The world of cryptocurrency and decentralised finance (DeFi) can seem confusing at first. Most understand it to be a highly volatile asset class, with huge risk-return potential, but that’s only half the story.
We explain the basics of cryptocurrencies and the crypto market to better prepare new investors who might be interested in this controversial emerging technology. Discover what crypto mining is, learn about some of the different types of cryptocurrencies and how to buy crypto.
Cryptocurrency is a digital or virtual currency based on a distributed network, called a blockchain . Cryptocurrency transactions are secured using cryptography, an encryption technique that ensures only the sender of a cryptoasset and its intended recipient can access it.
Cryptocurrencies are not issued by a central authority in the same way that fiat currencies are. Instead, crypto uses a decentralised system to record transactions and issue new units. Crypto utilises a peer-to-peer system, meaning anyone in the world can send and receive payments, as long as they have access to the Internet.
Despite their price volatility, at their core, cryptocurrencies are secure, decentralised digital currencies that offer an alternative to traditional, government-backed fiat currencies.
What is cryptocurrency mining?
There are three primary ways for cryptocurrencies to be obtained: as a reward for work completed on a blockchain; by purchasing them from a cryptocurrency exchange ; or through mining. Crypto mining is one of the most widely known, but least understood, means of generating cryptocurrency, including new bitcoin (BTC).
To avoid using third parties, users are tasked with validating and adding transactions to the blockchain. Some blockchains, referred to as Proof of Work (POW) networks, use a system of “mining” to make sure the system is fully decentralised.
Those interested in undertaking this work are called validators. Validators use computer resources to solve complex mathematical problems. The first person — or computer — to achieve the correct answer will automatically be eligible to validate the next block of transactions. Validators are called miners because the process leads to the creation of new coins, which are distributed to the successful individuals as a reward.
Tip: Cryptocurrency mining is a very energy-intensive process that requires a lot of computational power. Investors interested in purchasing and owning cryptoassets could consider buying them from exchanges or trading platforms.
Understanding the cryptocurrency market
Cryptocurrencies were not originally created to be used as investment vehicles. In 2009, Bitcoin was launched as a potential replacement for government-issued fiat currencies. Thousands of cryptocurrencies have been launched since then, with more being created every day. Most have a primary purpose, aside from acting as a potential investment opportunity.
The crypto market is split into two distinct sections: crypto coins and crypto tokens. Coins are native to their blockchains and are primarily used as a method of payment, making them more closely aligned with traditional currencies. Tokens are created on existing blockchains and are treated more like assets. Let’s take Ethereum as an example: ETH is the coin native to the Ethereum blockchain, whereas ApeCoin (APE) is a token hosted on Ethereum.
Tip: As Bitcoin was the first cryptocurrency, all other cryptocurrencies are referred to as “altcoins.” Some don’t consider Ethereum (ETH) to be an altcoin because of its market capitalisation, but this is not the case.
Different types of cryptocurrencies
As cryptocurrencies continue to grow in popularity, it is important for potential investors to understand the different types of cryptocurrencies and what they’re used for.
| Token Type | Function |
|---|---|
| Utility | Utility tokens serve specific functions on their blockchains, enabling users to perform actions on a network or decentralised application (DApp) . |
| Security | Security tokens represent ownership of an asset. Security tokens can be sold by companies to raise capital. |
| Payment | Payment tokens usually have their own blockchains and rarely serve an additional purpose outside of use in transactions. |
| Governance | Governance tokens represent voting rights on a blockchain. Holders of these tokens are able to vote on the direction that a blockchain project takes, helping to decentralise decision-making. |
Top 10 cryptocurrencies
In terms of popularity, the two largest cryptocurrencies are bitcoin and ethereum, although there are plenty of other cryptocurrencies for investors to consider. The top cryptocurrencies are ranked according to their market capitalisation, and the top 10 cryptocurrencies change all the time. The list usually contains a variety of different coin and token types, including:
- Layer 1 blockchain cryptocurrencies
- Layer 2 blockchain cryptocurrencies
- Stablecoins
There are three primary ways for cryptocurrencies to be obtained: as a reward for work completed on a blockchain; by purchasing them from a cryptocurrency exchange; or through mining.
How to buy cryptocurrency
Investors who want to purchase and own cryptocurrencies have several options available to them. For some, the best option is to use a trading platform. Here, investors can trade fractional shares of their chosen cryptocurrencies and set Stop-Losses and Take-Profits to help negate market volatility.
There are other alternatives available. Some investors prefer purchasing their cryptocurrencies on crypto exchanges and then transferring them to their cryptocurrency wallets for safekeeping.
Some investors, rather than buying the underlying asset, choose to invest in blockchain stocks or ETFs (Exchange-Traded Funds). Although this is an indirect investment, the value of the asset could potentially follow the price movements of the general crypto market, but perhaps with less volatility. It is also possible to invest in ETFs that track and replicate the price of bitcoin.
Tip: Regardless of how you buy them, it’s important to do thorough research before you start trading and investing in cryptocurrencies. Crypto can be very volatile and, like other financial assets, can be impacted by macroeconomic factors.
Final thoughts
Cryptocurrencies can seem like a daunting proposition at first. Whether you fully understand the notion of blockchain or not, cryptocurrencies themselves are a relatively uncomplicated asset to understand. Despite their price volatility, at their core, cryptocurrencies are secure, decentralised digital currencies that offer an alternative to traditional, government-backed fiat currencies. Once you understand that, you could be ready to start investing.
Head over to the eToro Academy to learn more about cryptocurrencies and the blockchain.
FAQs
- How does cryptocurrency work?
-
Cryptocurrencies run on a blockchain. Blockchains act as distributed public ledgers, recording all transactions conducted with the cryptocurrency in question. Cryptocurrencies are decentralised, and although anonymous, all transactions can be viewed and verified at all times.
- Why is crypto important?
-
Many crypto investors consider cryptocurrencies to be an important step in the history of finance. Cryptocurrency can be used to make direct and secure payments globally, and — as long as the individual in question has a mobile phone and an Internet connection — provides universal access to finance. For some, the decentralisation of finance is important, with crypto offering greater transparency, anonymity and less third-party interference than traditional alternatives.
- Why are cryptocurrencies so volatile?
-
Crypto is an incredibly volatile asset class, meaning the value of individual cryptocurrencies, as well as the overall crypto market capitalisation, can fluctuate greatly. Most cryptocurrencies, such as Cardano (ADA) and Solana (SOL), have a limited supply of available coins and tokens. Therefore, when demand for a particular cryptocurrency increases, so does the price.
Crypto is also very speculative. When a new project is launched, or news about an existing project breaks, investors jump onto the trend to try and turn a profit. Once the news dies down, or the metaphorical bubble bursts, the price often falls to reflect this.
This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments.
This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.