How Does Cryptocurrency Work? Everything You Need to Know About Crypto

"I don't think that this Bitcoin stuff is going to be around for very long. It just doesn't make any sense to me." 

This is what I said to a friend in 2018 when he asked me about the cryptocurrency market. I didn't think that cryptocurrency made any sense. 

A few years later, Bitcoin started hitting lows and I was proud of my decision to not invest into cryptocurrency. In 2021, the cryptocurrency market made a comeback and now everyone's talking about how to get into cryptocurrency. I couldn't ignore the cryptocurrency market.

How does cryptocurrency work? What is cryptocurrency all about? Keep on reading to find out...

You can't go anywhere without hearing about cryptocurrency these days. Everyone appears to be talking about the cryptocurrency market now. 

People on social media are claiming to be getting rich from it. You keep on hearing about new coins and all kinds of celebrity endorsements are coming in (don't even get me started on Elon Musk and Dogecoin!). 

Then there are others who aren't fans of cryptocurrency and they don't care to understand how cryptocurrency works.

You're likely still reading because you're  wondering how to get into cryptocurrency and I'm here to make sense of how cryptocurrency works.

[Note from Martin: From the moment that I began writing this article, the cryptocurrency prices have been all over the place. It's difficult to make sense of what is going on with cryptocurrency most of the time.]

What is cryptocurrency? How does cryptocurrency work?

Warren Bufffett says that you should clearly understand what you're investing into. This is why I had to research cryptocurrency investing relentlessly before getting into it so that I could explain how cryptocurrency works.

What is cryptocurrency and how does cryptocurrency work? Let's see what the experts had to say about what is cryptocurrency...

This article on Forbes describes cryptocurrency:

"Cryptocurrency is decentralized digital money, based on blockchain technology. You may be familiar with the most popular versions, Bitcoin and Ethereum, but there are more than 5,000 different cryptocurrencies in circulation, according to CoinLore.

You can use crypto to buy regular goods and services, although many people invest in cryptocurrencies as they would in other assets, like stocks or precious metals. While cryptocurrency is a novel and exciting asset class, purchasing it can be risky as you must take on a fair amount of research to fully understand how each system works."

According to this article on Wealthsimple about cryptocurrency:

"Cryptocurrencies, like Bitcoin, are entirely digital currencies that can be used as online versions of cash. They can be bought and sold using a crypto trading platform or online exchange. Transactions using cryptocurrencies are highly secure and can’t easily be shut down by governments. And though transactions are public—everyone can see that someone sent $10 worth of Bitcoin to someone else—the identities of the sender and recipient remain anonymous."

Here's what Nerd Wallet had to say about how cryptocurrency works:

"Cryptocurrency is a form of payment that can be exchanged online for goods and services. Many companies have issued their own currencies, often called tokens, and these can be traded specifically for the good or service that the company provides. Think of them as you would arcade tokens or casino chips. You’ll need to exchange real currency for the cryptocurrency to access the good or service.

Cryptocurrencies work using a technology called blockchain. Blockchain is a decentralized technology spread across many computers that manages and records transactions. Part of the appeal of this technology is its security."

Here's what the team at Investopedia had to say about cryptocurrency:

"A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation."

Those were the best definitions that I could find on how cryptocurrency works. I also took the time to speak with friends who are cryptocurrency investors to see if they could explain it to me. Then I watched every possible video on how to get into cryptocurrency.

I must admit that I'm still a bit confused as I write this article so don't worry if you're not 100% confident on cryptocurrency yet. You won't figure out the cryptocurrency space in one article.

I suggest that you try to find some podcasts and videos on cryptocurrency. Any of the aforementioned links are an excellent starting point if you want to learn more about cryptocurrency.

Why do people like crypto so much? Why's investing in cryptocurrency so popular?

I'm sure you've noticed that your friends who are into cryptocurrency can't stop talking about it. So why's everyone talking about this investing strategy? What's all of the hype about with the cryptocurrency market?

Here's what I've been able to gather from lovers of crypto assets and why cryptocurrency investing has become so popular lately...

People believe that cryptocurrency is the future of currency.

As I was editing this article, El Salvador announced that they would be the first country in the world to accept Bitcoin as legal tender.

Why will Bitcoin be accepted as a payment? According to this article on CBC:

"The president said it would increase financial inclusion, investment, tourism, innovation and economic development."

Those who are proponents of cryptocurrency believe that it's the future of currency and that digital currency is the way to go. With moves like this being made, it's easy to see why some feel this way.

Young investors like that they don't have to deal with bank interference and large institutions that are typically involved in everything.

Cryptocurrency becomes a part of your identity.

In this article on why cryptocurrency is so popular, Finn Breton mentions how cryptocurrency becomes a part of your identity and how there's an entire culture and community around this space.

This one line stuck out to me about the cryptocurrency market:

“When you buy bitcoin, you’re actually buying into a whole scene.”

I'm not sure about you, but most crypto investors are quick to tell you about how much they love cryptocurrency. This community aspect brings many young investors together.

Everything is digital in the cryptocurrency market.

If you were born in the late-80s, you pretty much had a cell phone since you were a teenager. If you were born in the 90s, you had a phone in your hand since you started grade school. If you were born in the 2000s, you've been glued to a cell phone since birth.

We all have phones in our hands. Everything that we do is digital, from booking a trip to our daily banking.

Cryptocurrency is also all digital and many people prefer this over the traditional banking model. You certainly don't have to wait in line for an hour to be upsold on a new account.

Cryptocurrency is relatively new system with promise.

Many people have lost faith in the government and in the "system" overall. So now folks are turning to new ideas and new systems. The cryptocurrency market is a new system with promise for many people around the world.

In this interesting interview with Frederick Kaufman he mentions this about why so many people are turning to cryptocurrency:

"If you look back at the history of apocalyptic moments, people fly toward security. And that’s what money is. Some people see their security blanket as gold, some see it as crypto. Some see it as cash."

The gains have been exceptional in the cryptocurrency market.

A savings account comes with a pathetic interest rate these days and many young people can't afford real estate. The gains in the cryptocurency space have been amazing compared to other investments.

Stories are coming out about folks who made millions from taking risks on memecoins and cryptocurrency.

This one guy became a Dogecoin millionaire for example. He was inspired to put a hefty amount of money into the memecoin and then his investment paid off in April when the value of Dogecoin skyrocketed.

Paul Pierce mentioned that he makes so much money from the cryptocurrency market that he doesn't need his job at ESPN. I have people on social media posting pictures in ridiculously gorgeous destinations bragging about how they don't need to work due to their cryptocurrency investments.

When you hear stories of such exceptional gains with the cryptocurrency market, it's understandable why people love crypto and why so many folks are looking for how to get into cryptocurrency. Most crypto fans love the fact that they can get in without saving up for years to get started.

Cryptocurrency investing doesn't stop.

One thing that I've learned from this cryptocurrency experiment is that the market never stops. I'll check my phone on a Friday night before going to sleep to see that everything has gone up 40%. It makes no sense. Then on a Monday morning things are down 30%.

The cryptocurrency market is always open for business. Cryptocurrency is 24/7. Many folks love this aspect of cryptocurrency. They can make moves at any time of the day.

There's no central authority.

There's no commission and nobody in charge of the cryptocurrency space. There are no real rules or regulations. Cryptocurrency investors like this aspect.

On that note...

Cryptocurrency is anti-establishment.

A lot of billionaires like Donald Trump are not fans of cryptocurrency. Then there are investors like the 97 year-old business partner of Warren Buffett, Charlie Munger, who are so anti-cryptocurrency that they call crypto is disgusting and bash it.

This doesn't deter young investors at all. Those who are anti-establishment find themselves turning to cryptocurrency.

This article on CNBC on how cryptocurrency works mentions this interesting point:

"One reason young people have turned to alternative investments like crypto is simple: Many just don’t trust traditional investment institutions."

That's why cryptocurrency is so popular these days. 

A few concerns about investing into cryptocurrenies...

I can't finish this article off without a few concerns about cryptocurrency. You have to know what you're getting into when it comes to investing your hard-earned money.

What are the major concerns with cryptocurrency investing?

There are many "get rich quick" schemes.

There are many people out there chasing altcoins and schemes to get rich in the cryptocurrency market.

I personally decided to put money into the main coins (Bitcoin and Etherium). I then set aside some money for some riskier options.

So I reached out to a friend who's always bragging about his investments. He recommended a coin that was supposed to take off. I put down $200. After a few weeks, there was some controversy about this coin and my money was lost. I was obviously annoyed, but I also accepted that I signed up for this risk. Turns out this this trader had put down $20,000 into this coin and it was all gone.

Could you imagine losing $20,000 over a transaction gone wrong?

Another word for these get-rich-quick schemes in the cryptocurrency market is "pump-and-dump."

Here's the official definition of a pump and dump scheme (replace stock with coin).

"In a pump and dump scheme, fraudsters typically spread false or misleading information to create a buying frenzy that will “pump” up the price of a stock and then “dump” shares of the stock by selling their own shares at the inflated price. Once the fraudsters dump their shares and stop hyping the stock, the stock price typically falls and investors lose money. "

The government could get involved soon in the cryptocurrency market.

I don't even want to speculate on what could happen when it comes to cryptocurrency exchanges and the potential government intervention.

This is just something to think about. There's no way that the government just lets this space slide. China is working hard to shut down cryptocurrency and who knows what's next.

You still have to consider tax implications.

As always, you can't avoid taxes in life. Since the tax laws are completely different depending on where you live, it's difficult to speak on this. There are still tax consequences to consider with cryptocurrency exchanges.

Elon Musk.

I had to give Elon his own section since one of his tweets can wipe out billions of dollars of assets. I don't want to get too into Elon Musk and cryptocurrency in this article, but it's startling how much influence one human can have.

There's a lot of noise in the cryptocurrency market.

There's so much happening in the cryptocurrency space. There are so many self-appointed "experts" who are quick to share a strategy that's guaranteed to make money allegedly and I'm convinced that nobody really knows how cryptocurrency works.

The cryptocurrency market is very volatile.

If you look at any cryptocurrency price charts, you're going to see a rollercoaster. The weekend that I started investing there was a dip. Then two weeks later there was a huge increase. Here are some of the charts of just ONE week.

The volatility means that you're going to be questioning yourself every time it dips and then you're going to feel like you're an investing genius whenever it's on the rise.

Check out the price of Bitcoin over the last three months. Bitcoin had an all time high price of $64,829.14 in 2021. 

Cryptocurrency investing can get confusing.

If you just purchase the popular coins (like Bitcoin), then it's a fairly straightforward process. You can buy the cryptocurrency and hold it without any hassle.

Things can get pretty confusing when you begin to dabble in the DeFi space (another topic for another day). This is where you start using Pancakeswap and you have to worry about getting the right address. 

Those are the main concerns with cryptocurrency investing at the moment.