Cryptocurrency: What It Is and How It Works? — Simplified 2022

In 2021 alone, the cryptocurrency market grew from less than $200 billion to nearly $3 trillion. Such a meteoric rise has attracted investors from around the world to invest in this new digital asset. However, the cryptocurrency market is still evolving, and it is extremely important for investors to understand the basic concept behind cryptocurrency so they do not fall victim to the hype.

So in this article, we will take a closer look at what cryptocurrency really is and give you a high-level idea of how cryptocurrency works.

What is Cryptocurrency?

A cryptocurrency is a form of digital money that does not require to be maintained by a centralized authority such as a bank. They are completely decentralized and are powered by blockchain technology which is secured by cryptography. So to fully understand cryptocurrency, we have to first understand these three terminologies — blockchain, decentralization, and cryptography.

Decentralization: Decentralization, in very simple terms, refers to the transfer of control and decision-making from a centralized entity (such as an individual, organization, or group) to a distributed network. Everyone in the network has a vote, and to take a particular decision, everyone in the network has to agree to it. Decentralized networks aim to reduce the level of trust that participants must place in one another and therefore are considered to be more transparent than any centralized system.

Blockchain: You can think of blockchain as a digital ledger that contains all the information of every transaction made on the network. Everyone in the network has access to this distributed ledger and can access the data at any time. The purpose of blockchain is to create a secure network that can run itself without any intermediary supervision of a central organization.

Cryptography: Cryptography is the method that secures data from unauthorized access by the use of encryption techniques. Cryptography is not a new technology at all, and throughout history, people have used Cryptography to hide or secure their data. However, in this day and age, Cryptography has transformed, enabling blockchains to be immutable, meaning anything that the blockchain records is there forever and cannot be modified or tampered with by anyone.

What can Cryptocurrency be used for?

Bitcoin was the first cryptocurrency and was launched in 2009. It was designed for digital payments but later became a way to store value without the intervention of a centralized body like a bank or government. Bitcoin can be compared to “digital gold”, as the asset’s real value will only continue to go up as Bitcoin becomes more and more scarce. Only a finite number of coins can exist to ensure that the coin’s value is retained. Bitcoin reached an all-time high of around $69,000 in November 2021, though the price constantly fluctuates.

But not just payment; cryptocurrencies have other use cases; for example, Ethereum, the second most popular cryptocurrency, can be used as a software platform that enables you to create different applications. Developers can create crypto-oriented apps, software, and games that are based on the Ethereum blockchain.

How Does Cryptocurrency Work?

Now that we have a better understanding of what cryptocurrency is and have seen some of its use cases let us discuss how cryptocurrency actually works. Because any central regulatory authorities do not control it, there are some key elements of cryptocurrencies that combine together to enable the technology to work.

1. Mining

Cryptocurrencies are not made randomly, rather, there is a finite amount of available coins, and it is the responsibility of miners to add new coins to the blockchain. Miners are also responsible for validating every transaction made on the network to ensure the network is not exploited. However, validating all the transactions involves solving complex mathematical operations requiring high computational power. This is why miners are rewarded for their service with a small share of the coin they validate. This makes mining a safe and reliable way to make passive income. You can learn more about mining strategies by clicking here.

1. Buying, Selling, and Storing

Cryptocurrencies are digital assets that can be bought, sold, or stored using crypto exchange platforms like Binance and Kraken. Investors can research and invest their money into any cryptocurrency they think will hold value in the long run. They can then store these coins in a hot or cold wallet. You can learn more about wallets by clicking here.

Should You Invest In Cryptocurrency?

Investing in cryptocurrency has become a lucrative business mainly because of its huge earning potential. However, investing in cryptocurrency has its fair share of pros and cons. Here are the top three reasons that work in favor of and against cryptocurrency investment in 2022.

Advantages

Anonymous and secure: One of the main advantages of investing in cryptocurrency is the privacy that surrounds it. Cryptocurrency is not governed by any central entity, making it less likely for regulatory bodies to intervene.

Immutable to hacking: Blockchain technology that powers cryptocurrency is immutable, meaning hackers can not easily exploit your data because miners are needed to authenticate each transaction. So, overall, cryptocurrency is more secure than any other financial system. However, your wallets and accounts holding crypto are vulnerable to scams.

Allows you to beat inflation: We mentioned how cryptocurrency is often compared to “Digital Gold” this is mainly because cryptocurrency is finite, and like any valuable asset, its value will increase with time. This makes holding crypto valuable over a period of time as it is able to grow faster than the inflation rate.

Disadvantages

Scalability issue: The biggest issue with cryptocurrency is scalability, as it is often bottlenecked by the limitation that blockchain introduces. Blockchain is sluggish in nature and is prone to transactional delays. Mining Cryptocurrency also requires a significant amount of processing power, causing energy demands to surge.

Prone to high risks: Investing in cryptocurrency can be risky. Their high volatility can often prompt sharp downward spirals, which can cause the market to crash. Take Bitcoin, for example; it was trading at around $60,000 in 2021; however, in 2022, the price has fallen to just $19,500.

They are not widely understood: Crypto being a new concept, is still not widely understood by the mass market. This can prompt people to make decisions that are not always accurate. Many cryptocurrencies also take advantage of this and create hype and lure investors in different scams.

Conclusion

It will be interesting to see whether cryptocurrency does become the future of money or not. But one thing is clear; investors should not be riding the hype train when making investment decisions. It is strongly advised to do research before investing in cryptocurrencies. You can check out our crypto-buying guide to keep yourself ahead of the curve.

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