • Volatility: The price volatility of cryptocurrencies is well-known. Their value might fluctuate significantly quickly, making them potentially risky investments.
  • Regulatory uncertainty: The landscape of cryptocurrency regulation is continuously evolving, creating uncertainty for users and investors.
  • Adoption barriers: It might be difficult for beginners to understand and use cryptocurrencies. This may restrict their uptake and use.
  • Security risks: While cryptocurrencies themselves are secure, exchanges and platforms that offer cryptocurrency trading are susceptible to hacking and other security vulnerabilities.

Did you know? China, once a global hub for cryptocurrency mining and trading, imposed a complete ban on all cryptocurrency-related activities in 2021.

The future of cryptocurrencies

The future of cryptocurrencies is a topic of great excitement as cryptocurrencies like BTC and ETH continue to evolve and integrate with the mainstream financial system. It is anticipated that the usability and trust in cryptocurrencies will rise as regulations become more supportive and clearer, making them an alternative method for everyday transactions.

Technological developments will also greatly influence the future of cryptocurrencies. Enhancements to scalability, security, and blockchain technology will make digital currencies more functional and appealing. Furthermore, NFTs and DeFi markets could create new opportunities and use cases for cryptocurrencies.

However, to make cryptocurrencies part of the mainstream financial system, the negative aspects must be addressed, including market volatility, scams and hacks and regulatory uncertainties. Once these problems are fixed, cryptocurrencies have the potential to revolutionize the global financial landscape by offering innovative solutions for investment opportunities, payment methods and financial inclusion. 

Written by Onkar Singh