How Does Cryptocurrency Work?

Cryptocurrency is one of the hottest words in the financial market right now, however most people still don’t understand exactly how it works. Cryptocurrencies have been infiltrating the world more and more over the years with Bitcoin, Ethereum, Litecoin and Ripple the names people are most familiar with. Even celebrities and huge companies are talking about cryptos, with the likes of Elon Musk getting behind Bitcoin by posting his fulsome support on Twitter and Clubhouse and various other social media platforms. But what once was a niche concept has grown to become worth a lot of money. How much, you ask? According to CoinMarketCap, on February 18^th 2021 the combined value of all cryptocurrencies exceeded $1.6 trillion.

The popularity of cryptocurrency has reached a point at which it’s not uncommon to hear people casually talking about crypto trading at parties, but if you’re not part of that conversation it might all sound like gibberish. Well, fear not—if you’ve always wondered what cryptocurrency is and why people talk about crypto trading so much, we’re here to answer your questions. Let’s go back to basics to delve into what cryptocurrency is, where it came from and how it works. Then we’ll take a look at some cryptos that are changing the game, such as Bitcoin and Ethereum.

What is cryptocurrency?

In essence, cryptocurrency is digital money that can be used to purchase goods or services online. Some people invest in cryptocurrency price fluctuations just like other assets like gold or oil. What sets crypto apart and attracts all kinds of interest is that it doesn’t rely on a bank or other centralised authority, but instead transactions are recorded in a digital ledger also known as a blockchain, making them decentralized. Cryptocurrency can be stored in a digital wallet or e-wallet, and from here people can spend or store their crypto. One of the primary attractions to cryptocurrency is the fact that it’s largely decentralized, meaning it’s not regulated by any central financial body (such as the way a country’s fiat currency is regulated by its central bank). Some people see cryptos as the currency of the future and are in a hurry to learn more about crypto trading, while others are attracted to the fact that it uses blockchain technology which can be very secure. Either way, people are talking about cryptos and they’ve taken off in a big way across the financial markets, leading some to wonder how it could impact our traditional payment platforms and financial systems overall.

A brief history of crypto

The first cryptocurrency, Bitcoin, was created back in 2009 by a group or person who goes by the pseudonym Satoshi Nakamoto. To this day, the real identity of Nakamoto remains unknown, and Bitcoin continues to be shrouded in mystery. Since then, over 6700 cryptos have been created and are traded publicly. In 2010, Bitcoin was given a monetary value for the first time, and in 2011 more cryptocurrencies began to emerge as the idea became more popular. Then in 2013, the price of Bitcoin took a huge nosedive, and it took the crypto another two years to reach its previous high. In 2016, along came Ethereum, a rival that almost stole Bitcoin’s thunder. Ethereum is now the second largest cryptocurrency, however it has a different use to Bitcoin and many people are confused as to how they differ.

Ethereum enters the scene

While Bitcoin and Ethereum seem similar at the outset and rival each other to an extent, their platforms were built for different purposes. Bitcoin is a cryptocurrency and is used as a medium for exchange, while Ethereum is a platform and is not being used as a medium for exchange. Ethereum trumps Bitcoin when it comes to transaction speed, and the rise of Ethereum 2.0 is going to see even faster speeds on the platform in the near future. Ethereum’s transactions differ from Bitcoin’s in that they can be in the form of executable code, instead of monetary value. Raoul Pal, CEO and co-founder of financial media group Real Vision said, “I’ve always thought this digital asset space is huge – and it’s not just bitcoin – because there are going to be different applications for different things.”

The primary purpose of Bitcoin was to be an alternative to traditional currencies and a store of value that can be exchanged for goods or services. On the other hand, Ethereum was created as a decentralized software platform, to serve multiple purposes, using Ether as the cryptocurrency fuel for the platform. Decentralized apps and smart contracts can be used on top of the platform, and Ethereum’s blockchain is, in fact, the most actively used. Ethereum is a flexible platform that can even hold Bitcoin on it, as it was developed on the idea of a blockchain, as opposed to a cryptocurrency.

In the markets, Ethereum has risen by 530% over the last year, as decentralised finance takes off. At the same time, while Bitcoin makes up about 72% of the total market capitalisation of all cryptocurrencies and Ethereum makes up 15%, the other cryptocurrencies are far behind.

Now that you know the difference between Bitcoin and Ethereum, let’s look at how crypto trading works.

Crypto trading as CFDs

One way to enter the crypto trading market is by investing in CFDs or Contracts For Difference, which essentially allow you to take advantage of price volatility of a chosen cryptocurrency such as Ethereum or Bitcoin. Such volatility can present both opportunities and risks for CFD traders, who open deals based on price movement in both directions—increases as well as decreases—without having to purchase the underlying asset (in this case, that means any actual Bitcoin or Ethereum). For example, if you think the price of Ethereum is going to go up, you can open a “Buy” deal or “Go long,” but if you think prices are going to go down, you can open a “Sell” deal or “Go short.”