What is Crypto and How Does it Work?

What is cryptocurrency? 

The term cannot be mentioned without talking first about Bitcoin, which many investors consider to be the original cryptocurrency. Bitcoin, founded in 2009 by a programmer (or, possibly, a group of programmers) under the pseudonym Satoshi Nakamoto, is known as a type of cryptocurrency because it uses cryptography to keep it secure. However, it isn't really a currency, it’s more like an asset such as gold or silver, except that it’s also divisible and easily transferrable, which brings added benefits and flexibility. 

There are no physical Bitcoins, only balances kept on a public ledger that anyone with a computer has access to and can view in real time. However, it’s important to note that each record is encrypted and the identities of the people behind each transaction or blockchain address are anonymous. 

Bitcoin is not issued or backed by any banks or governments, nor is an individual Bitcoin valuable as a commodity. All bitcoin transactions are verified by a massive amount of computing power via a process known as "mining." The Bitcoin system is really a global collection of powerful computers (also referred to as "nodes" or "miners") that all run Bitcoin's code and store its blockchain. 

What is Blockchain?

Metaphorically, a blockchain can be thought of as a collection of blocks. In each block is a collection of transactions and as each block gets filled, it attaches itself to the previous block and forms an ongoing and unalterable digital chain of data. Because all the computers running the blockchain have the same list of blocks and transactions, and can transparently see these new blocks being filled with new Bitcoin transactions, no one can cheat the system. In addition, as Bitcoin’s blockchain is distributed in a decentralised manner, there is no central entity that controls the network, rather, each user collectively retains control and each new transaction further stabilises and strengthens the blockchain.

What’s the difference between a Coin and a Token?

BTC, as it is abbreviated when traded, is classed as a “coin”, rather than a “token”. The main differences between the two are that a coin is issued on its native blockchain - e.g. BTC for the Bitcoin network and ETH for the Ethereum network - and is used for making payments on that blockchain. Tokens, on the other hand, operate on a non-native network, for example, Tether (USDT) or Bancor (BNT) operate on top of the Ethereum network, and typically represent something that you own, such as a piece of art, a share in a company or a piece of merchandise, or have some specific utility such as in gaming or trading.

A simple way to look at it is by comparing fiat currency (e.g. US dollars, Pounds Sterling, Euro etc, which is money that is not backed by anything, rather, is issued by a bank or government decree) to a coupon or voucher for a restaurant or retail store. The dollars can be spent anywhere on any service or product, whereas the coupons can only be spent at the restaurant or retail store for which they were issued. Another example of a token is the deed for your house or car, which, when sold, needs to be transferred to the new owner. The deed is the tokenised representation of the asset itself.

Another distinction between coins and tokens is that the creation of coins requires a lot of work, resources and computational energy, whereas anyone can make a token, often for free and within mere moments, by using software templates or token generators online.

Is it Legal?

Despite Bitcoin not being legal tender in most parts of the world, though many more nations are jumping on board since El Salvador became the first nation to make it legal tender in June of 2021, Bitcoin has gained popularity and has triggered the launch of tens of thousands of other cryptocurrencies, collectively referred to as altcoins (alternatives to Bitcoin).

What’s an “Altcoin”?

Altcoins belong to the individual blockchains they were designed for and most of them are forks from Bitcoin and Ethereum. A fork is a splitting and creation of a new blockchain that is not compatible with the original chain. Altcoins attempt to improve upon whichever cryptocurrency and blockchain they originally forked from, though not all are successful. The first altcoin was Litecoin, forked from the Bitcoin blockchain in 2011. Even though Ethereum is not a fork of Bitcoin, it is still classed by most as an altcoin and is among the most popular altcoins on the market today.

What types of tokens are there?

Cryptocurrencies are used for many different things and as such, there are different types of cryptos. The most common are:

Payment Tokens:

Used for facilitating payments, i.e., designed to be used as an exchange of value between parties. Bitcoin is the original payment crypto.

Utility Tokens:

Those that have some utility, for example, to provide services or facilitate payments of transaction fees or “gas” (“gas” is the fee that represents the computational power it takes to mine a new block, for example, ETH is used to pay gas fees on the Ethereum network, no matter which token is being traded; MATIC is used to pay gas fees on the Polygon network, AVAX on the Avalanche network etc). Utility tokens can be purchased on exchanges and held or traded, however, their intended use is on their own network to keep it functioning.

Governance Tokens:

These provide the holder voting powers and other rights within the native blockchain, such as deciding upon the direction of a DAO (Decentralised Autonomous Organisation) or whether or not certain changes should be made to the protocols of the network.

Meme Coins:

These are generally short lived tokens that were created as a joke or to capitalise on popularity of a celebrity or circumstance, for example, the Will Smith Inu token and the SlapDao NFT (Non-Fungible Token), which were both created in the wake of Will Smith’s public slap of Chris Rock, but others gain so much popularity that they end up having some stickability, such as DOGE (Dogecoin), which was created as a farce and ended up with a huge cult following, including Elon Musk, whose company, Tesla, now plans to accept DOGE as payment for merchandise and for charging at their supercharging stations.

Stablecoins: 

These are tokens that are pegged to a fiat currency. The most popular being USDT (Tether) and USDC (USDCoin), which are both pegged to the US Dollar. The value of stablecoins is not meant to fluctuate beyond a narrow margin, nevertheless, these assets are among the most popular traded on centralised exchanges.

Security Tokens:

These are essentially the digital, tokenised form of a regulated asset such as a stock or bond. These sorts of tokens are approved by the SEC and are not currently available to retail investors. 

How do I buy crypto?

So, how does one buy a cryptocurrency? There are several ways, but whichever way you choose, you must have a digital wallet in which to receive your crypto. 

A crypto wallet comes in two forms: cold storage (physical hardware such as a Trezor or Ledger wallet - these are the most secure) and hot storage (mobile apps or online wallets such as MetaMask, Exodus or an exchange-based wallet). There are also two forms of wallet ownership - custodial and non-custodial. 

A Trezor or MetaMask, for example, is a non-custodial wallet, which issues a set of random words to the user upon set up of the wallet, called your “recovery phrase” or “seed phrase”. These words allow the user to recover their crypto assets on any device, should their wallet become compromised or corrupted, thus, the owner of this phrase has custody over the assets in the wallet to which the phrase relates, rather than the wallet issuer or creator. 

A custodial wallet does not produce a recovery phrase or other manner of guardianship to the user, meaning the control of those assets is actually held with another party. Centralised exchanges (CEX) such as Binance, KuCoin and Coinbase use custodial wallets (they are the custodians of your wallets), so it’s always recommended that cryptocurrencies that are not being traded in the meantime are stored offline in a hardware/cold storage wallet.

Once you have a wallet, you can store your cryptos. The most popular places to buy crypto is on a CEX such as Binance or Coinbase, and regulations or limits will differ depending upon your locality. This is where most newcomers start but also where many other markets may be made available to an advanced user, such as the derivatives markets and peer-to-peer transactions. Peer-to-peer (P2P) refers to settling a payment directly with another individual and can also be accessed via other P2P markets such as LocalBitcoins or Paxful. 

Another way to buy crypto is via a decentralised exchange (DEX), one of the most prominent being Uniswap. Its interface is simple, user-friendly and of course there is no KYC (know your customer) obligations, unlike the highly regulated CEXs. It allows for automated, permissionless, secure and anonymous exchange of ERC20 tokens on the Ethereum network via smart contracts (which are codes that automate agreement terms between buyers and sellers or lenders and borrowers), rather than a middle man. Users can swap tokens instantly or deposit token pairs into Liquidity Pools in order to earn yields on their deposits.

Can I spend crypto in the real world?

Can you spend your cryptocurrency? The answer is yes! You can buy anything from event tickets to merchandise, groceries to property, or even pay your insurance premiums in crypto. The easiest way to spend your crypto is by using a crypto debit card, whereby your crypto is spent but the retailer receives fiat currency, and more and more online retailers are accepting payments for products and services via crypto payment gateways such as CoinPayments or Bitpay. 

Should I invest in crypto?

As for investing in cryptocurrency, just like any investment, there are pros and cons. The crypto market is still very young and therefore incredibly volatile, which can make or break an investor. It’s possible to lose your entire investment even as an experienced trader or investor. There are also many scams and ponzi schemes out there trying to capitalise on newcomers hoping to become the next crypto millionaire, so, buyer beware. There are two acronyms you’ll constantly see peppered throughout Twitter, YouTube, Discord and Telegram: DYOR and NFA. These stand for "Do Your Own Research” and “Not Financial Advice”. 

It is always recommended to thoroughly research your chosen cryptocurrency and the platform from which you wish to purchase, ensuring that the platform is genuine and the token or coin is well established. Much of the characteristics and background info about a coin or token can be found at coinmarketcap.com or Coingecko.com, though this won’t be exhaustive. Remember that this space is infantile compared to traditional markets and as such, while there are many highly knowledgeable analysts in the crypto space, none claim to be a financial advisor for crypto and so you will often hear these two phrases issued as disclaimers. If you choose to invest your money in the crypto space, you do so entirely at your own risk.

There are otherwise numerous benefits to investing in the crypto space, such as getting in early on a burgeoning market and capitalising on time in the market, or diversifying your asset portfolio in something as finite and valuable as precious metals, but with the flexibility that comes with it being digital. Many HODLers (HODL = Hold on for Dear Life) have made genuinely life changing gains simply by buying BTC or ETH at a good price and holding onto it for several years, or by Dollar cost Averaging (DCA) and purchasing at regular intervals no matter what the market is doing. There are new cryptocurrencies being created all the time, for all manner of reasons, so it may be that the next big thing to invest in is a crypto asset that solves a genuine problem that you find frustrating. Either way, it’s highly likely that the crypto industry is here to stay and will only improve and strengthen with time, much like the internet did. With the creation of Decentralised Finance (DeFi) and smart contracts, the NFT space and tokenisation of goods, the metaverse and the expansion of online gaming and entertainment, the possibilities or cryptocurrencies are truly endless and the future looks incredibly exciting. 

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