How Does Cryptocurrency Work?

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By now, you've probably heard of Bitcoin, and you know that Bitcoin is the first of a new class of currencies called cryptocurrency. But how does cryptocurrency work? How is it secure, and how does it get its value? 

Cryptocurrency Definition

Before we get into how cryptocurrencies work, it's important that we agree on what a cryptocurrency is. Cryptocurrency is a form of digital or virtual currency secured by cryptography. Cryptocurrencies take advantage of blockchains to prevent the currency from being double spent or being counterfeit.  

Blockchain technology uses a distributed ledger that leverages a decentralized network of computers to validate and track each transaction.

How do Cryptocurrencies Work?

When Bitcoin was released, it was the first cryptocurrency to use a decentralized network to track ownership of the currency. The breakthrough was that Bitcoin showed it was possible to build a decentralized currency without the need for a central authority. 

This is a defining feature of cryptocurrencies. By being issued and managed by a decentralized network rather than a central authority, they are more censorship resistant and immune to interference and manipulation.

So what's the underlying technology behind this cryptographic revolution? 

Cryptocurrencies use a new kind of digital architecture called a blockchain. 

Enter the Blockchain

Blockchain is a term used to describe the technology that underpins all of the cryptocurrencies you've probably heard of. It refers to a shared, decentralized ledger that keeps track of all cryptocurrency transactions.  

By recording each transaction on the blockchain, and keeping a copy of the blockchain on every computer on the network, it’s very easy to detect fraud, bugs, and foul play. 

This also makes it impossible to double-spend or counterfeit cryptocurrency, as any attempt to do so would be immediately apparent to everyone on the network. 

Blockchain technology derives its security from its decentralization. Decentralized networks of nodes, validators or miners (depending on the particular cryptocurrency and its consensus mechanism) compete for the chance to validate transactions, add them to the chain, and get rewarded for their activity. This process secures the network by making it extremely difficult for any network participants to add false or fraudulent transactions.

If this sounds confusing, don’t worry! There is a lot to learn here. To dig deeper on blockchain technology, check out our blog Blockchain for Beginners.

But with that, let’s move on to a very common question for new participants in this space.

Is Crypto Safe?

Due to the disruptive nature of blockchain technology, the cryptocurrency industry can be subject to a disproportionate amount of fear, uncertainty, and doubt.  

While investing in crypto comes with a unique set of risks - many of which are related to the volatility that characterizes the industry - the truth is that you can mitigate these risks with research and by doing due diligence on assets before trading. Once you understand the technology and the market, you can make informed decisions about which projects to invest in.

Crypto is also a self-sovereign digital asset, which means that people are in control of their own crypto (versus it being stuck in a bank). This creates new potential for human error and mistakes that can lead to loss. That said, crypto security is a topic many learn early in their crypto journey.

What’s important for consumers to remember is that the set of tools and platforms available to them to help them manage their crypto has never been higher. Crypto users have more options than ever before to keep their crypto safe and secure. 

Examples of Digital Assets

Since the industry's birth in 2009, an explosion of cryptocurrency projects has sprung new initiatives and revolutionized the way people interact with money. Today, there are over 18,000 blockchain and cryptocurrency-related projects, collectively known as digital assets. While it would be impossible to name all of them, many of the digital asset projects you'll encounter will fall into the following 4 categories: 

Layer 1 Protocols

Layer 1 protocols are base layer blockchains that can validate and settle transactions without relying on another network to do so. Each layer 1 has a native token. These include Bitcoin, Ethereum, Solana, Avalanche and more. 

Layer 2 Protocols 

Layer 2 protocols are secondary frameworks that operate on top of a baselayer protocol, taking advantage of the base chain for settlement and security while creating options to help scale transaction speed or efficiency. Layer 2 protocols tend to have their own token. 

NFTs

Non-fungible tokens, or NFTs, are cryptographic tokens that represent something unique and, therefore, are not substitutable with another token. NFTs first appeared in 2017 with CryptoKitties, a game that allowed players to collect and breed digital cats. The NFT space saw the beginning of the modern phase in late 2020 and early 2021 and has seen rapid growth recently, with collections like Cryptopunks and Bored Ape Yacht Club generating worldwide interest and billions of dollars in trading volume.  

Stablecoins

Stablecoins are cryptocurrencies that seek to minimize price volatility by pegging their value to a stable asset, like the US dollar. USDT, USDC, and DAI are all examples of stablecoins. By minimizing volatility, these crypto assets enable markets to offer more advanced financial instruments in a permissionless environment. 

How to Trade Crypto with FTX

After deciding to trade in the crypto industry, choosing a platform that best meets your needs as a trader is key. FTX offers a wide range of features for beginners and experienced traders alike.  

Aside from trading in currencies like Bitcoin, Ethereum, and Solana, FTX is also a trusted, regulated gateway to other parts of the digital asset space, including NFTs.  

If you're ready to make your first purchase, register for an account on FTX today! 

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