What Is Cryptocurrency and How Does It Work?

The market for cryptocurrency – decentralized digital money managed on blockchain technology – has dramatically expanded in the last few years. This article of TechTrends will discuss in detail what is cryptocurrency and how does it work?

While the idea of digital assets seemed skeptical at first, compared with traditional ones, cryptocurrency has gained popularity quickly. Cryptocurrency definition can be simply put as allowing people to buy goods and services or trade them to gain profit. You might have already heard its most popular versions called Bitcoin and Ethereum; however, there are more than 5,000 different types of cryptocurrencies around nowadays. To keep your money safe in the future, you need to know what this digital asset is, where it came from, and the different types of cryptocurrencies. Let’s answer the question what is cryptocurrency and how does it work?

What Is Cryptocurrency and How Does It Work?

Cryptocurrency definition can be simply put as allowing people to buy goods and services or trade them to gain profit. Source: losspreventionmedia.com

Cryptocurrency is a digital or virtual asset that isn’t dependent on banks for transaction verification. With its peer-to-peer system, anyone can send and receive payment anywhere. Crypto payments are completely digital entries in a database compared to physical money used in real life. The transaction records will be in a public ledger when you transfer crypto funds. To store it, you can use digital wallets.

The name cryptocurrency is given to this digital asset because it uses encryption for transaction verification, which means there is an advanced coding used in storing and transmitting cryptocurrency information kept in wallets and public ledgers. Encryption’s purpose is to provide security and safety.

The growing interest in cryptocurrencies is mostly to trade for profit rather than exchange goods and services. When it comes to some decentralized financial networks, cryptocurrency also plays a crucial part in the operation.

The first and the foremost cryptocurrency is Bitcoin, which originated in 2008 and is well-known today. Satoshi Nakamoto had a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” and wrote in 2008. He described it as “an electronic payment system based on cryptographic proof instead of trust.”

How Does Cryptocurrency work?

Transactions are recorded into blocks connected to the previous filled block in chronological order, unbroken “chain”, which is why it is named “blockchain.” Source: https://devops.com/

Now that you know the cryptocurrency definition, let’s jump into “How does cryptocurrency work?”. Cryptos are recorded on a distributed public ledger called a blockchain. Its units are made in a mining process that uses computing power to solve mathematical problems that create coins. Furthermore, these computer networks have two specific functions: the first one is to process transactions, the other is to keep the database that manages and stores those transactions. Overall, transactions are recorded into blocks connected to the previous filled block in chronological order, unbroken “chain”, which is why it is named “blockchain.”

Users can purchase currencies from brokers and then store or spend them with the help of wallets. If you have cryptocurrency, your possession is not anything tangible. What you own is a key that permits you to record and move a unit of measure without the need for a trusted third party.

Different Types of Cryptocurrencies

There is a wide range of goals behind cryptocurrency usage like utility, governance, rewards, and proving ownership of assets. Source: https://nairametrics.com/

Assuming that you have a solid understanding of cryptocurrency definition and what is cryptocurrency and how does it work?, there is a wide range of goals behind the usage of cryptocurrency to learn about. Among them are utility, governance, rewards, and proving ownership of assets. Let’s discuss in detail what each of these purposes means.

Utility tokens

These types of tokens have one specific purpose behind them. It contributes to capitalizing and financing projects for companies as an Initial Coin Offering (ICO) that helps them raise funds to make sure their project can meet its full potential. Its most popular type is is a payment choice for purchases on the platform. For instance, Siacoin (SC) is used on the Sia network to rent decentralized cloud storage.

Security tokens (equity tokens)

This type of cryptocurrency’s function is like traditional securities. Some of them are supported by real-world assets. As an example, PAX Gold (PAXG) is backed by gold. In addition, Security tokens can function as the company’s stock or share, which is first given to investors when the sale of the token or coin offering has reached an end. Like stocks, a security token’s worth may go up or down based on the company’s performance.

Governance tokens 

With the help of this cryptocurrency type, stakeholders can collaborate on how they want the future of the network to be. There is a democratic voting process in Governance tokens, where those who have an amount of it can vote on new proposals for the community. Uniswap (UNI) can be mentioned as an example. It allows stakeholders to vote when it comes to the protocol or network upgrades. Even token holders on some exchange platforms can vote on new asset listings.

NFTs

Non-fungible tokens or NFTs, managed on blockchain technology, offer a one-of-a-kind thing, such as a piece of art or a collectible. This type of cryptocurrency’s ownership is digital, with a virtual signature that won’t be forged. They represent digital assets, but people believe they would represent concert tickets, vaccine passports, or real estate in the future. Some of the most popular NFTs are Crypto Punks, which are pixel art portraits, and some of them are worth millions of dollars.

Stablecoins

Notwithstanding their name being so misleading, stablecoins are a type of cryptocurrency. They are pegged to fiat currency such as the U.S dollar or the Euro. Their value does not fluctuate very often, meaning stablecoins can create a secure place for keeping the money without the risk of price volatility. Furthermore, for those living in areas dealing with economic struggles and unstable government-issued currencies, these digital currencies provide people with a method for value transfer. Tether (USDT) and USD Coin (USDC) are the two most well-known stablecoins.

Reward tokens 

In some blockchain applications, these types of tokens are utilized as a reputation system. Reward tokens can be used as a reward to express appreciation for services. It is like giving a compliment on Uber. Although they are not valuable, they will help the driver get more customers. Medipedia Point Rewards (MPR), which is used to give service providers on the Medipedia platform, is its blockchain-based example.

Most Popular Cryptocurrencies by Market Capitalization

There are thousands of cryptocurrencies available currently, but Bitcoin and Ethereum remain the most popular. Source: https://voi.id/

Now that you are familiar with what is cryptocurrency and how does it work, let’s dig into its different types. Although there are thousands of cryptocurrencies available currently, the followings are the best and most popular ones:

  1. Bitcoin with market capitalization of $923.2 billion
  2. Ethereum with market capitalization of $470.6 billion
  3. Binance Coin with market capitalization of $88.6 billion
  4. Tether with market capitalization of $77.4 billion
  5. Solana with market capitalization of $56 billion
  6. XRP with market capitalization of $46.6 billion
  7. Cardano with market capitalization of $46 billion
  8. USD Coin with market capitalization of $42.4 billion
  9. Terr with market capitalization of $34.1 billion
  10. Avalanche with market capitalization of $29.3 billion

Two of the most well-known cryptocurrencies are Bitcoin and Ethereum. To have a broader answer to what is cryptocurrency and how does it work? It is essential to know all about its two most popular types.

  1. Bitcoin (BTC): How does Bitcoin work?

Price: $47,710

Market cap: $901 billion

Bitcoin is the first successful digital currency. Source: https://www.dignited.com/

The first and the most important coin to know in learning what is cryptocurrency and how does it work is Bitcoin. The first big debut of cryptocurrency was in 2008 when Satoshi Nakamoto introduced Bitcoin; it is the first successful digital currency. It is a peer-to-peer electronic cash system that enables decentralization and completely cuts off the third party. In other words, with the use of this digital currency, you can purchase, sell, and exchange goods without the need for an intermediary like in real-life banks. When Bitcoin gained popularity, other types were also introduced, helping the market grow and giving investors access to multiple options year after year.

How does Bitcoin work? Well, Bitcoin, which is known as a type of cryptocurrency, uses cryptography to provide security. There is no physical Bitcoin, and it is only a balance kept on a public ledger. A massive amount of computing power – mining – happens to verify its transactions. Every Bitcoin transaction that has ever been done is easily accessible to everyone on a public ledger, and it is hard to change and fake. Because of their decentralized nature, no banks or governments are behind Bitcoin. Although it is not legal tender in many parts of the world, it is extremely popular. It has risen drastically in price and worth, leading to the launch of many other types of cryptocurrencies called “altcoins” collectively. When being traded, Bitcoin is abbreviated to BTC.

“The reason why it’s worth money is simply because we, as people, decided it has value—same as gold,” says Anton Mozgovoy, co-founder & CEO of Holyheld, a digital financial service company.

As mentioned earlier in the article, what is cryptocurrency and how does it work? Bitcoin is managed on a blockchain. As the name implies, the information is linked together, making units called blocks that store data, like date, time, total value, buyer and seller, and a unique code for every exchange on each transaction. The data are chronologically linked together, making a digital chain of blocks. The fact that Blockchain is decentralized, meaning no one controls it, and the notion that anyone can edit the Blockchain, might have appeared risky at the beginning; however, that is the main reason why Bitcoin is trustworthy and secure. Most Bitcoin holders must verify the transaction for it to be added to the Bitcoin blockchain. In addition, that code used to verify users’ wallets and transactions should obey the correct encryption pattern.

It is challenging to fraudulently produce these kinds of codes, as they are random and long numbers. To further elaborate on its safety, it is like guessing the necessary code to your Bitcoin wallet, which has the same odds as someone being a Powerball lottery winner nine times consecutively, based on what Bryan Lotti of Crypto Aquarium said.

  1. Ethereum (ETH):

Price: $3,979

Market cap: $472 billion

One of the Bitcoin alternatives is Ethereum (ETH), a platform promising smart contracts and decentralized applications (dApps). Source: https://www.dignited.com/

The second coin that is important to know all about in learning what is cryptocurrency and how does it work is Ethereum. One of the Bitcoin alternatives on the list is Ethereum (ETH), a platform promising smart contracts and decentralized applications (dApps) for building and running with no downtime, fraud, control, or interference of a third party. This type of cryptocurrency aims to make a suite of financial products that is available for anyone to access around the world, despite their nationality, ethnicity, or religion. Ether (ETH), a native cryptographic token of this platform, is used to run the applications on Ethereum. Imagine ETH as a vehicle you can go around on this platform. Developers and investors use this token to run applications inside this platform and purchase other digital currencies. Ethereum was launched in 2015, and after Bitcoin, it is the second-largest virtual currency.

Ethereum’s consensus algorithm was transitioned into proof of stake (PoS) from proof of work (PoW) in 2020 with the intention of allowing its network to run itself using less energy and have better speed in a transaction, as well as to contribute to a more deflationary economic environment. Users are permitted to “stake” their ether to the network by PoS. Those who do that will receive ether as a reward, just like an interest account.

Final Thoughts

Despite cryptocurrencies being more convenient when compared with traditional banking and investing, those who speculate in these digital assets should not put in more than they can afford to lose. Volatility can sometimes be intense. It is easy to get caught up in the latest and best currencies, financing, and investing, but you must carefully plan if you want to make smart decisions about the future. The wisest choice is to gather information on what is cryptocurrency and how does it work? And work with professionals.

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