How Does Cryptocurrency Work? A Simple Guide

Approximately 11% of all Americans own Bitcoin, the most popular and well-known form of cryptocurrency.

You hold this cryptocurrency in a super-secure account online called a digital wallet, and you can convert these “coins” (really strings of encrypted code called blockchain) into hard cash or purchase goods directly.

But how does cryptocurrency work? For the uninitiated, it can seem confusing. How can a string of code have value? Furthermore, how can a digital currency even exist without a commodity or government to back it up?

Basically, cryptocurrency values rise and fall like gold or other precious metals. So you can add Bitcoin to your traditional portfolio of stocks, bonds, and money market assets. Still not sure?

In the following article, we’ll delve into what cryptocurrency is and explore in-depth how Bitcoin works.

Bitcoin and Blockchain

So, what is cryptocurrency? The mysterious Satoshi Nakamoto, the founder of Bitcoin, rolled out blockchain and cryptocurrency in 2008. Blockchain is a database where all transactions are records or chained together. You can always add to a file with blockchain, but it is impossible to delete, so you always have a verified document.

Nakamoto turned blockchain into an actual currency called Bitcoin. Since you cannot delete Bitcoin tokens, you can only transfer them from one account to another; they can make for a stable form of tradable commodity. Also, there is a limited number of Bitcoins in the world. You can actualize Bitcoins through computers solving complex mathematical computations. Experts call this crypto mining. Once a computer solves the equation, a Bitcoin unit is added to a public ledger.

The public ledgers record Bitcoin’s creation, transactions and are viewable by anyone.

How Does Cryptocurrency Work for Transactions?

Bitcoins are held in digital wallets validated by the public ledgers. A transfer of Bitcoin is considered a transaction. The public ledger records the owner’s encrypted signature, and while you hold control of the wallet and signature through a password key, your identity is impossible to decipher.

Since there’s a bit of back and forth verification that needs to take place, transactions are rarely instantaneous and can take many minutes to authenticate.

Companies all over the world now invest in cryptocurrencies. There are even ATM-like machines where you can convert your Bitcoin into hard cash.

Why Should You Care?

Cryptocurrencies are currently valued at more than $1.9 trillion. Bitcoin alone weighs in at $849.5 billion. Crypto supporters cite several factors for the currencies’ popularity.

First is supply and demand; since the currencies are relatively new and the supply is limited, investors are rushing to buy the coins pushing up the price.

Another aspect of the currencies’ popularity involves the lack of influence by central banks. Since these banks can’t push more crypto into the marketplace, they can’t devalue the cryptos through inflation.

Supporters also cite the security of the crypto transactions. Unlike traditional banking, it’s challenging for your digital wallet to get hacked. It is more common for users to misplace the password to their digital keys and lose their cryptos through a lack of access.

However, not everyone considers cryptocurrencies a sure bet. Some see the coins, which are not backed by governments or by commodities, as speculation.

Crypto Investing

So now that you have an answer to “how does cryptocurrency work?” you may ask yourself, “Should I Invest in cryptocurrency?”

Cryptocurrency investments, like other traditional investments, should be part of a diversified portfolio. There’s a big difference between investing and gambling. An investment pays over time. A gamble could lose you money very quickly. Consult a financial planner before making a Bitcoin investment that turns out to be a gamble.

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