What is Cryptocurrency & How does Cryptocurrency Work

In the last 4-5 years, the Indian investment space has witnessed a new wave of digital currency that runs on a coded network. Yes, we are referring to the infamous cryptocurrency. It’s the talk of the town. Some believe it’s the future while others think it’s too risky to dip your toes in. So what exactly is this new currency and how did it become so popular? Should you consider investing in crypto? Let’s answer all you need to know about cryptocurrency.

What is Cryptocurrency?

Cryptocurrency is a digital currency that is used to trade, invest and make payments. The use cases are much like physical currency. The only difference is in its working model. Unlike RBI-issued currency, crypto is not a legal tender. This means that it can not be used to make payments everywhere in the country. You can not go to a vegetable vendor and make payments in cryptocurrency (yet). However, some conglomerates like Etsy, Starbucks, Microsoft, etc. have started accepting crypto as a mode of payment. Usually, it is used by investors to trade. All the trades and transactions take place within a coded network called blockchain ledger technology. Blockchain is a decentralized network, which means that it is not regulated by any individual, group, or association. The authority is evenly distributed among all who access the chain and it is impossible to counterfeit or double-spend. Read Decentralization in Blockchain to understand this better.

How does cryptocurrency work?

Cryptocurrencies are digital tokens or virtual cash that work as the medium of payment for services bought on a computer network. It is a peer-to-peer network with no authoritative involvement. Every time a new crypto is bought or sold, a new block is added to the network. All the new blocks are first identified and checked by a network of miners. Crypto mining is not a layman’s job. It is highly analytical and time-consuming. The miners keep a track of all the transactions taking place in a blockchain. Note that every cryptocurrency has its own blockchain network. But who are these people and why do they do it? Simple- for rewards. Miners are the first people to get access to a cryptocurrency. Every new block is connected to its former and latter blocks. So no individual miner can tamper with the chain. Also, since the rewards are hefty, many people are encouraged to mine cryptocurrencies. However, as the miners increase in a particular currency, the rewards go down. For instance, Bitcoin miners could get up to 50 bitcoins initially but it has gone down to 6.25 Bitcoins after the recent halving in 2020.

Types of Cryptocurrency

Bitcoin was the first cryptocurrency. Altcoins were launched after Bitcoin to improve on it. Several of the altcoins follow the price trajectory of Bitcoin, meaning their value follows the growth and fall of Bitcoin’s price in the exchange. Based on data available on September 30, 2021 few of the popular cryptocurrencies are as follows:

Bitcoin: market capitalization $821 billion
Ethereum: market capitalization $353 billion
Tether: market capitalization $68 billion
Cardano: market capitalization $67 billion
Binance Coin: market capitalization $64 billion
XRP: market capitalization $44billion
Solana: market capitalization $41 billion
USD Coin: market capitalization $31 billion
Polkadot: market capitalization $28 billion
Dogecoin: market capitalization $26 billion

The purpose of including a list of top cryptocurrencies in crypto trading for beginners is to let you understand scopes of investing beyond Bitcoin.

Is it a good investment option?

To understand cryptocurrency as an investment option, let’s make a pros and cons list.

Pros of Cryptocurrency

Crypto is a widely adopted currency for a reason. Let’s explore the benefits of investing in cryptocurrency.

1. Not regulated by a single entity

Crypto works on a decentralized virtual network. It means that the control is not placed in any individual, company, or in even in the government’s hands. It makes it an error and bias-free environment. Users don’t have to place their trust in any particular regulator or bank.

2. Fast transactions

Being virtual money, crypto is very fast in transactions. While bank wires may take days due to human involvement, investing and transacting in the blockchain takes minutes. It could even take seconds if they didn’t double-ensure every block for safety, which brings us to the last point-

3. Secure transactions

The transactions in blockchain are highly secure, i.e get recorded on blockchain and almost impossible to tamper with. Every block is connected to nodes that are in turn verified by a network of miners. Issues like counterfeit, double spend, insider trading and corruption can not occur in this digital mode of currency.

Cons of Cryptocurrency

The RBI banned the use and trade of cryptocurrency in 2018. It was lifted back up in 2020 by the supreme court. There has been a lot of controversy around crypto due to the cons it carries.

1. High volatility

These currencies are highly volatile. In December 2017, the value of one bitcoin dropped from 19,000 to 7,000. Similarly, in December 2020 it surged from Rs. 5,30,604 to Rs.13,52,524. The graph of crypto prices has witnessed some drastic changes. And the riskiest part is that these prices depend on the popularity of a particular currency. For instance, the currency created after a meme called dogecoin saw a spike in value after much attention from Gen Z.

2. Not open to uncertainties

When you become a crypto investor, you are given two keys: one public for keeping track and one private for making transactions. In case this key is lost, or you forget the password, there is no way to recover your data, i.e money.

3. Backdoor to criminal activity

Cyrpocureny is not a new concept. It has been in the system since the early 2000s and was mainly used by criminals to make backdoor payments. Due to no regulation by the government, nobody could question it either. This is one of the main reasons behind the ban of 2018. Furthermore, no regulator means no investment standards either.

How do I buy cryptocurrency?

Many platforms are available in India where investors can buy cryptocurrencies from exchanges, like Coinbase and Coindesk. However, the best platform for buying Bitcoin is Zebpays. One can transfer money from their savings account to the Zebpay platform to buy Bitcoins. You will have to complete the usual KYC formalities to place a buy order. Once done, you can purchase cryptocurrencies, paying through digital payment methods. One can start investing in Bitcoin with just Rs 500 and increase their exposure as they gain confidence. Traders trade crypto coins in the exchanges like stocks and realize a profit from changing prices. However, cryptocurrency prices are highly volatile, and investors must understand the inherent risk. Besides direct investment, investors can also gain exposure to cryptocurrencies through cryptocurrency ETFs. ETFs invest a corpus in a bucket of cryptocurrencies or derivatives with cryptocurrencies as underlying. Instead of a single currency, ETFs follow a bucket of currencies and offer double benefits.

Low-cost access to cryptocurrencies
Eliminates the steep learning curve by outsourcing

Closing thoughts Cryptocurrency has gained a lot of attention in recent years. However, to decide whether it is a viable investment option for you or not, you must access your risk profile. The risk in this digital asset is high, but so are the returns. To sum up-Invest in what you understand.