Cryptocurrency: What Is It and How Does It Work?

Although the first cryptocurrency emerged in 1990, the buzz surrounding cryptocurrency exchange has seemingly exploded in recent years. Despite the opportunities, market volatility serves as a reminder of the risk involved in cryptocurrency trading. Whether you're interested in virtual currency for career, hobby, or investment opportunities, understanding cryptocurrency and how it works is an essential first step. You can learn more about crypto technology and popular cryptocurrencies in the following guide. 

What is cryptocurrency?

Cryptocurrency is a digital currency, as opposed to physical, traditional currency. It has no regulating authority or central bank. Instead, it uses cryptography (the process of writing and deciphering code) to issue, verify, and secure transactions. Not only is cryptocurrency secure, but it can’t be counterfeited. Through public ledgers, transactions remain traceable.

This peer-to-peer digital asset system makes it fast, easy, and inexpensive to send and receive payments worldwide. There's no currency exchange needed, nor are there hefty fees. These transactions get publicly recorded, stored digitally, and transmitted via encryption, with detailed coding required for transmission and storage.

Read more: What is a Cryptographer? 2023 Career Guide

How cryptocurrency works

Cryptocurrencies are based on blockchain and cryptography, making them very secure, although it’s still up to investors to choose trustworthy exchanges. Your crypto wallet, where you store your holdings, is also secure because you use a private key to access it. Other elements that set cryptocurrency projects apart from more traditional investments include:

• Accessibility. Crypto investing is open to anyone with internet access and a computer, smartphone, or mobile device.

• Low transaction costs. Cryptocurrency blockchain transactions cost no more than a few dollars, with many costing just pennies.

• Transaction speed. Few other institutions are faster than cryptocurrency for sending, receiving, and moving assets worldwide.

• Transparent transactions. Cryptocurrency payments are on public record. Anyone can look up transaction information and see the contents of a crypto wallet. Transparency makes it easy to reduce fraud and prove transactions were carried out correctly.

Types of crypto assets

Cryptocurrency is an umbrella term that describes multiple types of digital assets. When Bitcoin first hit the market in 2009, it spurred the creation of other cryptocurrencies. Today, there are many options. Crypto investments typically fall into one of three main categories:

1. Crypto coins. When investing in cryptocurrency coins, you're investing in financial assets created via their unique blockchain. Coins function similarly to physical currency: You can exchange them for business or save them to store value. Many people consider Bitcoin the only genuine coin, although others in this category include Ethereum.

2. Altcoins. As the name implies, this is an alternative to coins. These coins belong to the blockchains they were designed for but may also split that blockchain for alternate uses. For example, Ether is an altcoin that branched off Ethereum. It was created for the express purpose of paying transaction fees.

3. Tokens. You can use this type of cryptocurrency as digital currency, but it has other use cases. For example, non-fungible tokens (NFTs) have been used as a means of digital art in the crypto space. Alternative tokens may verify individuals' identities or provide access to applications.

Read more: What is an NFT? Your Guide to Non-Fungible Tokens in 2023

Is cryptocurrency a good investment?

Crypto investing has a lot of hype surrounding it. For novice investors, it can be easy to become overwhelmed and overextended. That’s why it’s essential to have a solid, foundational knowledge of crypto technology before investing. Whether or not cryptocurrency is a good investment depends on your goals. To guide your decision-making process, learn as much as you can about how blockchain technology works and how the crypto market operates first.

Key concepts include decentralization, self-custody of crypto assets, and the difference between a centralized exchange (CEX) and a decentralized exchange (DEX). You can also read each cryptocurrency's white papers to learn more about the crypto project developers' goals and details. It's essential to define your goals, weigh the benefits and risks, and understand how the industry works.

Short-term crypto investment

As 2022's crypto crash demonstrated, the crypto market is volatile and unpredictable. Trading is a popular short-term crypto investment strategy that requires you to buy and sell based on when you expect prices to increase or decrease. Many short-term traders watch average prices over a period to get a feel for how they're trending. Having technical analysis skills, which use past patterns and prices for the crypto investment you're considering, is an essential skill to master.

Long-term crypto investment

If you approach crypto investment as a long-term strategy, the ups and downs will likely be less concerning since short-term fluctuations will impact your strategy differently. Consider how much Bitcoin has appreciated since launching in 2009. The value increased by approximately 12,000 percent. Ethereum, which hit the market in 2015, has appreciated at an even higher rate that exceeds 92,000 percent [1].

While both values have fluctuated wildly in the short term, investors who approached them as long-term investments reaped the rewards. Additionally, some experts expect emerging technologies, new regulations, and more widespread adoption to fuel the growth of the cryptocurrency industry.

How to invest in cryptocurrency

People often invest in crypto in a few different ways: as a personal hobby, a wealth-building strategy, or as part of their profession. The crypto investment buzz has made hobby-level investing popular, particularly among younger investors.

Define your investment goals.

Why are you investing in cryptocurrency? What are your client’s or employer’s goals? If you're solely looking to make a lot of money quickly, this might not be the right investment. Many investors have come before you looking to get rich quickly, and many end up with significant losses. Additionally, most coins and tokens pay the largest gains to those who hold onto them for the long term.

The tolerance for risk and the reasons behind the investment can help guide your choices. For example, if you believe in the technology or you're looking for an investment with the potential for stable long-term value, cryptocurrencies could be a suitable option. As with any investment, you must remain aware of the risks and avoid putting more money into crypto investments than you can afford to lose.

Analyze the state of the crypto industry.

If you ask established crypto experts for advice, many will suggest starting small and taking time to develop a feeling for how the world of crypto trading and digital currency works. For example, there are many different cryptocurrencies and blockchain technologies to consider.

Additionally, there are other ways to get in on cryptocurrency. Examples include crypto funds and futures, which allow you to essentially bet on the price swings of coins and altcoins like Bitcoin and Ethereum. Blockchain exchange-traded funds (ETFs) are another investing option. They let you invest in a bundle of companies that use blockchain technology in their business operations.

Calculate your risks.

Risk is a natural part of investing. Because of the volatility of cryptocurrencies, it comes with a substantial amount of risk that you must be aware of and understand to best manage. For example, if you’re looking to invest in the short term, you might create a set of rules to sell when the price drops by a certain percentage. As a long-term investor, you might decide that you won’t sell despite price drops.

Another way to manage your risk, particularly when you’re new to crypto investments, is to set aside a portion of investable funds. For example, if you have $100 to invest, start investing a small percentage of that money in crypto. Doing so gives you time to get a feel for how the market works while actively participating. It also gives you a bankroll on reserve to work with on future trades.

Taking time to watch the performance of the cryptocurrency you're considering before investing can help increase your chances of success. Doing your homework now can help minimize risk. On the other hand, jumping in too quickly because you’re afraid you’ll miss out can lead to significant losses. Regardless of the strategy, it is wise to consider investing only what you are willing to lose.

Join a cryptocurrency community online.

Blockchain and cryptocurrency are fast-moving, ever-evolving arenas. Things change very quickly. By joining a community of people who are enthusiastic about this digital landscape, you can better navigate the changes. You'll be able to stay abreast of emerging trends and learn more about what's going on to develop a stronger understanding.

Careers in cryptocurrency 

Hobby investing isn’t the only way to work with cryptocurrency. You’ll also find various cryptocurrency-related jobs, including some careers that don't work directly with the investment side but with clients who do. Examples include business development representatives and marketing managers.

In positions like these, you may work with crypto companies and organizations that work with cryptocurrency to help create awareness and build their customer base. Additional examples include:

• Financial analyst. As a financial analyst or advisor, you would recommend investments and create investment strategies for a roster of clients.

• Data scientists. A data scientist working with cryptocurrency might be tasked with forecasting changes in the price of digital coins. This is another in-demand role, mainly because the technology is still new, and people with analytical skills are needed to work with engineers.

• Machine learning engineer. You might help create digital applications that provide secure access to exchanges and investing platforms as a crypto machine learning engineer.

10 cryptocurrencies to keep on your watchlist

There are thousands of different cryptocurrencies out there. Bitcoin’s success led to a flood of new coins—called altcoins—and tokens emerging. Due to the volatile nature of cryptocurrency, it's best to seek professional investment advice and become very familiar with the crypto industry before deciding to invest. The following are examples of cryptocurrencies with a higher market cap and therefore tend to be more stable. Market capitalization figures are current as of June 8, 2023 [2]:

1. Bitcoin

Market cap: $513.3 billion

Considered by many as the gold standard of cryptocurrency, Bitcoin runs on a blockchain and requires solving cryptographic puzzles, which keeps it a secure coin.

2. Ethereum

Market cap: $221.6 billion

This coin, considered an altcoin by some, is another popular option. Its developers aim to create a globally accessible, decentralized roster of financial products and applications that run without fraud or third-party interference.

3. Tether

Market cap: $83.3 billion

Tether was the first stablecoin, a type of crypto tied to the value of the United States dollar. That backing can help level some of the dramatic fluctuations and make it easier to convert your holdings into dollars.

4. USD Coin

Market cap: $28.4 billion

The Ethereum blockchain powers this cryptocurrency. It's a stablecoin that, like Tether, is backed by the US dollar.

5. XRP

Market cap: $27 billion

XRP is the native coin of the Ripple exchange and payment settlement platform. You can use XRP to trade, invest, make purchases via Ripple, or exchange for other cryptocurrencies.

6. Cardano

Market cap: $11.3 billion

You can use Cardano (ADA) to get rewards for holding it (called staking), making transactions on the Cardano exchange, or investing. When you hold ADA, you hold a stake in the Cardano blockchain network.

7. Dogecoin

Market cap: $9.4 billion

This meme coin may have started as a joke, but it hit the radar of investors in a big way when its price rose dramatically in 2021. It's an open-source cryptocurrency that uses a script algorithm, has an unlimited supply, and has a loyal following. Major companies, including SpaceX, accept Dogecoin.

8. Solana

Market cap: $7.4 billion

This relatively new crypto emerged in 2021. It has a unique blockchain and was developed to support decentralized applications and finance.

9. Polkadot

Market cap: $5.9 billion

Polkadot (DOT) launched in 2017 on the Polkadot blockchain, which allows for cross-blockchain transactions (interoperability). You can use DOT for staking, connecting to a new blockchain (parachain), or for governance of the Polkadot network.

10. Avalanche

Market cap: $4.8 billion

The blockchain platform Avalanche calls its native currency used for transactions on the network AVAX. Avalanche is an Ethereum competitor known for its speed and efficiency, thanks in large part to its use of proof-of-stake (PoS) to verify and authenticate information.

Keep building your cryptocurrency expertise

Beginners can gain a solid foundation of knowledge in FinTech, crypto, and blockchain technology in the self-paced, online course Blockchain and Cryptocurrency Explained by the University of Michigan. If you already have some experience, you could take your skills to the next level with an intermediate Specialization like Decentralized Finance (DeFi): The Future of Finance.