This post aims to demystify cryptocurrency (crypto), explaining what it is, how it works, how to gain exposure to it, its major types, advantages, risks, and factors that influence its prices, along with a quick trading guide for beginners.

What is Crypto?

Crypto is a digital currency that doesn’t rely on central banks to verify transactions and create new currency units. Instead, it uses cryptography to confirm transactions on a publicly distributed ledger called a blockchain. 

The first crypto, Bitcoin, was developed in 2009 by a programmer using the pseudonym Satoshi Nakamoto. In a 2008 white paper, “A Peer-to-Peer Electronic Cash System,” Nakamoto provides the first description of blockchain. Blockchain is the technology that enables crypto to work like government-issued (fiat) currencies but without the involvement of any central bank.

Specifically, blockchain solves the “double-spending problem” associated with digital cash. Since digital information is easily copied, digital cash requires a mechanism that reliably prevents a currency unit from being “duplicated” or otherwise spent more than once.

Unlike the traditional financial systems that rely on central authority to validate transactions, the blockchain technology uses a public and immutable ledger to establish and maintain trust. The immutability prevents hackers from producing fraudulent transaction records and establishes trust among users. We’ll examine how blockchain technology works by looking at the lifecycle of a crypto transaction.

Crypto Transaction

Crypto transactions involve sending assets from one wallet to another. Here is an overview of how crypto transactions work:

1. Initiation: The sender initiates a transaction by authorizing the movement of a specified amount of crypto from their wallet address to the recipient’s wallet address.

2. Verification: The transaction is broadcast to the crypto network and awaits verification by miners or validators.

3. Added to Blockchain: Once verified, the transaction is included in a new block and added to the blockchain.

4. Confirmation: Once added to the blockchain, the transaction is confirmed. The recipient sees the transaction in their wallet.

We’ll explore the core concepts involved in the transaction process, including wallet, blockchain and transaction verification.

What is Wallet?

A crypto wallet is a tool that allows users to interact with blockchain networks. They are necessary when sending and receiving crypto. Unlike the traditional wallets in everyday life, crypto wallets don’t really store your funds. Your cryptos are simply part of a blockchain system as pieces of data, and the wallets serve as a means to access them.

Most crypto wallets are able to generate one or more pairs of public and private keys. A key is a long string of random, unpredictable characters. The public key is used to generate wallet addresses, which are needed to receive payments. The private keys are used for initiating and verifying transactions. While a public key is like a bank account number and can be shared widely, a private key is like a bank account password and should be kept secret.

There are three types of wallets:

• Software Wallets: Applications or programmes that can be installed on computers or mobiles, offering balance between security and convenience. Examples include Exodus and Electrum.

• Hardware Wallets: Physical devices that provide offline storage, enhancing security against hacks. Examples include Ledger and Trezor.

• Paper Wallets: Physical printouts of public and private keys, providing a very secure method of storage but requiring careful handling.

Software wallets are best suited to beginners or regular traders who need to make quick, online payments.

What is Blockchain?

A blockchain is a digital ledger that records transactions in a series of linked blocks on a crypto network. Each block is a collection of transaction data, such as:

• Person A sent X amount of the crypto to Person B.

• Person C received Y amount of crypto from Person D, and so on.

In addition to transaction data, a block includes a reference to the block that immediately precedes it. This creates a chain of blocks, where each is securely linked to the previous one. If someone attempts to alter a block, they would need to recreate the entire chain of blocks that follow it. Otherwise, the chain of invalid references would be rejected by the network.

To maintain the integrity of the blockchain, blocks also include additional information that further enables the crypto network to verify their validity. For example, many cryptos use a consensus mechanism called proof-of-word. According to this mechanism, crypto miners use large amounts of computing power to add blocks to the blockchain. The computing power solves complex puzzles, such as math problems, for which solutions are easily verified as correct. The miners are typically rewarded with crypto and transaction fees. 

New blocks cannot be added to the blockchain without a miner computing a valid solution to the block’s puzzle. With every transaction, the blockchain grows longer, and the computing power required to add a new block increases. This growing complexity makes blockchain increasingly secure and tamper-resistant. For a hacker to alter any transaction on the blockchain, they would need control of computing power exceeding the combined power of the entire network—a nearly impossible feat for most decentralized networks.

As you can see from the above description, blockchain technology has several distinctive features that set crypto apart from traditional financial markets:

• Decentralization: Crypto transactions occur directly between users, without third party intervention.

• Transparency: The public ledger allows anyone to view and verify transactions, promoting accountability and trust within the system.

• Security: Crypto transactions are encrypted with blockchain technology, making them highly resistant to fraud and hacking.

Crypto Transaction Example

With the concepts discussed earlier, let’s explore crypto transactions with an example. Suppose Alice wants to transfer one unit of Bitcoin to Bill. Alice initiates the transaction by sending an electronic message with her instructions to the crypto network, where all users can see the message. Since the system is not instantaneous, Alice’s transaction sits with a group of other recent transactions waiting to be compiled to a block (which is a group of the most recent transactions). Once enough information is gathered,  the information in the block is turned into a cryptographic code. Miners then compete to solve the code to add the new block of transactions to the blockchain.

When a miner successfully solves the code, other users of the network check the solution and reach an agreement that it is valid. The new block of transactions is added to the end of the blockchain, and Alice’s transaction is confirmed.

Source: Reserve Bank of Australia

Way to Gain Exposure to Crypto

Cryptocurrencies can be bought, speculated, or earned. Below is how each of these processes works.

Buying 

You can buy them on crypto exchanges, which are platforms that facilitate the buying, selling and trading of cryptocurrencies, where users can exchange fiat currency (e.g., USD, EUR) for cryptocurrencies. Here are the general steps to buy on an exchange:

1. Choose an Exchange: Select a reputable exchange based on factors like security, fees, and available cryptocurrencies.

2. Open an Account: Users register and verify their identity on the exchange.

3. Deposit Funds: Users add funds to their account using a bank transfer, credit card, or other payment method.

4. Buy Crypto: Select the crypto to buy and place an order.

Speculating

Rather than buying and using cryptos for payment in the blockchain networks, the primary interest in cryptos has been more speculative (buying and selling cryptos to make a profit).There are five popular speculative investment products that provide crypto exposure:

• Crypto CFDs allow you to speculate on crypto price movements without owning the actual asset.

• Crypto Spot Trading involves buying and selling actual crypto. You own the asset outright when you buy a crypto on a spot market. 

• Crypto Futures are contractual agreements to buy or sell a crypto at a predetermined future date and price.

• Crypto Investment Trusts are funds that hold crypto on behalf of you, allowing exposure without direct ownership.

• Exchange-Traded Funds (EFTs) are investment funds traded on stock exchanges, allowing you to hold a basket of cryptos or track a crypto index.

From the below comparable table, you can see each investment product’s pros, cons and potential risks:

For beginners interested in crypto, speculative investment through instruments like CFDs can be a practical option. CFDs are derivative instruments that let you speculate on the price movements of crypto without owning the asset. This eliminates the need for a crypto wallet, making the investment process more straightforward.

Additionally, CFDs are leveraged, meaning you can open a position with only a fraction of the total market exposure. However, leverage amplifies both profits and losses, so it’s essential to approach with caution. One key advantage of CFDs is the ability to profit from both rising and falling markets.

If you decide to trade CFDs, take the time to understand how they work and familiarize yourself with some essentials. Proper education will help you navigate the complexities and streamline your investment experience.

Mining

Mining is a process by which new crypto coins or tokens are created and transactions are verified using the proof of work consensus mechanism. Miners use computing power to solve complex math puzzles that secure the network. And in return, they are rewarded with newly created coins and transaction fees. This process is resource-intensive and requires significant computing power.

If you plan to mine Bitcoin or Ethereum, be aware of two key points:

First, mining is no longer feasible on a personal computer. It now requires specialized mining machines and a reliable electricity supply to be effective.

Second, use a Bitcoin or Ethereum calculator to estimate potential returns from mining and determine whether it's worth your time and investment. It’s also recommended to join a pool of miners who combine resources to run a successful mining operation.

Crypto Types

As of  November 14, 2024, there are 10,018 cryptos listed on CoinMarketCap, with many others now defunct. The vast number of cryptos is due to the ease of creation. Ethereum’s blockchain enables users to write code and deploy tokens, making it simple for anyone to launch a new crypto that uses the Ethereum network.

Currently, the three largest cryptos by market cap are:

Data source: CoinMarketCap as of Nov. 14, 2024.

Bitcoin is by far the most valuable crypto. It is the first decentralized crypto and uses blockchain technology to facilitate payments and digital transactions. Bitcoin has the strongest adoption rate and a large network of miners, ensuring it remains at the top of this list. One of Bitcoin’s most significant features is its limited supply. The total supply of Bitcoin is capped at 21 million coins. This scarcity is intended to mimic precious metals like gold, giving Bitcoin its “digital gold” moniker and contributing to its value proposition as a store of value.

Ethereum’s Ether is consistently the second-largest crypto and is used to facilitate transactions on the Ethereum network. Ethereum is a platform that uses blockchain technology to enable creation of smart contracts (that automatically execute when conditions are met) and other decentralized applications, meaning the software doesn’t have to be distributed on app exchanges like Apple’s APP Store or Alphabet’s Google Play Store, where they might have to give a 30% cut of any revenue to the tech giants. Ethereum is both a currency and a software development sandbox.

As the third-largest crypto, Tether is a stablecoin designed to maintain a stable value by pegging its price to a reserve of fiat currencies, combining the benefits of crypto–like fast transactions and blockchain technology–with the stability of traditional currencies. It claims a 1:1 backing of USDT with a mix of fiat, cash equivalents, and other assets, aiming to minimize price volatility by providing a stable medium of exchange and store of value. Thus, it is useful for traders looking to hedge against market fluctuations and for businesses seeking to leverage the advantages of blockchain technology without exposing themselves to the volatility of other cryptos.

For crypto beginners, buying Bitcoin is an obvious choice since Bitcoin is widely supported and a well-established ecosystem of software is available to facilitate transactions. Ethereum is also attractive because the Ethereum blockchain is valuable for establishing new tokens, DeFi services, NFTs, and other blockchain applications. 

Advantages

Crypto has several advantages over traditional finance:

• High Returns: Crypto brings high potential returns that attract investors.

• Lower Fees: The cost of using crypto is substantially lower than using traditional financial institutions. For example, the cost of sending money to international parties is extremely low compared to traditional international remittance services.

• Less Restriction: Unlike traditional finance, there’s no need to provide a valid ID or go to a bank to use crypto. Users can access and use crypto from anywhere in the world. This can be extremely attractive for the millions of unbanked people worldwide.

• Diversification: Adding crypto to your investment portfolio can provide diversification, potentially reducing overall risk.

Risks and Challenges

There are also some disadvantages and risks of holding or investing in crypto:

• High Volatility: There has also been a high degree of volatility in the prices of many crypto. For example, the price of Bitcoin increased from about US$30,000 in mid 2021 to almost US$70,000 toward the end of 2021 before falling to around US$35,000 in early 2022. Ether has experienced similar volatility.

• Regulatory Concerns: Governments and regulatory bodies are grappling with how to regulate cryptos. Issues such as taxation, money laundering, and consumer protection are at the forefront of regulatory discussions. Uncertain and evolving regulations can impact the growth and adoption of cryptos.

• Security Issues: While blockchain technology is inherently secure, the broader crypto ecosystem is not immune to risks. Hacks, scams, and fraud have occurred, resulting in financial losses. Users must remain vigilant and adopt best security practices.

Crypto Price Analysis

The crypto market is volatile and complex, influenced by a variety of factors. Here are some major factors:

• News and Events: Major corporate announcements and political events can significantly impact crypto values. For example, Bitcoin surges to a new record of over $93,000, after Donald Trump won the 2024 presidential election. His deregulatory stance could support crypto innovation and adoption, positively influencing market sentiment.

• Regulations: New regulations and policies regarding the crypto market can also make a difference.

• Market Sentiment: Investor sentiment, including anxiety or optimism about the future of the crypto market can also influence the crypto value considerably.

• Competition between Cryptos: Cryptos compete with each other to attract investors and users, which can affect the value of each particular crypto.

• Blockchain Technology Development: New and improved blockchain technologies have a direct impact on the value of crypto which uses these technologies.

• Traditional Asset Market Fluctuation: Fluctuations in traditional asset markets, like stocks, gold, oil can affect the crypto market.

Guide to Trade Crypto

1. Understand the basics

Familiarize yourself with the fundamentals of crypto and decide which crypto aligns with your investment goals. Additionally, explore the different kinds of speculative investments strategies to find the one that suits you best, and take time to educate yourself on the essentials of your chosen strategy. For beginners, trading Bitcoin and Ethereum with speculative investment strategies like CFDs is recommended.

2. Choose a reliable broker

Select a regulated, reputable, and reliable broker that provides access to crypto and supports your preferred investment strategy. 

3. Identify a crypto trading opportunity

Stay informed about key factors influencing crypto price, such as political events, regulations and market sentiment. Regularly monitor these factors to spot profitable opportunities.

4. Manage your risk and place your trade

Before opening a position, manage your risk: only trade with money you can afford to lose; limit potential losses with a stop-loss order; avoid putting all your funds into a single crypto.

5. Monitor and close your position

Once you open a position, watch its performance and be prepared to close your position if you’ve hit your profit target or stop-loss limit and to adjust your strategy if market conditions change.

Summary

Cryptocurrencies are digital assets that rely on blockchain technology for secure transactions without central authorities. Blockchain ensures trust through a decentralized, transparent, and immutable ledger. Crypto can be bought, speculated on, or mined, each offering different ways to gain exposure. Major cryptos like Bitcoin, Ethereum, and Tether offer different use cases, from a store of value to enabling decentralized applications. While crypto offers advantages like high returns, lower fees, less restriction, and diversification, it also poses risks, including high volatility, regulatory uncertainty, and security concerns. Price movements are influenced by news, regulations, market sentiment, competition, blockchain advancements, and traditional asset market fluctuations. By understanding the basics, managing risks, and staying informed about the market trends, you can make more informed decisions when navigating the crypto space.