Crypto Basics

What Is Cryptocurrency And How Does It Work?

  • 23 Jan, 2023

  • 3 Min read

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Before investing in the crypto space, it’s important to understand what cryptocurrencies are, how they work, and some of their advantages and disadvantages. Let’s go over some of the basics.

What is cryptocurrency?

Cryptocurrencies are a new form of money built on blockchain technology. Simply put, a blockchain is a list of transactions shared across a network of computers and secured by math and code (cryptography). Cryptocurrencies capture the value of these secure networks in the forms of coins and tokens.

What makes cryptocurrency groundbreaking is its inability to be counterfeit or double-spent. Double-spending is simply the risk that a coin or token can be used more than once.

Bitcoin is the world’s first cryptocurrency, created in 2009 by an anonymous person (or group of people) known as Satoshi Nakamoto. At its peak, Bitcoin captured over $1T in market value.

How does cryptocurrency work?

Cryptocurrencies run on blockchains, a type of distributed ledger technology, which store and broadcast a record of all transactions to its network.

These currencies can be created in different ways. Some are “mined,” which requires electricity to solve math equations and create new coins. “Miners” pay high energy bills in exchange for cryptocurrency rewards.

Other cryptos are minted — aka created, or printed. Rather than being rewarded for dedicating energy, users are rewarded for staking their tokens to secure the network. The amount of tokens to be minted are decided by the developers of each specific blockchain.

What is cryptocurrency used for?

The main use cases for cryptocurrencies are:

  • Buying and selling goods
  • Storing value
  • Securing a blockchain network
  • Voting power
  • Proving ownership of items
  • Investing in a particular ecosystem
Advantages of cryptocurrency
  • Low-cost, fast, permissionless transactions
  • Cryptographic security
  • Personal ownership of assets
  • Outsized investment returns
  • Increased privacy or publicity, depending on preference
  • Limited supply (for some tokens)
  • Instant cross-border payments
  • Inclusivity (anyone with internet access)
  • 24/7 trading markets
Disadvantages of cryptocurrency
  • Potential for illicit activity
  • Responsibility of custodying your own tokens
  • Scaling issues
  • No cancellations or refunds
  • Potential for high energy consumption

Different types of cryptocurrency

The first key distinction to make with different types of cryptocurrencies is coins vs. tokens. Crypto coins are typically the native asset of a blockchain, like BTC for Bitcoin or ETH for Ethereum. Crypto tokens are applications that are built on top of these blockchains. For instance, ERC-20 tokens like MATIC or SHIB are built on top of the Ethereum blockchain. 

Next up is bitcoin vs. altcoins – this one’s pretty straight forward. Altcoin stands for “alternative coin,” and refers to any existing coin or token that is not bitcoin. Depending on their size, certain altcoins are considered “high cap” — like ETH or XRP — “mid cap” — like QNT —  or “low cap,” like CSPR, or other lower liquidity, early opportunities available for trading on Uphold. According to CoinMarketCap, there are over 20,000 altcoins in existence.

A third type of cryptocurrency, stablecoins, are tokens that are pegged to the value of another asset, such as fiat money, gold, stocks, or even another cryptocurrency. As of mid-2022, stablecoins pegged to the U.S. Dollar have a combined market cap of over $100B and continue to grow quickly as crypto regulation takes shape across the world.

What is the best cryptocurrency to invest in?

Choosing the right cryptocurrency is a matter of your portfolio construction and risk tolerance. Bitcoin is the longest tenured, most secure and most decentralized. Depending on their specific use cases, altcoins may have a higher price ceiling, but also a much lower floor.

When researching a new cryptocurrency, you’ll want to consider its current market cap, its tokenomics (max supply, current supply, token release schedule), the team building the protocol, existing partnerships, who their competition is, the size of the market they’re going after, and the amount of volume currently being traded.

Is cryptocurrency secure?

Generally speaking, cryptocurrencies are secure due to the cryptography they’re built upon. However, different blockchains take different approaches, and it’s possible that certain chains are less secure than others. Bitcoin’s blockchain uses the SHA 256 algorithm, which is borrowed from existing, secure databases and has never been cracked.

Outside of the blockchain itself, how you decide to store your cryptocurrency is another major factor in security. The most common ways to store your coins are in software or hardware wallets.

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Uphold Team photo
Written by
  • Digital Money Platform
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