Confused by ‘crypto’?
You’re not alone.
In this article you’ll learn exactly what cryptocurrencies are, how they’re linked to blockchain technology, the different types of cryptocurrency, as well as how to buy and sell cryptocurrencies.
By the end of it, you’ll understand everything you need to know to get started with cryptocurrencies.
What is cryptocurrency?
At its most basic, a cryptocurrency is a virtual currency which can be traded, spent at any retailers that will accept it or just held as a long-term investment.
The ‘crypto’ in ‘cryptocurrency’ comes from ‘cryptography’ – the science of secret codes.
Why are codes relevant to electronic money?
Cryptocurrencies are made secure using a secret code to encrypt information which can only be decoded by someone with the correct ‘key’. If the owner of the cryptocurrency takes the right precautions, then no-one should be able to ever steal their funds.
If you own a Bitcoin, what do you actually ‘have’?
If you open your wallet, you may have some bank notes in there – brightly coloured bits of paper with pictures of Nelson Mandela and some of our beautiful animals. You know that you can give these pieces of paper to people at a shop in return for goods, and that shopkeeper can then use those same banknotes to pay their staff, their suppliers or take a salary. The system works because everyone has agreed that these pieces of paper have a value assigned to them, whether that’s ZAR100, ZAR50 or ZAR10.
You likely also have a credit or debit card. These pieces of plastic can’t be directly exchanged for goods in the same way as paper money or coins, but they can be used to exchange money from your bank or credit provider. They send money to the recipients’ bank account once you have authorized the transaction and then keep an updated record of how much you have or how much you owe.
With cryptocurrencies, there is no ‘bank’ that holds your bitcoin. In fact, each individual acts as their own bank, with a personal address that is used to store their holdings. In essence a digital bank vault.
When you buy a bitcoin, the information related to that holding is transferred to your personal digital bank vault and held there securely protected by a secret code until you decide to release it by spending it or selling it.
How do cryptocurrencies work?
Before we can understand how cryptocurrencies work, we need to take a step back and look at what underpins each of them: ‘blockchain’.
Blockchain is something you’ve probably heard of but many explanations are filled with jargon which can leave you more confused than when you started.
The key thing you need to know about blockchain is that it is a basically an unhackable way of recording information.
What makes the blockchain different to a traditional way of storing data is that identical copies of the information is held on hundreds, or thousands or millions of different computers – this is known as being ‘‘distributed’ or decentralised’.
The advantage to this is that no one company or person controls it, which means that it isn’t subject to manipulation by a Government or any other type of organisation.
Record keeping systems built on blockchain need a way to represent information and to allow people to transfer that information with ease: the blockchain achieves this by making use of cryptocurrencies – the most famous cryptocurrency is bitcoin.
Each blockchain only has one cryptocurrency, but it’s important to know that cryptocurrency doesn’t necessarily have to relate to money – it can represent anything.
Of course, it can represent money that belongs to you, or it could be used to record your vote in an election, a title deed for a property that you own, or any other ownership of value that can be represented digitally.
Ownership of the information is crucial because if no ownership was given to the information on the blockchain, anyone could claim ownership of the information and therefore the underlying value e.g. they could steal your identity, your house, or your money.
How is ownership of cryptocurrency proven?
Blockchain makes use of secret codes to prove ownership. Again, this is the ‘crypto’ in ‘cryptocurrency’.
These codes are assigned to you when you join the blockchain by either opening a wallet to store your cryptocurrency or joining an exchange where you can trade e.g. Binance.
These secret codes are needed to transact on the blockchain and can be thought of as a personal identification number with a twist. The twist is that only you and the blockchain know your personal codes.
All information and value on the blockchain that belongs to you is linked to your codes.
Equally, if information that is public on the blockchain does not belong to you, you won’t have the correct code to decipher it and you therefore won’t be able to understand it.
The system works because the blockchain translates the information into a language that only it understands with uncrackable encryption. In fact, it’s estimated that it would take 0.65 billion billion years to crack a bitcoin wallet code.
This makes the blockchain very secure and assures you that your information is safe.
Transferring ownership of cryptocurrency
The most common usage of cryptocurrency currently is to invest and trade.
If you are buying bitcoin on an exchange, you are buying it from another person for an agreed price, so to buy and sell cryptocurrencies we need a way to transfer ownership from one party to another.
When you do so, you are essentially just moving information relating to that cryptocurrency holding (e.g. 1 bitcoin) from someone else’s address (their personal bank vault) to yours.
If you are selling cryptocurrency, you are therefore moving the information relating to that holding from your personal address to someone else’s.
To transfer this information, you first need to prove that the information belongs to you by showing the blockchain network that you have the correct codes linked to the information.
When transferring the information to someone who is buying from you, the codes that belong to the recipient are linked to the information and your codes are disconnected from the information, thus transferring ownership of the information.
How cryptocurrencies are produced
There are two ways that cryptocurrency can be produced, with one much more common than the other.
The first, and most common, way that cryptocurrency is produced is called ‘mining’.
Mining is the most complicated part of blockchain technology, and we won’t go into too much detail about how it works in this article, but we’ll include two explanations (of varying complexity) below:
Super-simple explanation of cryptocurrency mining:
In essence, mining involves a computer solving a complicated maths problem. If it solves it, it is rewarded with one unit of the cryptocurrency.
What complicates things is that there is only one problem that can be worked on at a time across a whole blockchain, so everyone is trying to solve the same problem at the same time. Whoever solves it first is rewarded with the new unit of cryptocurrency, while everyone else receives nothing and the process starts again with a new problem.
The other complication is that the maths problems that are being solved get increasingly more difficult as time goes on, which means that more powerful computers are required to solve them.
Slightly more technical explanation of cryptocurrency mining:
All blockchains make use of mining to process and verify its information.
Mining involves computers on a blockchain competing with each other to solve a computational puzzle. The computational puzzle involves the computers on the chain asking themselves, “How can I take the information that is already stored on the blockchain and combine it with information that still needs to be processed and added to the blockchain?”.
The computers take part in this game by taking groups of unprocessed transactions and generating a hash (digital fingerprint) of all the information about them such as who took part in the transaction, how much was transacted, etc. This hash represents a new block of information processed.
The computers then check if they have the right answer by submitting their hash to the blockchain. The blockchain then decides whose hash is correct and whose new block gets added to the chain. If a computer’s newly processed block of transactions get added to the blockchain, then the person whose computer solved the puzzle receives a reward paid in cryptocurrency.
Minting in the cryptocurrency world is the same as minting in the real world – it’s when the total supply of coins or cryptocurrency is increased or decreased.
In the physical world, the decision to increase the supply of a traditional currency is left to the governments and central banks of the countries that own them. Governments usually do so to encourage spending and economic activity or to pay off debt.
Most cryptocurrencies have a fixed supply. Meaning that if the last coin of that cryptocurrency is introduced to the market then no more can be created or mined. Popular cryptocurrencies like Bitcoin and Litecoin have a fixed supply. Bitcoin has a fixed supply of 21 million and Litecoin has a fixed supply of 84 million.
However, there are some blockchains that have the ability for new coins to be minted. The most popular blockchain with a mint capability is Ripple (XRP). In cases like this, it’s only people authorised to do so who can increase the supply of a cryptocurrency – this is normally members of the development team.
Do cryptocurrencies really have value?
A common criticism of cryptocurrency is that they have no ‘intrinsic’ or underlying value.
To understand whether this is a fair criticism, it’s important to understand what ‘value’ really means.
Value is basically something that people agree to attribute to an object. A note is worth ZAR10 because we collectively agree it is and that it can be exchanged for a bottle of water or a loaf of bread.
While once currencies were back by physical gold, this is no longer the case for most countries. You can’t go to a Government vault anywhere and exchange your ZAR10 note for ZAR10 worth of actual gold – it isn’t sitting there waiting for you. Money that isn’t backed by a physical asset like gold is known as ‘fiat money’ – money that is given value by Government decree and the agreement of the South African people.
Economies are built on the collective understanding of the value of money and its ‘utility’ in being able to be traded for goods and services.
In this way, cryptocurrencies are just as good a store of value as traditional ‘fiat’ currencies as the market has collectively agreed that they are worth something.
Gold is often used as a comparison to Bitcoin as the ultimate ‘store of value’. The properties that make gold effective as a store of value are:
- It’s scarce – while there isn’t an upper limit on the amount of gold in the world, the most obvious reserves have been exhausted, so it’s slow
- It’s durable, and can’t be destroyed
- It’s ‘fungible’, which means that one item can be replaced with another identical item with no loss in value
- It’s divisible – it can be melted down and formed into coins or ingots
- It’s portable
How does a cryptocurrency like bitcoin compare?
Bitcoin ticks all of these boxes, with some requirements being much more effectively fulfilled by bitcoin than gold. For this reason, even traditional proponents of gold as an investment asset are starting to invest in Bitcoin to ensure that they don’t miss out if it starts to become seen as a safer store of value.
Types of cryptocurrency
Most cryptocurrencies that are transacted on a blockchain are referred to as coins. They represent your ownership of value on a blockchain. The most popular coins are Bitcoin, Bitcoin Cash, and Litecoin.
Altcoins, or alternative coins, refer to any cryptocurrency coins that are not Bitcoin and that do not have the large market capitalisation that Bitcoin does. Some examples of altcoins are Litecoin, Peercoin, and Dogecoin.
Tokens are given out during an Initial Coin Offering (ICO) to raise funds for the project that they are linked to. An ICO is much like a stock offering, or an Initial Public Offering (IPO).
Tokens are a type of cryptocurrency that represent an asset or specific use such as security tokens for your account, or as utility tokens for a specific use. These tokens reside on their blockchains. Some examples are Bancor, OmiseGo, and Status.
Stablecoins are a class of cryptocurrency that aim to provide price stability. It achieves this by being backed by a reserve asset. This reserve asset could be the U.S. Dollar or the price of gold. Examples of stable coins are Tether, Bitcoin, and USD Coin.
Difference between token and coin
Tokens and coins differ in that coins have their own blockchain and tokens are built on top of an existing blockchain. The best example of this is the Ethereum blockchain. Ethereum has its own cryptocurrency coin, called Ether, which can be invested in and traded.
However, Ethereum also allows anyone to build decentralised apps with their own tokens using the Ethereum blockchain.
Another difference is that coins can only be used for one thing – payments. Tokens on the other hand can have multiple purposes including, but not limited to, payments.
Risks of cryptocurrency
As with anything financial, there are risks when it comes to cryptocurrency, and due to the significant amounts of money that can be involved, and the relative inexperience of some market participants, there can be some bad actors looking to take advantage of others.
Cyber and fraud risk
As cryptocurrency is essentially a money system, it has attracted scammers and fraudsters that have the ability to hack exchanges, drain cryptocurrency wallets of funds, and corrupt people’s computers with malware that steals cryptocurrency.
These scammers and fraudsters make use of various techniques to achieve this which include impersonating a representative of the cryptocurrency through email or messages, or performing calculated electronic attacks on exchanges and wallet service providers.
Individuals bear much more of the responsibility for the safety and security of their cryptocurrency investments than most other forms of investments.
It is very hard to recover cryptocurrency funds once they are lost since you cannot rely on a bank to recover the funds for you.
Simple user mistakes can be devastating and result in a permanent loss of funds. These mistakes can be sending a cryptocurrency like Bitcoin to a non-Bitcoin address, or forgetting your password to your wallet and not being able to reset it. It is vital that anyone in the cryptocurrency world practices caution when transacting in the cryptocurrency world.
Regulatory and compliance risk
Global regulation is still catching up with cryptocurrency. A risk that may affect cryptocurrency users is their local government deciding that cryptocurrency is illegal and banning the use of it by them. This is a scary, yet real, possibility. Governments may resort to banning cryptocurrency altogether if they are unable to design their own regulatory protocols around it.
The price of most cryptocurrencies relies on the demand for the cryptocurrency. A potential risk is that everyone loses interest in a cryptocurrency. This will have the negative effect of decreasing the value of the cryptocurrency significantly.
Benefits of cryptocurrency
Cryptocurrency users have more autonomy of their funds in the cryptocurrency world than they do in the real world. Users can spend their cryptocurrency freely without having to rely on a bank or financial institution to facilitate the transactions.
This opens the door for possibilities for your finances such as where you want to invest them, or being able to store your funds offshore.
Cryptocurrency users have complete discretion when it comes to transacting on the blockchain. Unless they openly share their transactions, nobody will be able to trace transactions on the blockchain back to them. This allows you to transact freely on the blockchain with the peace of mind knowing that nobody can track your spending and income.
Distribution of control to actual owners
The unique quality of cryptocurrency is that it is not issued, owned, controlled, monitored, or regulated by any central government or financial institution.
On top of this, the value of the cryptocurrency is not determined by governments and central banks – it’s a direct result of the market demand for it and its available supply.
As mentioned earlier, cryptocurrencies are built on top of blockchain technology which means that every transaction that takes place is made available to the public (even though it’s gibberish without the secret codes).
There is also no 3rd party that you need to rely on to keep the blockchain running. This closes the door of opportunity for any large institution to falsify records on the blockchain, which is sometimes the case for fiat currency.
Although the information on the blockchain is available for everyone to see, it would look like gibberish if the person does not have the codes linked to the information.
This means all of the information on the blockchain that belongs to you cannot be used by anyone else who does not have your codes. This gives you an extra layer of security and privacy when transacting on the blockchain.
Every transaction that took place, is taking place, or will take place on the blockchain is recorded in the blockchain’s memory. This can allow a user to track their information as it moves from user to user on the chain. An example where this could be useful is when taxpayers pay their tax and can keep track of how governments spend the money.
Cryptocurrency is available to anyone with a smartphone or a computer. This may not be everybody, but it is a lot more people than the current banking system since significant proportions of the world don’t have access to the traditional banking system, credit cards, or other forms of payments.
Easy international payments (reduced fees)
Depending on the cryptocurrency, international payments can be completed anywhere from about a few seconds to a few minutes – significantly faster than traditional banking transfers that usually take a few days. On top of that, blockchain does not charge exorbitant fees for international payments like a bank or financial institution usually would. This is great for anyone who has family members living abroad – funds can easily be sent from one country to the family member’s location.
How to buy cryptocurrency
Step 1: Research which coin you want to buy
Before you begin purchasing cryptocurrency it is important that you do your research regarding which coins that you want to buy. This research should involve getting to know the team behind the project, how long the coin has been around for, etc. This research will help you in your investing choices as you might find a coin that is very undervalued. It will also help you identify potential scams.
Step 2: Select a broker
The next step is to find a broker that offers the coins that you want to buy. There is the possibility that you won’t find all of the coins that you’re looking for on one broker.
Another thing to consider is that it is best to use a broker that is local to your country, this will reduce fees a bit. Beginners in South Africa might want to look at the more popular and well established coins such as Bitcoin, Litecoin, Ethereum, and Bitcoin Cash. These coins have direct support for Rand, meaning that you can easily exchange Rand for these coins and vice versa. If you are interested in purchasing other coins then you may need to exchange one cryptocurrency for the desired cryptocurrency. This is a bit more complex. Normally you can use Bitcoin to exchange for any other cryptocurrency.
Step3: Buy your coin
The next step after deciding the coins that you want to buy and the broker that you will use is to finally buy the cryptocurrency. There are multiple ways to do this with a broker. The most important thing is that you deposit Rand into your broker’s account first. You won’t be able to buy cryptocurrency if your Rand account has no funds.
Once the Rand has been deposited onto your broker’s platform you have 2 options to buy cryptocurrency. The first is the quick buy/sell functionality that broker’s offer. The second option is purchasing cryptocurrency by placing a buy order on the exchange platform. The latter is for more advanced users. It is recommended that beginners make use of the quick buy/sell functionality.
Step 4: Store it securely
The last and final step is to store your cryptocurrency securely. This can be in a wallet of your choice. If the funds aren’t secured then you risk losing the funds forever.
How to sell cryptocurrency
Step 1: Send cryptocurrency to broker
Before you sell your cryptocurrency, you need to send it to the broker of your choice. This broker can be the one that you purchased the cryptocurrency through or another broker of your choice. If you kept the coins that you bought on the broker platform and did not send it to another wallet then you can skip this step.
Step 2: Sell cryptocurrency
Once your cryptocurrency that you want to sell is on the broker platform you can then either sell the cryptocurrency through the platform’s quick buy/sell capability or through the exchange platform. Once again, the latter is only recommended for more experienced users.
Step 3: Withdraw the funds
The last step is to withdraw the funds from the exchange to your bank account. You will need to fill in and confirm your banking details with the exchange if you haven’t already. It will take between 2-3 business days before the funds reflect in your bank account.
Future of cryptocurrency
It’s evident from the number of adopters growing and institutions joining the cryptocurrency world that crypto is here to stay.
Exactly what that future looks like, however, is still in question.
A change that we will see more of is that governments are being pressured by the rapid increase in adoption to design regulation around cryptocurrency – you can learn more about the South African Government’s current policies here. When governments do increase regulation, it may have a negative impact on cryptocurrencies globally as it impacts some of the factors that make cryptocurrency so flexible and private.
Some also believe that eventually a large majority of cryptocurrency and blockchain projects will discontinue. This is mainly due to the fact that the projects offer little significant value to the public and there is only space for cryptocurrencies that are delivering value. Investing in major coins like Bitcoin and Ethereum should be a good way to avoid this.
However, as we’ve seen, cryptocurrencies are increasingly being seen as having the potential to replace gold as a global storage of value, with some calling it gold 2.0. We like this quote from entrepreneur and Bitcoin proponent Naval Ravikant:
“One way to think about Bitcoin, or any of the cryptocurrencies’, is like a Swiss bank account, but a Swiss bank account with finite space.. and if you want shelf space in that Swiss bank account with finite space you have to buy out one of the existing holders in that space.
So imagine a Swiss bank account that’s impregnable, no Government can break into it, it’s secured by a consensus across millions of people using massive computation power around the globe.. And if you want one of those safety deposit boxes, you need to buy it from someone who is already there. So as long as the demand for new people trying to get into the Swiss banks account is greater than the number of people who are trying to get out of the Swiss bank account, you’ll need to pay more for that box.
That’s where the speculative power of it comes from’.