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Avast Academy Security Other Threats What Is Cryptocurrency and How Does It Work?

What Is Cryptocurrency and How Does It Work?

It may be a fixture in the news, but cryptocurrency remains an enigma to many. Is crypto the future of finance, an economic bubble ready to burst, or something else entirely? Learn more about how crypto works and whether it’s a worthy investment. Then protect all your digital assets with ironclad privacy and security software like Avast One.

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What is Cryptocurrency?

Cryptocurrency is a digital currency that uses blockchain technology — a shared ledger that records transactions and tracks asset ownership. Cryptocurrency assets and trades are secured with cryptography, which provides powerful security against fraud. Because cryptocurrency isn’t issued or regulated by a central authority, crypto is immune (in theory) to currency manipulation and government interference.

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    Cryptocurrency is totally digital and doesn’t rely on banks, governments, or other authorities to verify transactions. It’s a peer-to-peer trading system that allows anyone worldwide to send and receive payments without third-party inference.

    Like other established currencies, cryptocurrency can be used as a medium of exchange, to buy regular goods and services, assuming the other party in the transaction accepts payment in crypto. But most people treat crypto like an asset — investing in it, like stocks.

    Because cryptocurrencies are new, dynamic, and often volatile systems, investing in crypto can be risky. Price volatility results in huge swings in value. Plus, cryptocurrency mining (or bitcoin mining) requires high energy consumption, which is expensive and detrimental to the environment.

    How does cryptocurrency work?

    Cryptocurrency works by using cryptography to prevent counterfeiting and double spending, and blockchain technology to verify and conduct transactions. Verifying transactions creates more crypto — which is then awarded to the verifier. Because processing transactions results in the creation of new currency units, cryptocurrency is a self-sustaining system.

    To some, a completely digital form of currency may seem alien. But the cryptocurrency model is very similar to how physical currency works. Individual units of cryptocurrency are referred to as coins or tokens, and you can also buy a fraction of a crypto coin (like pennies are fractions of dollars). Purchased cryptocurrency is stored in an app or device called a crypto wallet.

    Cryptocurrency units are created through a process called mining, which requires considerable computer power to carry out complex mathematics, resulting in earned crypto coins or tokens. However, most people purchase cryptocurrency through specialized brokers rather than mining.

    So how do you trade something digital? Here’s where cryptocurrency diverges from physical currency: Cryptocurrency is composed of encrypted keys that allow for the transfer of records between recipients. These records are held within the blockchain and represent the true value of cryptocurrency.

    Cryptocurrency is stored in virtual wallet, where you can use it to buy, trade, or sell more tokens.Cryptocurrency is stored in a virtual wallet, where you can use it like a physical currency to pay for goods and services, trade, or collect more crypto coins and tokens.

    What is the blockchain?

    The blockchain is a chain of computers that form an online ledger. Each part of the blockchain contains sets of transactions, referred to as blocks, that have been independently verified by all the others. Each new block in the chain must also be verified by all the other blocks, making it virtually impossible to forge transaction histories.

    As blockchain technology has evolved, it’s become integral to how cryptocurrency functions. Through the Distributed Ledger Technology of blockchain, cryptocurrency transactions are recorded with public-private key cryptography. A cryptographic signature called a hash is used to transfer coin ownership. Before being added to the blockchain, each transaction is checked by a computer — a miner. For their work, miners are rewarded in bitcoin (or another cryptocurrency).

    Here are the two blockchain validation types:

    • Proof of work: Participating miners race to solve a mathematical puzzle that helps to verify a block of transactions and lets them get added to the blockchain ledger. The first computer to do this successfully is rewarded with crypto. The proof-of-work method requires a lot of computer power and a substantial amount of electricity.

    • Proof of stake: This method is more energy-efficient, because it doesn’t require an energy-intensive contest. Instead, proof-of-stake miners are awarded opportunities to verify transactions based on how much crypto they “stake.”

      Each miner must temporarily lock up some crypto in a communal safe. The more crypto you stake, the higher your chances of getting an opportunity to verify. If chosen, a stake owner (or validator) is rewarded with crypto.

      To help discourage fraud, if a validator verifies invalid transactions, they must forfeit part of what they staked.

    Each verified transaction must be checked and approved by a majority of the blockchain. This helps to prevent any foul play. To interfere with a ledger, a hacker would need at least 51% of the blockchain to approve their fraudulent record entry. Considering the resources required for such a feat — it’s nearly impossible.

    Types of cryptocurrency

    Bitcoin and Ethereum are the most widely recognized types of cryptocurrency, but there are thousands of cryptocurrencies currently in circulation. So what is the best cryptocurrency to invest in? Each cryptocurrency has its own function and specification.

    Here are some common types of cryptocurrency:

    • Bitcoin (BTC)

      Made public in 2009, Bitcoin is the most widely traded and valuable cryptocurrency. The success of Bitcoin has led to the rise of many other cryptocurrencies.

    • Ethereum (ETH):

      Released in 2015, Ethereum is a blockchain platform that developed its own coin. Popular for financial transactions, Ether (ETH) or ethereum is the second most widely used crypto coin after Bitcoin.

    • Litecoin (LTC)

      Similar to Bitcoin, Litecoin developed innovations for faster payments and more transactions.

    • Solana (SOL)

      A competitor to Etherium, Solana is also a blockchain platform with its own coin.

    • XRP (XRP)

      Popular with financial institutions, XRP is a coin tailored to work with Ripple, a distributed blockchain ledger system that can track cryptocurrency and other types of transactions.

    • Tether (USDT)

      Anchored at $1 per coin, Tether is a stablecoin whose value is pegged to the US dollar.

    • USD Coin (USDC)

      Another stablecoin tied to the US dollar, USD Coin’s founders say its backed by assets held in an account that’s regulated by US government institutions.

    • Binance Coin (BNB)

      BNB is the cryptocurrency unit of Binance, one of the largest crypto exchanges in the world.

    • Dogecoin (DOGE)

      Initially created as a joke, Dogecoin gets its name from a meme with the Shiba Inu dog. Unlike other cryptocurrencies that cap coin issuances, dogecoin has unlimited issuance.

    • ADA (ADA)

      ADA is a cryptocurrency issued by Cardano, a currency platform created by the co-founder of Ethereum.

    What are stablecoins?

    Stablecoins are cryptocurrency coins that fix (or peg) their value to another currency, commodity, or financial instrument — like the US dollar or gold. In theory, pegging helps stablecoins avoid the volatility of more popular cryptocurrencies like Bitcoin.

    How can you mine cryptocurrency?

    To mine cryptocurrency, you need a ton of computing power or other cryptocurrency to stake. If you successfully validate transitions in the blockchain, you’ll be rewarded with more crypto. Generally, cryptomining simply refers to the process of generating new cryptocurrency through the process of validating transactions.

    Unlike mining for gold, you can’t use picks and shovels to mine for crypto, because it’s a completely digital asset. So, what exactly is mining cryptocurrency?

    New cryptocurrency is generated in exchange for validating transactions. Validation involves expensive hardware used to solve complex math problems. The first computer to solve the problem adds the validated transaction block to the blockchain ledger and receives cryptocurrency as a reward.

    Ultimately, in cryptocurrency, mining is a reward. Through verification, miners are building and contributing to the permanent, public record of cryptocurrency transactions on the blockchain. And newly-mined crypto is their prize.

    Because most cryptocurrencies offer a fixed number of coins, as crypto networks grow, validation becomes more complicated, requiring increased computing power to successfully mine each successive unit of crypto. The computational and energy demands of mining crypto make it very expensive for the average consumer to participate. Today, cryptomining is typically conducted by large mining farms with access to tons of computer servers and electricity.

    How to buy or invest in cryptocurrency?

    There are several ways you can buy or invest in cryptocurrency. Like other assets, different cryptocurrencies offer their own advantages and disadvantages. So where’s the best place to buy crypto? It depends on which currency you want to invest in and what you want to do with it.

    Here are ways you can buy or invest in cryptocurrency:

    • Traditional brokers: Along with other assets like stocks, bonds, and Exchange Traded Funds (ETFs), brokers are now offering ways to buy and sell cryptocurrency.

    • Cryptocurrency exchanges: Platforms like Coinbase and CashApp are marketplaces where you can buy and invest in crypto using regular currency. They use well-known payment services like PayPal and Venmo to facilitate purchases. Although relatively safe, look out for crypto exchange scams.

    Traditional investment vehicles are also starting to use cryptocurrency — specifically Bitcoin. Here are some ways to invest in Bitcoin:

    • Bitcoin trusts: A regular brokerage account allows you to buy shares of Bitcoin trusts. This exposes you to cryptocurrency through the stock market.

    • Bitcoin mutual funds: Bitcoin mutual funds or Bitcoin ETFs are also possible investment vehicles.

    • Blockchain stocks or ETFs: By investing in blockchain companies, you can indirectly invest in cryptocurrency through the tech that makes it possible. Another option is to invest in companies that use blockchain technology.

    NFTs

    Non-fungible tokens (NFTs) are digital assets, typically in the form of photos, videos, and audio. Like cryptocurrency, a blockchain is used to store and record ownership of NFTs. NFTs can be transferred by the owner, enabling them to be sold and traded. Unlike crypto, which are mass-produced, NFTs are singular items.

    Regular currency and cryptocurrency is fungible, so each unit is uniform in value. The value of one bitcoin is equal to another bitcoin. Non-fungible tokens have a digital signature so they are uniquely identifiable. Each NFT is singular — like a piece of art. So the value of one NFT is not equal to another.

    Just like cryptocurrencies, the popularity of NFTs has risen dramatically in recent years. To some, the idea of owning a unique piece of digital property is more appealing than investing in crypto. Though, like cryptocurrency, it’s unclear whether NFTs are a sound investment or just a fad.

    What is the best cryptocurrency to invest in in 2022?

    With so many cryptocurrencies on the market, how do you know which one to invest in? Let’s take a closer look at some of the more popular crypto coins. Keep in mind, crypto is extremely volatile and values can swing wildly.

    Here are some of the most popular cryptocurrency options in 2022:

    Cryptocurrency Symbol
    Bitcoin BTC
    Ethereum ETH
    Litecoin LTC
    XRP XRP
    Dogecoin DOGE
    Tether USDT
    USD Coin USDC

    What can you buy with cryptocurrency?

    Like other currencies, you can use crypto to buy goods and services — both physical and digital. Although not yet widely accepted, crypto is quickly establishing itself as a common form of payment.

    Technology sites and ecommerce sites — like Microsoft, Shopify, and Rakuten — were among the first to accept cryptocurrency for goods and services. Car manufacturers — like Tesla and Honda — also accept crypto. Even some insurance companies are coming around to crypto payments.

    Cryptocurrency is also used to purchase NFTs. Along with works of digital art, NFTs are expanding into the realm of digital real estate. Digital real estate refers to virtual spaces within the metaverse and so-called “sandbox platforms,” where owners can interact with others and construct anything they want.

    With companies like Nike and Starbucks already buying plots, digital real estate is an emerging opportunity where you can invest your cryptocurrency.

    How to store cryptocurrency

    Cryptocurrency is stored in a crypto wallet — usually an app or a physical device that holds the private keys to access your crypto. Crypto wallets are secure enough to keep hackers and other thieves out.

    Here are the two types of crypto wallet providers:

    • Hot wallet storage: Hot wallets use online software to protect the private keys that access your crypto assets. They typically charge fees.

    • Cold wallet storage: Also known as hardware wallets, cold wallets are offline, physical devices that store your private keys. They typically don’t charge fees.

    Cryptocurrency storage is also commonly handled by crypto exchanges, which are online platforms that function like a marketplace to safely allow users to store, send, receive, and convert cryptocurrencies. Many exchange platforms charge fees for withdrawing, transacting, and trading crypto. But, they also provide security services, storage, and withdrawal options.

    Some exchange services provide a crypto wallet — if yours doesn’t, find out what the best crypto wallet options are.

    You can store cryptocurrency in hot wallet storage (online), or cold wallet storage (offline).Online hot wallet storage for cryptocurrency usually charges fees, while offline cold wallet storage is usually free.

    Advantages of cryptocurrency

    Cryptocurrency has shifted the paradigm of financial infrastructure, because it’s a decentralized currency system that doesn’t rely on banking or government intermediaries linked to traditional currency systems. Many of the advantages of cryptocurrency stem from its decentralized nature.

    Here are some advantages of using cryptocurrency:

    • Streamlined financial architecture: There are no banks or other financial institutions facilitating crypto exchanges. Transacting parties exchange money directly. This removes the chance of a single point of failure setting off a large-scale calamity — like the financial crisis in 2008, triggered by the subprime mortgage crisis in the US.

    • More secure transfers: The cryptographic technology used to secure crypto makes for more secure money transfers. And because they cut out third-party intermediaries, crypto transfers are faster too.

    • Market value: Over the last decade, the value of cryptocurrency has shot up tremendously. At one point, crypto was valued as an almost $2 trillion industry. Cryptocurrency bets have made fortunes for some investors.

    • Passive income: People who validate cryptocurrency transactions before they’re added to the blockchain are rewarded in crypto. Although it’s difficult to make profits unless you’re a professional, “proof of stake” validation, in particular, gives you an opportunity to earn passive income.

    • Portability: Since cryptocurrencies are not linked to financial intermediaries, your money is totally portable. Plus, cryptocurrency is not affected by the whims of global finance intermediaries.

    • Transparency: Because blockchain technology serves as a public ledger, all transactions are publicly available. This helps eliminate shady dealings or cover-ups.

    Disadvantages of cryptocurrency

    With cryptocurrency, there is a disconnect between theory and practice. In today’s currency landscape, the idealistic notion of a decentralized currency with public records differs from its real-world implementation. Many of cryptocurrency’s disadvantages stem from this disparity.

    Here are the disadvantages of cryptocurrency:

    • Possibility to track transactions: Since blockchain technology is a public ledger, all crypto transactions can be tracked. Government agencies can track and decipher this digital trail, which means transactions on the blockchain are not private.

    • No regulation: A lack of worldwide regulations encourages criminal activity within the crypto community, such as money laundering and cybercrimes. Crypto is the ransom of choice in many new ransomware attacks, and hackers use all kinds of malware-laden programs to steal cryptocurrency. A DHL malspam campaign was recently stopped after the credentials of thousands of users were compromised.

    • Limited acceptance: Blockchain technology is still not widely adopted. This reluctance prevents cryptocurrency from reaching its potential, and it leads to hesitancy in investors — and therefore, market volatility.

    • High energy consumption: The complex math equations involved in crypto mining require a lot of computing power, which uses a substantial amount of electricity. Today, mining one bitcoin requires 9 years’ worth of the energy consumed by the average American household. This raises serious environmental concerns over cryptocurrency’s carbon footprint.

    • Concentrated ownership: Although cryptocurrencies are free of regulations, coin ownership is tightly concentrated to a select few. According to Bloomberg, just 1,000 investors held about 40% of bitcoin’s value in 2017.

    Is cryptocurrency safe?

    Generally, cryptocurrency is safe because most crypto is based on blockchain technology, which implements multiple points of verification. All crypto transactions also require two-factor authentication.

    Cryptocurrency is generally safe, because all transactions require two-factor authentication.All cryptocurrency transactions require two-factor authentication to complete.

    Still, “crypto hacking” is on the rise, and several high-profile attacks have devastated cryptocurrency start-ups. The infamous Mt. Gox hack in 2014 shocked the investment world and resulted in hundreds of millions of dollars of stolen bitcoin. In 2018, hackers attacked the start-up Coincheck, costing them $534 million. That same year, BitGrail, an Italian exchange, was hit for more than $150 million.

    Other cryptocurrency scams include:

    • Fake websites: These are fake crypto investing sites set up to steal investor money. Fake crypto sites include sham testimonials and phony jargon guaranteeing substantial gains on initial investments.

    • Virtual Ponzi schemes: These are fake opportunities to invest in cryptocurrency that guarantee returns to new investors, whose fees end up paying for the returns of old investors. From 2014-2019, Onecoin was one of the biggest crypto ponzi schemes. Marketed as the “bitcoin killer,” Onecoin robbed investors of almost $6 billion.

    • “Celebrity” endorsements: Fraudsters can pose as celebrities or billionaires to lend credibility to their scams. They pledge to multiply your investment, but steal it instead. They also start online rumors that a certain celebrity is endorsing a coin. Once the value is driven up, they sell off the coin and deplete its value.

    • Romance scams: Scammers also trick people on dating apps and social media to invest in crypto-based schemes. According to the FBI, the first half of 2021 saw 1,800 reports of romance scams involving cryptocurrency that resulted in $133 million in losses.

    Hackers are exploiting crypto with increasingly sophisticated attacks. Through cryptojacking, hackers can secretly use your device to mine new coins. With crypto-based phishing scams, hackers are posing as brokers or crypto exchanges to lure victims. Hackers have also been known to steal coins directly from crypto wallets.

    If you’ve fallen victim to a hack of any kind, report the internet scam to help mitigate damages and stop the perpetrators from attacking again.

    Are cryptocurrencies legal?

    Cryptocurrency is legal in some countries. In other countries, using crypto is a legal gray area or simply illegal. Since cryptocurrency is not backed by any public or private entity, it’s hard to establish legality in certain financial jurisdictions.

    Since 2021, El Salvador remains the only country to allow Bitcoin as legal tender. Crypto’s legal status in other countries depends on the financial jurisdiction. China has outright banned crypto and crypto mining. In many other countries, legislation regarding crypto is still in the early stages of development.

    Why is cryptocurrency volatile?

    Cryptocurrency is volatile because its value is affected by supply and demand, the actions of investors, government regulations, and even the media. All of these factors contribute to the huge swings — both up and down — in cryptocurrency value.

    Although it’s been around since 2009, cryptocurrency is still considered a new form of payment. As investors, governments, and global financial industries continue to sort out what crypto’s potential is, volatility will likely remain high.

    The value of crypto is also volatile because of the limited number of coins or tokens that can be mined — for Bitcoin, the cap is 21 million. The closer miners get to that limit, the more likely it is, in theory, that the value of cryptocurrency will increase. But what happens next is uncertain and will most likely be influenced by large financial players who dominate the cryptocurrency environment, as well as by government agencies.

    Protect your online assets with Avast One

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    Keep all your digital accounts secure and get alerted to any data leaks that may compromise your personal information. Avast One keeps your most precious assets safe and sound.

    FAQs

    Where can I buy cryptocurrency?

    You can buy cryptocurrency from popular crypto exchanges, like Coinbase or the Cash App. The type of service offered by an exchange varies. Some crypto exchanges are better for beginners, while others have better security features. Investors can also buy cryptocurrencies or crypto ETFs from brokers, along with other assets.

    What’s the point of cryptocurrency?

    Cryptocurrency provides a secure and streamlined currency exchange free of interference by governments or financial institutions. As a decentralized currency, crypto cuts out the middleman linked to traditional currency systems, like banks. Instead, crypto uses blockchain technology to verify and conduct transactions.

    Why is cryptocurrency so popular?

    Crypto is popular because it’s a revolutionary idea that employs technological innovations to rethink financial infrastructure. Still, cryptocurrency has plenty of critics who believe there’s a difference between crypto’s intended use and how it actually works in the real world. This debate contributes to its popularity in the news.

    What’s the most popular cryptocurrency?

    Bitcoin is by far the most popular cryptocurrency — followed by Ethereum. Other popular coins are XRP, Cardano, Polkadot, and Stellar. Due to the volatile nature of cryptocurrency, popularity is subject to change according to the market value of individual coins.

    Can I generate cryptocurrency?

    Although you can generate, or mine, cryptocurrency, the process requires tremendous computing power, so the industry is dominated by crypto farms. Cryptomining is the process of validating new crypto transactions by solving complex math problems, generating cryptocurrency as a reward.

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