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How does cryptocurrency work

How does cryptocurrency work?

  • 26 January 2022
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Cryptocurrency is a digital currency, or medium of exchange, that can be used to purchase goods and services. You can exchange US dollars for cryptocurrency in much the same way you exchange dollars for casino chips or arcade tokens. Cryptocurrency transactions are stored in a public ledger using Blockchain technology and secured by cryptography. Unlike traditional currency, which is stored in a central bank and managed by regulatory financial institutions, cryptocurrency is decentralized. Let’s see how does cryptocurrency work?

In 2008, Satoshi Nakamoto founded Bitcoin (BTC), the first cryptocurrency, and introduced blockchain technology to the world. Bitcoin remains the largest cryptocurrency, but there are now thousands of different cryptocurrencies on the market today including Bitcoin Cash, Ethereum, Litecoin, Cardano, Dogecoin, and XRP. They are often called altcoins because they are alternatives to Bitcoin. The cryptocurrency market has also inspired the rise of online brokers. Brokers like Coinbase, which allow you to purchase different types of cryptocurrencies.

How Does Cryptocurrency Work?

Cryptocurrency works a lot like PayPal or a credit card, except you exchange digital assets for goods and services instead of US dollars. To make a transaction with cryptocurrency, you must exchange currency with a peer using a digital wallet known as a cryptocurrency wallet. A cryptocurrency wallet is software that allows you to transfer funds from one account to another. To complete a transaction, you need access to a password, known as a private key. The private key is much like a bank account. You can own multiple keys and own all the funds sent to those keys. Transactions are recorded on a public ledger, which shows the transaction totals without revealing the identities of the parties involved.

Cryptocurrency mining is the process required to verify transactions. It involves a massive amount of computing power and complicated algorithms, but those who are successful at solving problems through mining can earn reward coins, tokens, or transaction fees.

How does cryptocurrency work: What Makes Cryptocurrency Different From Traditional Currency?

To understand how cryptocurrency is unique, you need to understand two basic components: blockchain and cryptography.

  • Blockchain technology: Blockchain is a database that keeps a record of cryptocurrency totals and transactions. It stores data in “blocks” that are linked, or “chained,” together in chronological order. Unlike traditional currency, there is no central authority overseeing blockchain. It is a distributed ledger that can be viewed by all cryptocurrency users. Processes known as “proof of work” or “proof of stake” are often built into this system to create new blocks and validate transactions.
  • Cryptography: Cryptography is a means of making the blockchain secure. Cryptographic codes, also known as “hashes,” link the blocks together, making them impenetrable to hackers. These hashes are a lot like a secure password—it’s easy for a user to create one, but nearly impossible for a stranger to guess it.

How does cryptocurrency work: How to Use Cryptocurrency?

Cryptocurrency functions a lot like traditional currency in the sense you can make purchases and treat it as an investment.

  • Purchases: You can use cryptocurrency to purchase goods online as well as hire people to perform services. Cryptocurrency exchanges can be made for fiat currency—or national currencies such as USD—and can be traded for different digital currencies.
  • Investment: You can also invest in cryptocurrency by purchasing a given amount at one value and selling it when the value increases. Cryptocurrency values are subject to volatility; the total value of a cryptocurrency, or market cap, can rise and fall quite quickly.

How does cryptocurrency work and get value?

There are thousands of different cryptocurrencies, according to data provider Coinmarketcap.com. Bitcoin is the largest and best known:

  • The number of bitcoins are finite
  • About 89% that will ever exist have already been created
  • The limit is 21 million and 18.6 million have been generated to date
  • Since 2010, the price of a single bitcoin has risen from 5p to about £35,000 in April 2021

With more people wanting to own bitcoin cash, and a limited supply available, the price others are willing to pay to own it has risen dramatically.

  • New bitcoins are created by cryptocurrency mining:
    • Computers compete to solve increasingly difficult mathematical puzzles
    • They win the right to sign off new blocks of transactions to the bitcoin blockchain
    • As a reward for keeping the blockchain working properly, they get a chunk of bitcoins
    • Every four years, this amount is cut in half

As of April 2021, the reward for adding new blocks of transactions to the bitcoin blockchain is 6.25 bitcoins – worth about £222,800 at time of writing.

Can I mine bitcoin at home?

In the early days, it was possible to “mine” bitcoin using a home PC but the puzzles get more complicated and harder to solve over time. Now only very specialised equipment has enough computing power to be able to run enough calculations per second to do it.

There are scores of publicly listed cryptocurrency mining companies that run vast farms of computer equipment dedicated to solving these puzzles.

For example, London-listed Argo Blockchain is planning to open a Texas mining facility capable of 200MW of mining — enough to power about 200,000 UK homes.

How does cryptocurrency work: make money with cryptocurrency

Investors who want to make money usually trade cryptocurrencies on a cryptocurrency exchange.

They hold onto bitcoin and wait for someone else to come along and pay more for it in the future.

  • April 2011: One bitcoin was worth about $1 (72p)
  • April 2021: One bitcoin hit a record high of $64,486 (£45,623)

If you had bought 100 bitcoin for $100 or £72 and held on to it for ten years, your stake would be worth $6,448,600 or £4,562,352 on 14 April 2021.

Not a bad investment!

Should I buy and hold bitcoin?

People who bought bitcoin very early on and held onto it for a decade or more have made massive fortunes. But not everyone has been so fortunate.

On May 22, 2010, he went onto the BitcoinTalk forum. He offered to pay anyone 10,000 bitcoins if they could deliver two pizzas to him. At the time, one bitcoin was worth about 1p.

Those pizzas cost Laszlo £356m!

That’s why so many crypto investors advocate holding onto bitcoin and cryptocurrencies for as long as possible, in case its value continues to rise.

What is cryptocurrency lending?

Decentralized Finance, or DeFi, is another way to make money with cryptocurrency that has only appeared in the past couple of years.

There are a vast array of applications for DeFi, but the breakout star to date is cryptocurrency lending:

  1. Users lend out their cryptocurrency for others to borrow
  2. In return they receive an annual percentage yield, on top of their original stake being returned to them when the lending period is over
  3. No third-party central authority involved in backing or guaranteeing these transactions

The DeFi market has exploded in value in the past 12 to 18 months.

According to industry data website DeFiPulse.com, the total value in these cryptocurrency financial contracts has grown from $800m in April 2020 to $58bn in April 2021.

What are the risks of cryptocurrency lending?

While DeFi is similar in principle to peer-to-peer transactions involving companies such as Zopa and Funding Circle, there are greater risks to consider.

Independent financial advisers often caution against investing more in cryptocurrency than people can afford to lose.

How does cryptocurrency work: Is cryptocurrency risky?

UK watchdog the Financial Conduct Authority has repeatedly warned over the dangers of cryptocurrency and in October 2020 banned the sale of certain high-risk types of cryptocurrency investments to retail investors.

  • Compensation schemes
    • UK bank deposits are almost always covered by protective schemes such as the Financial Services Compensation Scheme, this is often not the case for cryptocurrency investments
    • If a cryptocurrency exchange goes bust, there is no guarantee you will get your money back
  • Security
    • Cryptocurrency itself is extremely difficult to hack and the public ledger almost impossible to alter, but this is not true for cryptocurrency exchanges
    • As of 2021, more than 30 worldwide had been hacked or disappeared entirely – most high profile of these include Tokyo’s Coincheck, which lost in excess of $500m in 2018.
  • Volatility
    • Extreme volatility is a defining factor of cryptocurrency
    • On April 18, bitcoin posted its biggest one day drop in two months, falling 25% to $55,000. A week later it rose almost 10% in 12 hours
  • Double-spending
    • Happens when a blockchain network is disrupted
    • The cryptocurrency is essentially stolen
    • Thief sends a copy of the transaction data to make it look legitimate, or might delete the transaction altogether
    • Rare but it can happen
Should I use a digital wallet for cryptocurrency?

The alternative to holding cryptocurrency on an exchange when you buy and sell, is to download it and hold it offline in digital wallets. These look a lot like USB sticks.

“Hot” wallets – digital wallets that connected to the internet.

“Cold” wallets – digital wallets that are offline

Most require investors to create and remember a complex passphrase in order to gain access to their wallet and transfer coins in and out.

Can you really make money with cryptocurrency?

It is possible to make money with cryptocurrency, but like any relatively new technology, there are a lot of pitfalls and risks:

  • The market is heavily dependent on sentiment: how investors and traders feel about the future
  • Unlike stocks and shares, there are no earnings reports, profits or revenues for investors to point to as fundamental value
  • If a country bans bitcoin ownership or trading, it can dent the confidence that traders and investors have in the future
Which countries have banned bitcoin?

Different countries have taken different approaches to digital currencies:

Turkey’s central bank – recently banned crypto payments for goods and services, saying that the lack of global regulation posed significant risks for consumers.

China’s de facto central bank, the People’s Bank of China – told investors that it considers bitcoin an “investment alternative” and not a currency per se.

However, the country shut down the majority of mainland cryptocurrency exchanges in 2017 and has formally banned crypto projects from fundraising through initial coin offerings (ICOs)

How does cryptocurrency work for a beginner?
  1. Think of cryptocurrency like any other fiat currency, such as sterling or dollars that sit in your bank accounts
  2. You can buy stuff across the globe using your currency without an exchange fee, lowering transaction fees
  3. Instead of a bank holding onto that currency, and keeping a record of what you own and have spent, you maintain your own record in a digital wallet
  4. You use your digital wallet to pay for things with cryptocurrency
  5. Rather than using a credit card or holding physical notes and coins in a bank vault, your cryptocurrency ‘money’ is all held in your own personal digital wallet
  6. There is no central authority holding your cash; you are the authority
  7. Digital 1s and 0s represent the amount of cryptocurrency held in a particular wallet
  8. It’s really not much more complicated than that
Why Bitcoin?

The Bitcoin network introduced to the world in 2009 by an unknown individual or group called Satoshi Nakamoto. In 2021, there are more than 10,000 different projects in the field of cryptocurrencies. Each of them have its role in building the future of money.

The market value of cryptocurrencies reached $ 1 trillion for the first time in January 2021. It passed $ 2.5 trillion in less than three months later. It shows that this market is one of the growing markets in the favor of its investors.

Bitcoin Cloud Mining is the process by which you participate in a mining pool to a cloud miner website and purchase a certain amount of hash power. In this pool, the profit will distribute equally among all participants who have participated in the mining pool. It happen based on hash power. The cloud miner platform allows you to mine your Bitcoin without installing any hardware and at no extra cost.  Minerland, the best crypto cloud mining service, helps you invest in Bitcoin easily and with low risk.

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