What is cryptocurrency and how does it work? What you need to know
March 04, 2021 4 min read
An introduction to cryptocurrency. Learn what it is, how it works, and how it could affect the future.
You’ve probably heard of Bitcoin. But what about Ethereum? Or Tether and Polkadot? What are these? They’re all examples of cryptocurrency, digital currency that you can buy with real money and then spend in online transactions.*
It’s true that you probably can’t buy a meal at your favorite restaurant with Bitcoin or rely on Ethereum to fill your car’s gas tank. But cryptocurrency — or digital money — is becoming more popular and valuable. Coindesk.com, which covers cryptocurrency, reported that as of January 2021, the total value of all cryptocurrency topped $1 trillion for the first time.
And new cryptocurrencies pop up frequently. Coinmarketcap.com listed more than 4,100 types of them in an early 2021 price index published on its site.
But what do these digital currencies mean to you? Do you need to learn how to purchase them and spend them? Probably not.
But while digital money isn’t a necessity, it does have its uses. Fans of cryptocurrency say that digital transactions closed with cryptocurrency are more secure than those using credit cards. If you’re interested in the most secure virtual transactions possible, then, you might consider purchasing Bitcoin, Ethereum, and the rest. Just don’t expect to be able to buy everything you want with cryptocurrency just yet.
How does cryptocurrency work?
Struggling to understand the basics of cryptocurrency? It might help to think of a casino.
When you’re at a casino, you can spend traditional money to purchase chips. You then use these chips to gamble. When you’re done, you take your remaining chips — if you’re fortunate! — to the cashier and cash them in for a more traditional form of currency.
Cryptocurrency operates in a similar way: You purchase it with a more traditional form of payment, usually a credit card, debit card, or online bank transfer. You can then use your digital money to purchase items online, usually in peer-to-peer transactions, as if you were using physical cash or your credit card.
To do this, you have to first purchase a cryptocurrency wallet. You’ll store the digital currency that you’ve bought in these wallets, which come either as physical devices that you plug into your device’s USB ports or software that you download to your laptop, smartphone, or other device. Popular crypto wallet providers include Trezor, Ledger, and Exodus.*
How does a crypto wallet work, and what’s a crypto exchange?
Once you have your crytpo wallet, you can deposit cryptocurrency in it and transfer this digital money from it when you want to make a purchase.
A wallet isn’t enough on its own, though. You also have to buy your digital money. To purchase cryptocurrency, you’ll have to visit an online cryptocurrency exchange. These exchanges offer a wide variety of cryptocurrency types, with their purchase prices varying by the day. Some of the better known exchanges include coinbase, etoro, Robinhood and BlockFi.*
What can you buy with Bitcoin, Ethereum, and other digital currencies? Fans of the currency usually use it to complete online transactions from individual sellers, usually through peer-to-peer transactions. You might use Ethereum to purchase software from a seller you’ve found on Craigslist. You might use Bitcoin to buy rare books from a seller you found on Reddit. Have your eye on a retro video game system from your childhood? The seller might accept cryptocurrency.
Most traditional online retailers, though, won’t accept cryptocurrency. This includes the biggest of them all, Amazon. The online giant doesn’t accept direct cryptocurrency payments. You can, though, use this currency to purchase products from at least one major online retailer, Overstock.com.
Why would you want to use cryptocurrency?
If cryptocurrency can’t be spent in most traditional stores and if you need to invest in digital wallets and find exchanges to even purchase it, why would you bother?
It might depend on how much you value privacy and security when closing online transactions.
Cryptocurrency transactions rely on something known as blockchain technology. This is a type of digital ledger book that manages and records cryptocurrency transactions. Fans of digital currency consider this type of tech to be more secure than using credit cards to make online transactions. Cryptocurrency transactions are encrypted, too, which boosts the security of transactions.
Others use cryptocurrency because the transactions are fast and come without fees. That makes buying online a bit less expensive. There’s also privacy. You can use Bitcoin, Ethereum, Tether, and the rest anonymously.*
What about digital currency as an investment?
Other supporters of cryptocurrency purchase Ethereum, Bitcoin, and other digital currencies as an investment. Their hope is that the digital currency will increase in value after they buy it. They can then sell their digital currency for a profit.
The challenge here? Cryptocurrency is notoriously volatile. Prices rise and fall quickly. You might purchase a large amount of digital currency only to watch as the price plummets the following week. If you hold onto it for another week, the price might soar again.
Because of this, investment experts warn that if you don’t have a high tolerance for risk, you should avoid investing in cryptocurrency.
How do I avoid crypto scams?
As cryptocurrency becomes more popular, so do the scams associated with them.
Some scammers set up fake cryptocurrency exchanges. You might send real money to buy Bitcoin that doesn't exist. Once you send your funds, they're gone and your crypto wallet remains empty.
To avoid this scam, only buy cryptocurrency from the better-known exchanges. Don't do business with exchanges that seemingly pop up out of nowhere.
Then there's a more old-fashioned scam: Con artists send emails that supposedly come from the IRS, your bank, or another service provider. These messages say that you owe money for back taxes or that you need to make a quick payment to keep your bank account or credit card open. The email instructs you to send Bitcoin or some other form of digital currency to pay what you owe.
This, of course, is a scam. Legitimate government authorities and representatives from credit card providers, banks, or other service providers won’t demand money from you through email. They instead send notices through the regular mail. And even if you do owe money, they will never ask for your payment in the form of cryptocurrency. They’ll want a check or credit card payment.
If someone does send an email asking you to send cryptocurrency to pay an old bill? Delete it. It's a sure scam. And never send your Bitcoin or other digital currency to these con artists. If you do, you almost certainly won’t get it back.
Digital currency isn’t a necessity.
Digital currency might be generating plenty of headlines. But that doesn’t mean you must use it. Most major retailers, both online and brick-and-mortar, don’t accept Tether, Bitcoin, or Ethereum. Paying with cash, credit cards, debit cards, or checks remains a far more common option.
But if you’re interested in cryptocurrency and you think it’s the money of the future? That’s fine, too. Just remember that you’ll still need old-fashioned dollars, cards and checks in the present.
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Dan Rafter is a freelance writer who covers tech, finance, and real estate. His work has appeared in the Washington Post, Chicago Tribune, and Fox Business.
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