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Crypto 101 Ep 3: What Are Cryptocurrencies and How Do They Work?

Posted by Anushiem Chidera on August 27, 2022 in Guide/Series

Crypto 101 Ep 3: What Are Cryptocurrencies and How Do They Work?

Cryptocurrencies, often called crypto, are any form of currency that exists digitally or virtually and uses cryptographic techniques to secure transactions. Cryptocurrencies don't have a central issuing or regulating authority (such as the way CBN issues and regulates the Naira). Instead, cryptos use decentralized systems to record transactions and issue new units.

In more detailed terms, cryptocurrencies are digital payment system that doesn't rely on banks to verify transactions. They are a peer-to-peer system that can enable anyone anywhere to send and receive payments. Instead of being physical money carried around and exchanged in the real world, cryptocurrency payments exist purely as digital entries to an online database that describes specific transactions. When you transfer cryptocurrencies, the transactions are recorded in a public ledger.

‘Cryptocurrency’ derived its name because it uses encryption (cryptography) to verify transactions. This means advanced coding is involved in transmitting and storing cryptocurrency data between wallets and public ledgers. Encryption aims to provide extra safety and security. The first cryptocurrency was Bitcoin, founded in 2009, and remains the largest and best known today.

How do Cryptocurrencies Work?

Cryptocurrencies run on a distributed public ledger known as the blockchain, a record of all transactions updated and held by currency holders.

Units of cryptocurrency are created through a process called mining, which involves using computer power to solve complicated mathematical problems that generate more units of coins. This is in contrast to traditional currencies which are printed by the monetary authorities of countries. Users can also buy the currencies from centralized and decentralized exchanges, then store and spend them using cryptographic wallets.

How to Buy Cryptocurrencies

There are typically three steps involved in buying cryptocurrencies. These are:

Step 1: Choose a Platform

The first step to take when buying crypto is deciding which platform to use. Generally, you can choose between a traditional broker or a dedicated cryptocurrency exchange.

Traditional brokers: These are online brokers who offer ways to buy and sell cryptocurrencies and (often) other financial assets like stocks, bonds, and ETFs.

Cryptocurrency exchanges: There are numerous cryptocurrency exchanges to pick from, and they all provide access to a variety of digital assets, wallet storage, interest-bearing account alternatives, and other features. Asset-based fees are common on exchanges. When comparing various platforms, take into account the cryptocurrencies they support, the fees they levy, the security measures they have in place, the possibilities for storage and withdrawal, and any available educational materials.

Step 2: Fund your account

After selecting your trading platform, the next step is to fund your account so you can start trading. Although it differs by platform, most cryptocurrency exchanges let users buy cryptocurrency with fiat (i.e., government-issued) currencies like the US Dollar, the British Pound, or the Euro using their debit or credit cards. However, CBN policies mean that this option is currently unavailable for Nigerians.

Credit card purchases of cryptocurrencies are frowned upon, and some exchanges do not support them. Several credit card companies also forbid cryptocurrency transactions. This is because cryptocurrencies are volatile, making it unwise to risk incurring debt or paying hefty credit card transaction fees for some assets.

An important factor to consider when choosing is fees. These include potential deposit and potential withdrawal transaction fees plus trading fees. Fees will vary by payment method and crypto exchange, which is something to research at the outset.

Step 3: Place An Order

You can place an order via your broker's or exchange's website or mobile app. If you are planning to buy cryptocurrencies, you can do so by selecting "buy," choosing the order type, entering the type and amount of cryptocurrencies you want to purchase, and confirming the order. The same process applies when you wish to sell.

How to Store Cryptocurrencies

Once you have bought the crypto of your choice, you need to store it safely to protect it from hacks or theft. Crypto wallets are typically used to store cryptocurrencies. To carry out transactions, you have to send crypto to the wallet of the other party in the transaction — just like you would give money to the other party in a transaction.

These physical wallets or online software are used to securely store the private keys to your cryptocurrencies. Some exchanges allow you to store money directly through the site by offering wallet services. However, not all brokers or exchanges will automatically offer you wallet services.

There are numerous wallet providers from which to pick. "Hot wallet" and "cold wallet" are words that are used:

  • Hot wallet storage: "hot wallets" are a type of crypto wallet that employs internet software to safeguard your assets' private keys.

  • Cold wallets: Unlike hot wallets, which use online computers to store your private keys, cold wallets (sometimes referred to as hardware wallets) use offline electrical devices. Cold wallets typically attract fees, whereas hot wallets do not.

Four Tips For Investing in Cryptocurrency Safely And Profitably

All investments carry risk, but many experts consider cryptocurrencies to be one of the riskiest investment choices out there amongst CFDs. If you are planning to invest in cryptocurrencies, these tips will help you make sound choices.

Research exchanges:

Before you invest, learn about the cryptocurrency exchange you want to use. It’s estimated that there are over 500 exchanges to choose from. Do your research, read reviews, and talk with more experienced investors before moving forward. If in doubt, you can read my feature piece on Crypto exchanges.

Know how to store your digital currency:

If you buy any cryptocurrency, you have to store it. You can keep it on an exchange or in an offline cold wallet. While there are different kinds of wallets, each has its benefits, technical requirements, and security guarantees. As with exchanges, you should investigate your storage choices before making any choice. If you opt for cold wallets, make sure to buy from only the official website of the manufacturer of such wallets.

Diversify your Crypto Holdings:

Asset diversification is key to any good investment strategy, and this holds true when you are investing in cryptocurrencies. Don't put all your money in Bitcoin, for example, just because that's the only name you know or because it is the cool thing to do. There are thousands of options with crypto, and it is better to spread your investment across several cryptocurrencies.

Prepare for volatility:

Because of the market's extreme volatility, be ready for ups and downs. There will be substantial price changes. Cryptocurrency might not be the best option for you if your investment portfolio or mental health can't manage the turbulence that comes with highly volatile assets.

However, keep in mind that cryptocurrency is still in its relative infancy and is regarded as highly speculative. Be ready for challenges while investing in something new. Do your homework and start investing prudently if you intend to take part.

Bottom Line

We believe that this article has given you the basic information you need to understand cryptocurrencies. However, it’s important to note that crypto investments involve some degree of risk and the value of any cryptocurrency can change with time. As a crypto investor, you should base your decision on price and conduct thorough research and analysis.