Cryptocurrency: What Is It and How Does It Work?

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Cryptocurrency offers a robust mix of risk and reward. Like many investments, whether it’s a good match for you depends on various factors, including how risk-averse your investing style is.

[Featured image] A person in jeans and a blue and white striped shirt sits on a bed with a laptop reviewing cryptocurrency investments.

Although the first cryptocurrency emerged in 1990, the buzz surrounding crypto investments seemingly exploded in the past few years. Some crypto experts compare it to the internet in the early 1980s: There's still a bit of mystery surrounding crypto and its functions. There's also still an abundance of opportunity.

Despite the possibilities, recent volatility in the crypto market underscores the potential risk involved in cryptocurrency trading. Understanding cryptocurrency and its workings is an essential first step, whether you're considering investing or seeking a job in the world of crypto.

What is cryptocurrency?

Cryptocurrency is a digital currency, as opposed to a physical one. It doesn’t have a regulating authority or a centralized system. Instead, it uses cryptography, a process of writing and deciphering code, for issuing, verifying, and securing the currency. Not only is cryptocurrency secure, but it can’t be counterfeited and remains traceable from transaction to transaction. 

This peer-to-peer digital currency system makes it fast, easy, and inexpensive to send and receive payments worldwide. There's no currency exchange needed, nor are there hefty fees. These transactions get publicly recorded, stored digitally, and transmitted via encryption, with detailed coding required for transmission and storage.

Professional vs. hobby investing

People often invest in crypto in two main ways: as a personal hobby or wealth-building strategy or as part of their profession. The crypto investment buzz has made hobby-level investing popular, particularly among younger investors.  

If you’ve thought of investing as a hobby, you’re not alone. A May 2022 survey by The Ascent revealed that 46.5 million people in the United States, or 41 percent of respondents who didn’t already own cryptocurrency, said they'd invest in the coming year. That’s a significantly higher number than the 3 percent in 2021 who said they planned to make their first investment in cryptocurrency within the year  [1]. 

Crypto investment jobs

Hobby investing isn’t the only way to work with cryptocurrency. You’ll also find various cryptocurrency-related jobs, including some careers that don't work directly with the investment side but with clients who do. Examples include business development representatives and marketing managers

In positions like these, you may work with crypto companies and organizations that work with cryptocurrency to help create awareness and build their customer base. Additional examples include:

  • Financial analyst: As a financial analyst or advisor, you would recommend investments and create investment strategies for a roster of clients. 

  • Data scientists: A data scientist working with cryptocurrency might be tasked with forecasting changes in the price of digital coins.This is another in-demand role, mainly because the technology is still new, and people with analytical skills are needed to work with engineers.

  • Machine learning engineer:You might help create digital applications that provide secure access to exchanges and investing platforms as a crypto machine learning engineer.

How cryptocurrency investments differ from traditional

Cryptocurrencies are based on blockchain and cryptography, making them very secure, although it’s still up to investors to choose trustworthy exchanges. Your crypto wallet, where you store your holdings, is also secure because you use a private key to access it. Other elements that set them apart from more traditional investments include:

  • Accessibility: Crypto investing is open to anyone with internet access and a computer, smartphone, or mobile device.

  • Low transaction costs: Transactions cost no more than a few dollars, with many costing just pennies.

  • Transaction speed: Few other institutions are faster than cryptocurrency for sending, receiving, and moving assets worldwide.

  • Transparent transactions: Crypto transactions are a public record. Anyone can look up transaction information and see the contents of a crypto wallet. Transparency makes it easy to reduce fraud and prove transactions were carried out correctly.

Types of crypto investment

Cryptocurrency is an umbrella term that describes multiple types of digital currencies. When Bitcoin first hit the market in 2009, it spurred the creation of other cryptocurrencies, and today there are many options. Crypto investments typically fall into one of three main categories:

1. Coins: When investing in cryptocurrency coins, you're investing in a coin that gets created via its unique blockchain. Coins function similarly to physical currency: you can exchange them for business or save to store value. Many people consider Bitcoin the only genuine coin, although others include Ethereum in this category. 

2. Altcoins: As the name implies, this is an alternative to coins. These cryptocurrencies are any cryptocurrency that isn’t Bitcoin or Ethereum. These coins belong to the blockchains they were designed for but may also split that blockchain for alternate uses. For example, Ether is an altcoin that branched off Ethereum. It was created for the express purpose of paying transaction fees.

3. Tokens: You can use this type of cryptocurrency as digital money, but it also has other uses. For example, non-fungible tokens (NFT) can be used as digital art. Alternative tokens may verify individuals' identities or provide access to applications.

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Short-term crypto investment

As 2022's crypto crash demonstrated, the crypto market is volatile and unpredictable. Trading is a popular short-term crypto investment strategy that requires you to buy and sell based on when you expect prices to increase or decrease. Many short-term traders watch average prices over a period to get a feel for how they're trending. Having technical analysis skills, which use past patterns and prices for the crypto investment you're considering, is an essential skill to master.

Long-term crypto investment

If you approach crypto investment as a long-term strategy, the ups and downs will likely be less concerning since short-term fluctuations won’t matter. Consider how much Bitcoin has appreciated since launching in 2009. The value increased by approximately 12,000 percent. Ethereum, which hit the market in 2015, has appreciated at an even higher rate that exceeds 92,000 percent [2]. 

While both values have fluctuated wildly in the short term, investors who approached them as long-term investments reaped the rewards. Additionally, some experts expect emerging technologies, new regulations, and more widespread adoption to fuel the growth of the cryptocurrency industry.

What you should know before entering into the cryptocurrency market

Crypto investment is new and exciting, with a lot of hype surrounding it. For many novice investors, it may be easy to become overwhelmed and overextended. 

That’s why it’s essential to have a good foundation before investing. Learning about different options, how blockchain technology operates, and how the market works prepares you for a smoother road ahead. Additional key concepts include decentralization, self-custody of crypto assets, and the difference between a centralized exchange (CEX) and a decentralized exchange (DEX).

In addition to word-of-mouth from other enthusiasts, you can read each cryptocurrency's white paper to learn more about the project developers' goals and details. It also helps to know your goals, understand the benefits and risks, and understand how the industry works. 

Define your investment goals.

Why are you investing in cryptocurrency? What are your client’s or employer’s goals? If you're solely looking to make a lot of money quickly, this might not be the right investment. Many investors have come before you looking to get rich quickly, and many end up with significant losses. Additionally, most coins and tokens pay the largest gains to those who hold onto them for the long term.

The tolerance for risk and the reasons behind the investment can help guide your choices. For example, if you believe in the technology or you're looking for an investment with the potential for stable long-term value, cryptocurrencies could be a suitable option. As with any investment, you must remain aware of the risks and avoid putting more money into crypto investments than you can afford to lose.

Get a feel for the crypto industry first.

If you ask established crypto experts for advice, many will suggest starting small and taking time to develop a feeling for how the world of crypto trading and digital currency works. For example, there are many different cryptocurrencies and blockchain technologies to consider. 

Additionally, there are other ways to get in on cryptocurrency. Examples include crypto funds and futures, which allow you to essentially bet on the price swings of coins and altcoins like Bitcoin and Ethereum. Blockchain exchange-traded funds (ETFs) are another investing option. They let you invest in a bundle of companies that use blockchain technology in their business operations.

Join a community of cryptocurrency enthusiasts online.

Blockchain and cryptocurrency are fast-moving, ever-evolving arenas. Things change very quickly. By joining a community of people who are enthusiastic about this digital landscape, you can better navigate the changes. You'll be able to stay abreast of emerging trends and learn more about what's going on to develop a stronger understanding.

Understand the risk in crypto investment.

Risk is a natural part of investing.  Because of the volatility of cryptocurrencies, it comes with a substantial amount of risk that you must be aware of and understand to best manage. For example, if you’re looking to invest in the short term, you might create a set of rules to sell when the price drops by a certain percentage. As a long-term investor, you might decide that you won’t sell despite price drops. 

Another way to manage your risk, particularly when you’re new to crypto investments, is to set aside a portion of investable funds. For example, if you have $100 to invest, start investing a small percentage of that money in crypto. Doing so gives you time to get a feel for how the market works while actively participating. It also gives you a bankroll on reserve to work with on future trades. 

Understand timing.

Taking time to watch the performance of the cryptocurrency you're considering before investing can help increase your chances of success. Doing your homework now can help minimize risk. On the other hand, jumping in too quickly because you’re afraid you’ll miss out can lead to significant losses. Regardless of the strategy, it is wise to consider investing only what you are willing to lose. 

Understanding crypto price movements

Supply and demand determine a cryptocurrency's value, but various elements factor into pricing. Additional factors contributing to that value include regulations, competition, availability, and tokenomics, which refers to the supply and demand of crypto. Other details that can impact price movements include: 

•Node count tells you about the strength of the community and the network.

•Hype, particularly on social media, can spread news that raises or lowers prices.

•Production costs associated with mining and verifying increase crypto’s value. 

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11 cryptocurrencies to keep on your watchlist 

There are thousands of different cryptocurrencies out there. Bitcoin’s success led to a flood of new coins—called altcoins—and tokens emerging. Due to the volatile nature of cryptocurrency, it's best to seek professional investment advice and become very familiar with the crypto industry before deciding to invest. The following are examples of cryptocurrencies with a higher market cap and therefore tend to be more stable. Market capitalization figures are current as of December 1, 2022 [3]:

1. Bitcoin

Market cap: $329.3 billion

Considered by many as the gold standard of cryptocurrency, Bitcoin runs on a blockchain and requires solving cryptographic puzzles, which keeps it a secure coin.

2. Ethereum

Market cap: $157.5 billion 

This coin, considered an altcoin by some, is another popular option. Its developers aim to create a globally accessible, decentralized roster of financial products and applications that run without fraud or third-party interference. 

3. Tether

Market cap: $65.3 billion

Tether was the first stablecoin, a type of crypto tied to the value of the United States dollar. That backing can help level some of the dramatic fluctuations and make it easier to convert your holdings into dollars. 

4. USD Coin 

Market cap: $43.2 billion

The Ethereum blockchain powers this cryptocurrency. It's a stablecoin that, like Tether, is backed by the US dollar. 

5. Binance Coin

Market cap: $22.2 billion 

Binance is a crypto exchange. You can use Binance Coin for trading on the exchange or paying fees. You can also use it for booking travel or exchange it for other types of crypto, including Bitcoin.

6. XRP

Market cap: $20.2 billion

XRP is the native coin of the Ripple exchange and payment settlement platform. You can use XRP to trade, invest, make purchases via Ripple, or exchange for other cryptocurrencies. 

7. Cardano

Market cap: $10.9 billion

You can use Cardano (ADA) to get rewards for holding it (called staking), making transactions on the Cardano exchange, or investing. When you hold ADA, you hold a stake in the Cardano blockchain network.

8. Solana

Market cap: $5.0 billion

This relatively new crypto emerged in 2021. It has a unique blockchain and was developed to support decentralized applications and finance.

9. Dogecoin

Market cap: $13.8 billion

This meme coin may have started as a joke, but it hit the radar of investors in a big way when its price rose dramatically in 2021. It's an open-source cryptocurrency that uses a script algorithm, has an unlimited supply, and has a loyal following. Major companies, including SpaceX, accept Dogecoin. 

10. Polkadot

Market cap: $6.1 billion

Polkadot (DOT) launched in 2017 on the Polkadot blockchain, which allows for cross-blockchain transactions (interoperability). You can use DOT for staking, connecting to a new blockchain (parachain), or for governance of the Polkadot network. 

11. Avalanche

Market cap: $4.0 billion

US News & World Report anticipates this as one of the best long-term crypto investments. It debuted at $4.99 in 2020 and was trading at $13.09 as of December 1, 2022. 

What you need to invest in crypto

For hobby investors and crypto traders, the requirements are minimal. You'll need documents to verify your identity, information about how you're funding your investments, and an internet connection. It's also helpful to understand how capital gains tax will impact your earnings and some strategies for making your investments.

If you’re approaching crypto investments as a career move, you’ll need qualifications that mirror what employers often look for. You may benefit from a bachelor's or master's degree in computer science, data, or business. You'll also likely need some experience working in your chosen field.

Learn more about cryptocurrency

You can take several routes to learn about cryptocurrency trading and investing. For anyone who prefers independent learning, many websites and blogs offer advice. Consider talking to someone with experience. 

For a more formal, guided experience, consider taking a course. Get a solid foundation in FinTech, crypto, and Blockchain in Blockchain and Cryptocurrency Explained from the University of Michigan on Coursera. If you already have some knowledge, you could take it to the next level with an intermediate Specialization like Decentralized Finance (DeFi): The Future of Finance from Duke, also on Coursera.

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Article sources

1

The Ascent. “Study: Over 46 Million Americans Likely to Buy Crypto in the Next Year, https://www.fool.com/the-ascent/research/study-americans-cryptocurrency/.” Accessed December 1, 2022. 

Written by Coursera • Updated on

This content has been made available for informational purposes only. Learners are advised to conduct additional research to ensure that courses and other credentials pursued meet their personal, professional, and financial goals.

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