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How Does Cryptocurrency Work?

A cryptocurrency is a digital, encrypted, and decentralized medium of exchange. Unlike the U.S. Dollar or the Euro, there is no central authority that manages and maintains the value of a cryptocurrency. Instead, these tasks are broadly distributed among a cryptocurrency’s users via the internet. You can use crypto to buy regular goods and services, although most 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 understand how each system works fully. Bitcoin was the first cryptocurrency, first outlined in principle by Satoshi Nakamoto in a 2008 paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” Nakamoto described the project as “an electronic payment system based on cryptographic proof instead of trust.” That cryptographic proof comes in the form of transactions that are verified and recorded on a blockchain.

What Is Blockchain?

A blockchain is an open, distributed ledger that records transactions in code. In practice, it’s a little like a checkbook that’s distributed across countless computers around the world. Transactions are recorded in “blocks” that are then linked together on a “chain” of previous cryptocurrency transactions. “Imagine a book where you write down everything you spend money on each day,” says Buchi Okoro, CEO and co-founder of African cryptocurrency exchange Quidax. “Each page is similar to a block, and the entire book, a group of pages, is a blockchain.” With a blockchain, everyone who uses a cryptocurrency has their own copy of this book to create a unified transaction record. Each new transaction as it happens is logged, and every copy of the blockchain is updated simultaneously with the new information, keeping all records identical and accurate. To prevent fraud, each transaction is checked using a validation technique, such as proof of work or proof of stake.

How Can You Use Cryptocurrency?

While there are a number of goods and services that you can buy with crypto, particularly with Litecoin, Bitcoin or Ethereum, you may also use crypto as an alternative investment option outside of stocks and bonds. “The best-known crypto, Bitcoin, is a secure, decentralized currency that has become a store of value like gold,” says David Zeiler, a cryptocurrency expert at financial news site Money Morning. “Some people even refer to it as ‘digital gold.’” Using crypto to make purchases securely depends on what you’re trying to buy. If you’re trying to make a payment in cryptocurrency, you’ll most likely need a cryptocurrency wallet. One type of wallet is a “hot wallet,” a software program that interacts with the blockchain and allows users to send and receive their stored cryptocurrency. Remember that transactions are not instantaneous as they must be validated by some form of mechanism.