Cryptocurrencies have grown in popularity as a means of making online payments over the last several years, and their prevalence continues to steadily increase. Nowadays, it seems like there’s a new crypto token craze every few weeks. But before you invest any of your hard-earned money into cryptocurrency, you should know what cryptocurrencies are, how to secure your investment, and the risks involved when using cryptocurrencies.
What is cryptocurrency?
A cryptocurrency is a type of digital currency that uses encryption techniques to establish an alternate form of payment. These tokens utilize blockchain technology which operate as a public ledger, keeping track of who has what. That means counterfeiting or double-spending is practically impossible, so cryptocurrencies can be used as both a currency and a virtual accounting system.
One thing that sets cryptocurrencies apart from traditional currencies is the fact that they aren’t issued by any central authority, making them potentially impervious to government intervention or manipulation.
Even though cryptocurrencies are mostly seen as investments like stocks, they can also be used to buy goods and services, provide functionality, and much more. Cryptocurrency plays a crucial role in the world of decentralized financial (DeFi), which is the growing network of applications built on a blockchain. These applications can allow users to do a wide variety of things including exchanging tokens, borrowing and lending cryptocurrency, and more.
How many cryptocurrencies are there?
The number fluctuates, but there are over 9,900 cryptocurrency tokens available as of January 2022. It’s important to note that cryptocurrencies have a very low entrance barrier. In other words, creating your own cryptocurrency token is quite easy. Because of this, it’s important to do your research on the tokens you want to buy into. There is very little regulation within the cryptocurrency work, so there is always the potential for scam projects.
How does cryptocurrency work? What makes it different from traditional currency?
Cryptocurrency operates on something called “Blockchain Technology.” Simply put, a blockchain is a digital ledger or database of transactions. This database is shared over a network of computer systems. No single entity controls the blockchain ledger – rather, the operations of a blockchain are maintained by a decentralized network of computers. This network of computers also validates each transaction that occurs on the ledger.
Generally, a crypto investor buys a cryptocurrency if he or she believes in the power and utility of the digital asset’s underlying blockchain. Nearly all cryptocurrencies are built on the blockchain, which means that every time a crypto investor buys a cryptocurrency, they are betting on the robustness and attractiveness of the blockchain the currency is built on, whether they realize it or not.
On the underlying blockchain, cryptocurrency transactions are recorded infinitely. New sets of transactions are added to the blockchain as blocks, which authenticate the transactions’ legitimacy and keep the network up and operating. All batches of transactions are recorded by the shared ledger and made available to the public. The transactions on the most popular blockchains, such as Bitcoin and Ethereum, can be accessed by anyone at any time.
Centralized versus decentralized currencies
Centralized is used to describe the attribute of being controlled by a single, recognized authority, while decentralization involves the transfer of authority to different entities so no single body has full control. In contrast, our traditional currency (commonly referred to as Fiat) is fully controlled by the Central Bank – an extension of the government.
Cryptocurrency, unlike traditional currencies, is not governed by any central authority and has little to no backing from recognized governments. As a result, virtual currency is often considered less trustworthy than physical currency. Additionally, fiat money isn’t nearly as volatile as cryptocurrency since it’s so widely used and accepted.
Another difference is the use of intermediaries – centralized currencies typically require a bank or financial institution to conduct larger transactions, while decentralized currencies like crypto do not. Blockchain technology is used to verify crypto transactions, which means that all trading operations are permanently recorded, boosting the security of any exchange.
Nevertheless, centralized and decentralized currencies are two sides of the same coin. Although both types of currencies are distinctly different, they do have a few similarities and common attributes.
First off, both types of currency get much of their value from their widespread adoption around the world. Their respective credibilities are dependent on their acceptance which also gives them value. As cryptocurrency continues to grow in acceptance, its volatility should slowly decrease over time.
Is cryptocurrency legal to buy and sell?
As stated previously, government or financial authorities grant fiat currencies their power as mediums of exchange. On the other hand, because cryptocurrencies aren’t backed by any corporate entity or government, it’s proven challenging to establish their legal status in many countries throughout the world. The fact that cryptocurrencies have mostly operated outside of the current financial infrastructure hasn’t made things easier.
The regular use of cryptocurrencies in transactions and trade is greatly determined by their legal status. The Financial Action Task Force (FATF) suggested in June 2019 that cryptocurrency wire transfers be subject to the provisions of its Travel Rule, which mandates anti-money laundering compliance.
The regulation and legal status of cryptocurrency vary from one jurisdiction to another. El Salvador was the first country in the world to accept Bitcoin as legal tender for monetary transactions, and as of January 2022, they remain the only nation to have done so.
How do I invest in cryptocurrency?
The concept of investing in cryptocurrencies is essentially buying a coin you believe will increase in value when it is still low priced and selling it higher. Though some of the most popular and well-known cryptocurrencies, such as Bitcoin, can be purchased directly with US dollars, others require bitcoins or another cryptocurrency to be purchased.
In the crypto market, there are a variety of cryptocurrencies with varying fundamental values. Investors should be aware that cryptocurrencies can appear one day and vanish the next, rendering their investments useless. Therefore, it’s important to draw up a solid strategy for your cryptocurrency investment and understand how to limit your risk.
Beginners in cryptocurrency investing and trading should consider the types of cryptocurrencies available on the platform, as well as transaction fees and special features – like educational materials – that fit in with their goals and interests.
One of the easiest ways to buy cryptocurrency is through a centralized exchange (CEX) such as Coinbase, Gemini, and Binance. These exchanges are built and maintained by companies in the real world, meaning they must abide by governmental regulations. This typically means they are quite safe and secure, which is the perfect place to start your cryptocurrency journey.
Keeping your crypto on an exchange versus in a wallet
A cryptocurrency exchange is a website that allows you to purchase and sell cryptocurrency tokens at predetermined values and in a secure environment. Exchanges come in two different styles, centralized (as mentioned above), and decentralized exchanges (DEXs).
While CEXs are backed by real companies, DEXs are programs built directly on the blockchain and can operate completely by themselves. DEXs can provide users with a much wider variety of tokens to choose from, but they can only trade other cryptocurrencies. DEXs require a cryptocurrency wallet to transact on the platform, and since wallets can only carry tokens, you’ll have to use a CEX to buy cryptocurrency and then transfer it to your wallet.
A cryptocurrency wallet is a piece of software that allows you to store cryptocurrency. It operates by using a public address (similar to a bank account number) and a private key. The public address can be given to anyone and is the primary way to receive cryptocurrency tokens.
A crypto wallet’s private key enables you to sign transactions and ensures that it’s actually you. Consider these private keys to be secret codes that enable you to spend, exchange, and use the cryptocurrency you own.
These private keys are extremely important. If someone gains access to your private key then they essentially have access to your wallet. So be sure to keep this safe and NEVER share it with anyone.
Exchanges vs wallets
A quick glance at the history of bitcoin and other cryptocurrencies illustrates why leaving your cryptocurrencies on an exchange is risky. Over $1.65 billion in crypto assets has been stolen since 2011, and the statistics are growing every year. Aside from hacking, there’s a chance that problems will come from within the exchange. Any exchange could make a mistake, lose money, or even engage in fractional reserve banking.
Because they can hold billions of dollars in cryptocurrency, exchanges are attractive targets for hackers. Hacking a crypto exchange is often far more profitable than hacking a singular wallet. Because of this, exchanges are particularly vulnerable to sophisticated cyber-attacks.
The level of security provided by a wallet is determined by how the user handles the wallet. The private keys, which are stored in every wallet, are the only way the owner can access their cryptocurrencies.
When keeping cryptocurrencies in wallets, the user losing or having their private key stolen is the biggest threat to the cryptocurrency’s security. If the user loses their private key, they’ll never get access to their funds again. These keys can be lost in a variety of ways, including computer issues (like hard drive crashes), hacking, or physically losing the computer where the digital wallet is stored.
It’s entirely up to you whether you keep your cryptocurrencies on a centralized exchange or in a wallet. However, storing your digital currency on an exchange may result in the loss of all of your digital currency if the platform’s owners decide to make away with all the money or if the exchange is hacked.
Storing funds on a CEX can also be quite limiting. If you plan on interacting with applications on the blockchain such as decentralized exchanges, borrowing and lending platforms, or staking your assets, then you’ll need a cryptocurrency wallet.
Are cryptocurrencies a good investment?
Even though cryptocurrencies are known for appreciating in value, a lot of investors only consider them short-term speculative investments rather than long-term investments. This is because due to the absence of a cryptocurrency cash flow, other people have to lose money by paying more for the currency than you did before you can make profits.
This is the distinction between investing in cryptocurrency and a well-managed business that increases its value over time by growing profitability and cash flow slowly and steadily.
A lot of cryptocurrencies like Ethereum, Cardano, Bitcoin, etc. were created with lofty goals that can only be achieved over long periods of time. However, to be considered a long-term success, any cryptocurrency project must first achieve widespread adoption.
Conclusion
Investing in cryptocurrencies carries a high level of risk, especially for beginners. Even though there are many stories of crypto investors who have made, you can still lose money by buying and selling at the wrong time.
However, cryptocurrency and the world of decentralized finance provide a lot of exciting opportunities for those willing to put in the work and take some risks. Do your due diligence and look into a project or coin before jumping in. This could be the difference between investing in a high-potential project or throwing your money into a cleverly disguised scam.
Centralized exchanges are an excellent place to start learning and trading cryptocurrencies without having to deal with the complexity of the blockchain. However, as your knowledge grows, you may want to create a cryptocurrency wallet and begin exploring the fast-growing DeFi ecosystem. Not only does it provide many more opportunities for making money, but it could also very well be the future of the finance industry.