What is Cryptocurrency and How Does It Work

Typically, transferring funds between people requires an intermediary, such as a bank, but cryptocurrencies operate differently: they are built on blockchain technology, which enables transfers without banks or other intermediaries. Blockchain is essentially a data chain where each transaction is encrypted and secured.

The first cryptocurrency, Bitcoin, was created in 2009, and since then, the number of digital currencies has rapidly increased. In this guide, we’ll cover how cryptocurrency works, what drives its value, and how you can acquire and use it.

What is Cryptocurrency and How Does It Work?

Cryptocurrency is a type of digital currency that exists solely in electronic form and relies on blockchain technology to secure and verify transactions. Cryptocurrencies are represented by “coins” or “tokens,” depending on their type and purpose.

Cryptocurrencies present an alternative to traditional currency used to pay for goods and services. Interest in digital assets is rapidly growing as they offer an investment opportunity with the potential for significant returns, attracting investors in Russia and worldwide.

The Origin of Cryptocurrency

Cryptocurrency emerged as a groundbreaking concept in 2008 when an anonymous developer or group of developers, under the pseudonym Satoshi Nakamoto, released a document titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”

This whitepaper described an entirely new financial system that enabled direct transactions between users without intermediaries like banks or government institutions.

Blockchain technology was at the heart of this system—a distributed database that records all transactions in a secure and unalterable form. In 2009, Nakamoto launched the first cryptocurrency, Bitcoin, which laid the foundation for the crypto ecosystem as we know it today.

Initially, Bitcoin was primarily used by enthusiasts and developers, but it gradually gained popularity with a broader audience, attracting investors and entrepreneurs. Over time, other cryptocurrencies, known as altcoins, began to appear, including Ethereum, Litecoin, and Ripple, each bringing unique innovations.

Today, cryptocurrencies have become an integral part of the global financial system, creating new opportunities for investment, trading, and technologies like smart contracts and decentralized applications.

Types of Cryptocurrency

Cryptocurrencies generally fall into two main categories: coins and tokens.

• Coins are digital currency units that operate within their own blockchain. Coins can be mined through a process called mining, in which a user’s computing power helps maintain the blockchain network.
• Coins can be transferred to others and exchanged for fiat currency. Furthermore, some companies accept coins as payment for goods and services; for instance, Microsoft allows customers to buy products like Windows or Xbox using Bitcoin.
• There are also altcoins—alternative cryptocurrencies created based on Bitcoin’s blockchain.
• Tokens, on the other hand, are digital assets built on an existing blockchain. Unlike coins, tokens cannot be mined; they can only be purchased or earned by participating in a project.

Tokens are often used to access platform features or for voting purposes. For example, if a coin is like currency, a token can be considered a ticket that grants access to specific services or projects. However, tokens can also be traded on exchanges and converted into fiat currency at current rates.

How Cryptocurrency Works

Cryptocurrencies are based on blockchain technology, a decentralized database made up of a chain of blocks, each containing transaction records. All information is encrypted and protected by cryptography, making it impossible to forge or alter.

When a user wants to send cryptocurrency to someone else, they create a transaction record verified by a network of computers. These computers solve complex mathematical problems to confirm the transaction’s accuracy, after which it’s added to the blockchain—a process known as mining.

Miners are network participants who verify transactions using their computing power and, in return, earn new cryptocurrency. There are two types of mining: traditional and cloud-based. Traditional mining uses personal devices, such as GPUs and CPUs, while cloud mining relies on rented equipment.

Cryptocurrencies are not tied to any state or centralized system, meaning they are decentralized and free from control by any government or bank. These assets are secured by blockchain technology, which protects them from tampering and interference.

Key Features of Cryptocurrency

Cryptocurrency is a decentralized digital exchange medium distinct from traditional currencies and offers several unique features:

• Decentralization: Cryptocurrency is not governed by central authorities like banks or governments. Built on blockchain, it is distributed across thousands of independent nodes, making it resistant to external control.
• Cryptography: Cryptocurrencies use cryptographic methods to secure transactions and ensure anonymity. Each transaction is authenticated with a digital signature based on public and private key technology, ensuring only the private keyholder can access their funds.
• Limited Supply: The supply of most cryptocurrencies is predetermined and finite. For example, Bitcoin’s supply is capped at 21 million coins, making cryptocurrencies inflation-resistant and appealing to long-term investors.
• Irreversibility: Cryptocurrency transactions are irreversible. Once a transaction is confirmed, it cannot be canceled or refunded, underscoring the importance of careful management of personal data and wallet access.

How is Cryptocurrency Used?

The uses for cryptocurrency are expanding and becoming more diverse. Primary uses include:

• Investment: High returns make cryptocurrency attractive for long-term investments. For instance, Bitcoin saw a 70% increase in value in Q1 2023, outperforming many traditional investment instruments.
• Trading: The cryptocurrency market’s volatility attracts traders seeking to profit from price swings. Price fluctuations, sometimes occurring daily, create opportunities for speculation. For example, Elon Musk’s comments in 2021 led to a $10,000 overnight drop in Bitcoin’s price.
• Payment for Goods and Services: Some companies, including Amazon, eBay, and PayPal, now accept cryptocurrency as payment. Crypto ATMs and debit cards, such as BitPay, are gradually enabling cash withdrawals. However, in Russia, cryptocurrency use is restricted to investment, while the Russian Central Bank is developing a digital ruble similar to cryptocurrency to offer citizens digital payment options through banks.

In 2020, China began testing its national digital currency, DCEP, in several cities, showing growing interest in digital currency at the state level.

Popular Cryptocurrencies

Numerous cryptocurrencies exist, but the most well-known include Bitcoin, Ethereum, Litecoin, and Ripple. These cryptocurrencies dominate a large share of the market and fall into three categories: Bitcoin, altcoins (like stablecoins), and tokens (DeFi tokens, NFTs).

These popular cryptocurrencies attract the most investors due to their high market capitalization, trading volume, and user base. Notable assets offer steady growth and profit potential.

• Market Capitalization: The total value of all circulating units of a cryptocurrency.
• Trading Volume: The amount of cryptocurrency exchanged over a specific period.
• User Base: The number of individuals who hold or use a cryptocurrency in their wallets.

1. Bitcoin (BTC): Launched in 2009 by the pseudonymous developer Satoshi Nakamoto, Bitcoin uses blockchain technology for recording and verifying transactions within a decentralized network. The total supply of Bitcoin is limited to 21 million coins, often referred to as “digital gold” for its store of value and medium of exchange. Bitcoin’s market cap exceeds 2.7 trillion rubles.
2. Ethereum (ETH): Created in 2015 by Vitalik Buterin, Ethereum is both a cryptocurrency and a decentralized platform for developing smart contracts and decentralized applications (DApps). Its native currency, Ether (ETH), is used to pay for transactions and smart contract fees. Ethereum ranks second in market cap, over 1.5 trillion rubles.
3. Tether (USDT): Tether, introduced in 2014, is a stablecoin pegged to the US dollar at a 1:1 ratio, allowing digital asset transfers backed by fiat reserves without intermediaries. It provides a stable means for hedging risk and trading on crypto markets, with a market cap of over 1.2 trillion rubles.
4. Binance Coin (BNB): Launched in 2017 by the Binance exchange, BNB is used to pay platform fees and provides various discounts and benefits to exchange users. BNB plays a role in promotions and voting events on the platform, with a market cap exceeding 800 billion rubles.

Why Do We Need Cryptocurrency?

Cryptocurrency offers not only earning potential but also solutions to various financial challenges and economic limitations:

• Protection from Inflation and Devaluation: In countries with unstable economies and politics, cryptocurrency helps preserve savings and protects them from inflation and devaluation. It also provides access to international markets.
• Quick Transfers Without Intermediaries: Cryptocurrency enables instant money transfers without needing banks. In 2022, a record-breaking $1.1 billion Bitcoin transfer incurred a fee of just $3.54.
• Supporting Innovative Projects: Cryptocurrency can be used to launch decentralized applications (DApps) and services that impact various sectors, from business to healthcare.
• Boosting Competition and Creating Jobs: Cryptocurrency increases market competition, stimulates economic growth, and creates new job opportunities for millions of users.

However, it is essential to remember that cryptocurrency also carries significant risks, including price volatility, limited regulation, and threats from hackers. Before investing or mining, it is crucial to understand the fundamentals and potential risks.

What Determines Cryptocurrency Prices?

Cryptocurrency prices are directly influenced by network demand and supply. Unlike traditional currencies, cryptocurrencies are not controlled by governments or tied to national currencies. The higher the interest in a particular cryptocurrency, the greater the demand, and consequently, the price rises. When interest wanes, the price decreases.

For miners, the price of cryptocurrency also depends on the cost of equipment and electricity required for mining.

How to Buy Cryptocurrency

There are several ways to buy cryptocurrency with traditional currencies like rubles, dollars, or euros. Here are the main options:

1. Cryptocurrency Exchanges
   Exchanges are platforms where users can trade digital currencies at current market prices. These exchanges offer secure transactions and a wide selection of cryptocurrencies. Users can use various tools to analyze the market and manage risk, such as limit and market orders, stop-losses, margin trading, and others.
2. P2P Platforms
   On P2P (peer-to-peer) platforms, users exchange cryptocurrencies directly with each other, without intermediaries. This allows them to buy or sell cryptocurrency at favorable prices and choose convenient payment methods.
3. Online Exchangers
   Online exchangers enable quick exchange of fiat money for cryptocurrency, or vice versa, at a fixed rate. Unlike exchanges, exchangers don’t require registration or verification and support multiple payment methods, including bank cards, e-wallets, and payment systems.

Cryptocurrency-Related Risks

Since cryptocurrency isn’t regulated by governments, it comes with several risks. The main challenges faced by miners and investors include:

• Volatility: Cryptocurrencies are known for their price instability, which can fluctuate sharply over a short time.
• Depreciation Risk: Some cryptocurrencies with unlimited issuance, like Ethereum, may depreciate in the long run.
• Loss of Asset Access: If a cryptocurrency owner loses access to their wallet or private key, it’s impossible to recover the funds.

In most countries, using cryptocurrency for official purchases of goods and services is prohibited due to its anonymity, making it difficult for tax authorities to monitor. The use of cryptocurrencies in online stores and trading directly depends on demand; if user interest drops, cryptocurrency may depreciate, leading to potential loss of invested funds.

Conclusion

Let’s summarize the main points from our article on what cryptocurrency is, its purpose, and how it works:

Cryptocurrency isn’t just digital money—it’s an innovative financial system transforming global finance and the approach to financial operations. Based on blockchain technology, it provides a secure and decentralized form of currency that isn’t tied to any nation or central bank.

The technology has already shown the potential to transform the financial world fundamentally, giving people greater control over their money and allowing them to participate in a global digital economy without intermediaries.

A key advantage of cryptocurrency is decentralization. The absence of a central authority, whether government or bank, makes transactions fast, secure, and anonymous. The blockchain system underlying all cryptocurrencies represents a distributed database ensuring that each transaction is verified by a network of nodes.

Cryptography is used to encrypt each operation, making it virtually unbreakable and immutable. This also provides a high level of security and fraud protection.

Mining—the process of creating new cryptocurrency units—is a crucial element of its operation. Miners use computing power to solve complex mathematical problems that confirm transactions and add new blocks to the blockchain.

This process supports decentralization and ensures the network operates without needing central authorities.

Cryptocurrencies offer unique investment and trading opportunities, attracting individuals seeking alternative ways to earn. Cryptocurrency prices can be highly volatile, creating opportunities for high-yield speculation. However, it also carries risks, and understanding the market’s instability and lack of regulation is essential.

Moreover, cryptocurrencies open new horizons for technology development, such as smart contracts and decentralized applications (DApps). They can be applied in various sectors, from finance to healthcare and public services.

Thus, cryptocurrency is more than just digital currency. It’s a tool reshaping the financial world, providing access to new opportunities for millions. However, cryptocurrencies require a mindful approach, as their use comes with certain risks.

Before starting with cryptocurrency, understanding its mechanisms, characteristics, and prospects is crucial to minimizing possible losses and making the most of its potential to achieve your goals.