How Does Cryptocurrency Work? A Beginner's Guide

Cryptocurrency is digital money that doesn’t require a bank or financial institution to verify transactions and can be used for purchases or as an investment. Transactions are then verified and recorded on a blockchain, an unchangeable ledger that tracks and records assets and trades.   

If you’re interested in learning more about cryptocurrency, this guide explains how it works and what you need to know before investing in these financial assets.

New to the financial technology (FinTech) scene? You can master the basics in just 8 hours with the University of Michigan's beginner-friendly introductory course, Blockchain and Cryptocurrency Explained.

What is cryptocurrency?

Cryptocurrency, or crypto, is a digital payment platform that eliminates the need to carry physical money. It exists only in digital form, and although people mainly use it for online transactions, you can make some physical purchases. Unlike traditional money printed only by the government, several companies sell cryptocurrency. 

Cryptocurrencies are fungible, meaning the value remains the same when bought, sold, or traded. Cryptocurrency isn’t the same as non-fungible tokens (NFTs) with variable values. For example, one dollar in crypto will always be one dollar, whereas the value of one NFT dollar depends on the digital asset it’s attached to.

Although government regulations are absent from the cryptocurrency market, they are taxable assets. You’ll need to file any profit or loss with the Internal Revenue Service.

Read more: Cryptocurrency: What Is It and How Does It Work?

How are cryptocurrencies created?

Mining is the term used to describe the process of creating cryptocurrency. Crypto transactions need to be validated, and mining performs the validation and creates new cryptocurrency. Mining uses specialized hardware and software to add transactions to the blockchain. 

Not all cryptocurrency comes from mining. For example, crypto that you can’t spend isn't mined. Instead, developers create the new currency through a hard fork. A hard fork creates a new chain in the blockchain. One fork follows the new path, and the other follows the old. Crypto you can’t mine is typically used for investments rather than purchases.

Cryptocurrency vs. traditional currency

The government produces traditional currency in paper bills and coins you can carry with you or put in a bank. You can use it for purchases and other transactions that require cash. The government backs traditional currency, while cryptocurrency has no government, bank, or financial institution controls.

While you can hold traditional currency in a bank or financial institution, you store cryptocurrencies in a digital wallet. Banks insure money kept in bank accounts against loss, while crypto has no recourse in the event of a loss. 

What are the advantages of cryptocurrency?

When it comes to cryptocurrency, there are some advantages to it versus traditional currency. An advantage of cryptocurrency is privacy. When you make a purchase with cryptocurrency, you don’t need to provide any personal information. This protects you from potential identity theft and other fraudulent activities. And no matter what happens to the government, your investment is secure. 

Another advantage of cryptocurrency is that it’s global, so there’s no need to figure or pay foreign exchange rates, although cryptocurrency isn’t legal in some countries. You also don’t need to worry about bank account restrictions, such as ATM withdrawal limits. 

Types of cryptocurrency 

Cryptocurrency is available as coins or tokens. The difference between them is that tokens are assets that exist on a blockchain, while coins can be virtual, digital, or tangible. Coins are more like traditional money; a digital coin has its own blockchain.  Conversely, a token is created on an existing blockchain and can be used as currency or to represent asset ownership.

The first cryptocurrency introduced was Bitcoin, the most commonly traded one. Ethereum is the second most valuable cryptocurrency and can be used for complex transactions. Other more common cryptocurrencies, called altcoins, include Cardano, Solana, Dogecoin, and XRP. 

Do I need to learn about blockchain technology to understand cryptocurrency?

Popular cryptocurrencies like Bitcoin and Ethereum rely on the blockchain to record and process transactions securely. Familiarizing yourself with blockchain technology can help you build a better understanding of how cryptocurrency works. Before investing, you might consider enrolling in a free online course like Princeton University's Bitcoin and Cryptocurrency Technologies.

How to get started with cryptocurrencies

To start with cryptocurrency, you’ll need to choose a broker or crypto exchange. An exchange is an online platform where you can trade cryptocurrencies. Brokers use interfaces that interact with exchanges. 

An exchange allows you to trade without a third party. Should you decide to use an exchange, you’ll need to find buyers for your cryptocurrency. A broker can do that for you. Here are the steps to start trading cryptocurrencies. 

1. Create and fund your account.

When you’ve selected a broker or exchange, the next step is to open an account. You’ll want to keep a form of identification nearby since some platforms require it. Once you verify your identity, you can fund your account. Depending on your funding method, you may need to wait a few days for it to clear into your crypto account.

2. Buy crypto.

You can make your first cryptocurrency purchase when your account is set up and verified. You’ll find many options. You can purchase as much or as little as you’d like. When you’ve selected the one you want to start with, you’ll need to enter the ticker symbol and the amount you wish to purchase. Some of the more traded cryptocurrencies and their symbols are:

• Bitcoin (BTC)

• Ethereum (ETH)

• Dogecoin (DOGE)

• Tether (USDT)

• USD Coin (USDC)

• Uniswap (UNI)

3. Select a storage method.

Most often, you’ll store cryptocurrency in a crypto wallet. When you purchase from a broker, you might not have an option regarding how you store your crypto. However, you can choose between a hot or cold wallet when purchasing through an exchange.

Hot wallets

A hot wallet is a crypto wallet that offers online storage that you can access from a computer, phone, or tablet. A hot wallet has a security risk because it’s stored on the internet and is more susceptible to cyber-attacks. 

Cold wallets

A cold wallet doesn’t connect to the internet. You can store your cryptocurrency in an external drive, such as a USB device. You’ll receive a keycode to keep in a safe place. Should you lose the keycode, you may lose access to your crypto wallet and cryptocurrency.

Ready to get started with cryptocurrency? 

Cryptocurrency offers opportunities for investing, trading, and employment. Before getting started, you can learn more about crypto technology and how it works on Coursera. 

Bitcoin and Cryptocurrency Technologies, offered by Princeton University, is an online course that explains how Bitcoin works and what makes it different. The course explains what determines the price and the future of crypto. 

Blockchain and Cryptocurrency Explained is a beginner-level certificate course that takes approximately nine hours to complete. If you're interested in starting a career in FinTech, you might benefit from earning a credential. The course is offered by the University of Michigan and explains how blockchain works and the strengths and weaknesses of cryptocurrency.