What is Cryptocurrency and How Does It Work?

Have you heard of Bitcoin? What about Dogecoin?
Well, what about blockchain, decentralized, or a ledger?

Honestly, I have yet to meet someone who hasn't heard SOMETHING about cryptocurrency. But, the truth is I have met many people who don't have even a basic understanding of what cryptocurrency is other than a string of crypto buzzwords. The scary thing is a large portion of these people make up a large portion of the investors of cryptocurrency.

Now I'm not saying, you shouldn't invest in cryptocurrency, because in my opinion it's still a perfect time to invest. But ...

What is Cryptocurrency?

The word cryptocurrency is made of two other words you might recognize.

Cryptocurrency = Cryptography + Currency

Currency is probably clear. It's essentially money; something that is circulating and can be used to exchange for goods. So, cryptocurrency is a currency, but unlike paper money it's a digital currency. It's virtual and isn't something you can really touch. But, because it is currency you can use crypto to buy physical goods like cars and jewelry as well as digital assets such as NFTs which can sometimes only be purchased using cryptocurrency. As more and more companies start accepting cryptocurrency as a form of payment, the range of goods you can buy will only expand.

The "crypto" or cryptography portion of cryptocurrency is where it gets interesting. Cryptography is the art of creating secure communication, using secret protocols such as encryption. This concept and the underlying technology is makes cryptocurrency so special. Blockchain technology, which utilizes cryptography, is what secures any exchange of cryptocurrency. The "crypto" part of cryptocurrency is the means by which virtual currency transfers and exchanges between two people. It's what makes your cryptocurrency transactions secure, verified, and anonymous (if configured to be).

So in summary:

How Does Cryptocurrency Work

A good way to understand how cryptocurrency will work in a practical way will be to walk though what it's like to buy cryptocurrency and transfer it.

Let's imagine you want to buy your first cryptocurrency. To keep it simple let's say that you want to buy crypto's poster child, Bitcoin. You're definitely not going to store your Bitcoin into the wallet that's in your pocket or purse, so the first thing you need to have is a special wallet that can hold cryptocurrency. This could be a hardware wallet like Ledger or it can be a digital wallet such as MetaMask. The most common option is to use a digital wallet hosted on and created by a cryptocurrency exchange. A cryptocurrency exchange is essentially a platform where you can exchange, buy or sell, cryptocurrency. There are loads of cryptocurrency exchanges such as Crypto.com and Coinbase, where you they will create a wallet for you so that you can start trading on their platform.

After you have your wallet, you place an order for 1 Bitcoin and the order gets accepted. Before the Bitcoin actually becomes yours, the transaction will need to be validated. This is the job of miners, people/organizations who are using computing systems to solve a difficult mathematical puzzle. Just a miner as someone who's trying to solve a Rubix cube. Your transaction and a bunch of other unvalidated transactions make up this cube, or "block". When the miner eventually solves this cube, your transaction along with the other transactions in this block, get added to a database called the blockchain. The blockchain is essentially a long record, or ledger, of all the transactions, or solved Rubix cubes that ever existed. So when your order for 1 Bitcoin goes through, the miner solves your puzzle, your transaction gets validated and added to the blockchain, and then congrats! You finally have your 1 Bitcoin in your digital wallet. I know that was a lot, but actually all of this magic happens in a matter of a few seconds.

Why is Cryptocurrency So Popular?

Now that we've touched the surface of cryptocurrency and how it's actually used, I think it's important to understand why people are investing in it before you start investing yourself.  There's many reasons and implications that cryptocurrency will have for society, but here are some of the top reasons.

1. Cryptocurrency Is Decentralized
Here's where the words decentralized and fiat come in. Fiat currency is currency that is not backed by a physical commodity, such as gold or silver.
The idea behind fiat currency is that since it is not tied to a fixed resource, the government and banks can ideally regulate interest rates, liquidity, and the economy as whole and therefore protect the econmy from large booms/busts. Fiat currency like the US Dollar (USD) is issued and controled by the government. This makes it centralized; one entity controls the flow of USD.

40% of all USD in existence was printed in 2021.

Isn't that crazy? We've seen that fiat currency is not fool-proof. Inflation in America has recently hit an all time high, partly due to this centralized decision to printed all this money. Cryptocurrency, on the other hand, is often created with a fixed supply of coins and exists on a network of computers. This means that no one entity can create or withold coins, thereby protecting us from inflation. The fact of the matter is, a lot of people are starting to distrust the government's ability to manage the economy, and cryptocurrency has become like symbol of "sticking it to the man".

2. Fast and Secure
Another beauty of cryptocurrency is that transactions are extremely fast. Depending on the underlying network, transactions can take anywhere from 20 seconds to a few minutes. This speed comes from the fact that the role of a bank, which is to verify a transaction, is in fact handled by the network of computers that are using cryptography. The cryptography is also what makes transaction secure. The cryptography that verifies transactions is done so through using computing power to "solve" difficult "problems" that are generally irresversible. Rather than waiting a few business days for my ACH or wire to go through, I can transfer large amount of funds very quickly and securely.

3. Low Cost Transfers
If I were making a transfer internationally through my bank today, you'd have to pay a go through a longer process with a $30-40 fee before your money got to your recipient. Cryptocurrency is similar in that you have to potentially pay for transaction fees such as exchange fees, network fees, and even wallet fees; however, generally speaking this cost is still less than going through traditional means. Not to mention, again, it's faster!

Join Our Journey

I'm just like you, I'm just YourAverageInvestor. The world of investing is massive and all of us, myself included, are on a journey to increase our financial literacy, achieve our financial goals, and master the art of investing. That's why I want you to join OUR journey.

Cryptocurrency is still in its early stages and there's really a lot to take in and learn. But, the great thing is it's not too late. There's still lots of exciting opportunity in the cryptocurrency landscape and it's ripe for investing!

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