Cryptocurrencies are digital currencies. Like traditional currencies, people can use them to pay each other for goods, services, or gifts. Unlike traditional currencies, however, there is no digital cash that one person can physically hand to another. Instead, people transfer funds by using applications on their mobile devices and computers.
As cryptocurrencies gain in popularity, it’s important to understand how they work.
How Does Cryptocurrency Work?
- Digital ledgers powered by blockchain technology verify the currency.
- A crypto waller stores currency.
- People can create new currency by mining it by completing complex mathematical calculations.
- People can acquire cryptocurrency by purchasing it or mining it.
- A variety of market forces influence a currency’s value.
What Is Blockchain?
Blockchains are the underlying technologies that allow cryptocurrencies to function. A blockchain is, at heart, a digital ledger that serves an important function: to first confirm and then permanently list all digital currency transactions. Devices connected to the blockchain — also called nodes — are responsible for this task and for adding new blocks to the chain. New blocks include multiple transactions and detail the specifics about which parties were involved.
How Cryptocurrency Works
Cryptocurrency is a digital payment system. One part of the system is the actual currency; the second part, which is perhaps even more important, is the blockchain network that supports such digital currency transactions.
Cryptocurrency transactions work in concert with a crypto wallet that contains public and private keys. These keys are character lines that identify a person’s account. Both sides exchange their wallet keys to first confirm their identities and then initiate a transaction that becomes recorded on the blockchain. The validation process from other computers analyzes transactions and confirms the process via complex cryptographic math.
This design ensures that all trades remain safe. It also provides a universal approach to digital currencies, enabling them to work anywhere without restrictions.
How Crypto Mining Works
When a new digital currency is created, it is made publically available through a process called an initial coin offering or ICO. This is when all available coins are sold to investors. Additional coins can be created by those willing to work for the blockchain, however, via a process known as mining.
Mining can be performed by individuals or groups (called pools) who use computers to solve the complex mathematical equations the blockchain requires to validate transactions. The mining process requires computing power and multiple miners to support and confirm these equations. These computations become more complex as fewer and fewer coins are made available. That, in turn, increases the amount of time and energy needed to mine coins
Miners who complete these transactions receive a reward from the blockchain for their work: a small percentage of the digital currency on the blockchain. The rewards vary by coin. As of 2022, Bitcoin miners can earn 6.25 Bitcoin tokens for their work, while Ethereum miners receive 2 Ethereum tokens plus fees contained in a block.
How to Acquire Cryptocurrencies
People attain cryptocurrencies via two methods:
How to Acquire Cryptocurrencies
- By purchasing currencies from a cryptocurrency exchange.
- By mining currencies.
Regardless of the method, investors must store their currencies in a digital wallet. This device, called a crypto wallet, secures the keys necessary to validate all users’ crypto transactions. There are two keys: the public key confirms a deal while the private key verifies one’s identity when making a transaction.
Crypto wallets are available in cold and hot forms. A hot wallet connects to the internet and is easy to use, but requires protection to keep it safe. A cold wallet stays offline and is much easier to protect, as it’s unavailable to everyone except the owner.
How Is Cryptocurrency’s Market Value Determined?
Some crypto coins are worth tens of thousands of dollars. Other coins are pennies or fractions thereof. Investors can purchase entire coins or fractions of them. Many factors determine a coin’s market rate:
Factors That Influence Cryptocurrency Value
- Demand. Currencies rise in value if they are popular.
- Scarcity. The fewer the coins, the fewer the opportunities, and the higher the cost of each.
- Adoption. Any currency will rise in value the more it is accepted as payment in real-world situations.
- Inflation. As traditional (also known as fiat) currencies experience inflation, cryptocurrencies can increase in value.
- Node count. A currency with more nodes will be more active because there are more parties verifying transactions. Nodes are the number of digital wallets holding that currency.
Cryptocurrencies are exciting investments worth exploring. The potential for their values to increase is also tantalizing for many investors. As the world of cryptocurrencies and crypto investments continues to grow and evolve, the market will respond. Investors are wise to do their due diligence before investing, consult with a financial planner, and understand both the technologies and the markets in order to try to generate a profit.