DeutschCryptocurrencies are digital currencies that operate independently of banks and governments. They are based on cryptographic methods and a decentralized technology called blockchain.
In this article, you will learn in a simple and understandable way what cryptocurrencies are, how they work, and what they are used for.
Cryptocurrency: Definition & Explanation for Beginners
A cryptocurrency combines the characteristics of a currency with those of cryptography. Unlike our cash, they only exist digitally. You can transfer and pay with cryptocurrencies. If the merchant accepts cryptocurrencies, you can use them like real currencies. You can store them in a so-called wallet. This is your digital wallet, the access data of which you should never share with others.
The first cryptocurrency was Bitcoin. It was released on January 3, 2009 by Satoshi Nakamoto. To this day, it is not known who is behind the pseudonym of the Bitcoin inventor. Today, there are millions of cryptocurrencies. Accordingly, the functionalities of cryptocurrencies also differ in detail. Nevertheless, many cryptocurrencies are similar. This is due to the underlying Distributed Ledger Technology (DLT).
How do cryptocurrencies work?
In this section, we explain step-by-step what decentralization in cryptocurrencies is all about, what makes blockchain technology unique, and why consensus plays such a major role in cryptocurrencies.
Decentralization in cryptocurrencies: Why no bank is needed
Cryptocurrencies are decentralized. Because, unlike the Swiss franc or US dollar, cryptocurrencies are fundamentally not under the control of a state authority. With the fiat currencies mentioned above, there is a central bank behind them whose goal is to maintain the value of the currency. Its goal is to avoid excessive inflation. Because inflation causes our money to lose more and more value.
New coins (called coins or tokens) are generated by participants (or validators) through mining or staking. In German-speaking countries, cryptocurrencies are often alternatively referred to as crypto money.
The cryptographic key, which is also stored decentrally, is the owner’s proof of ownership of a certain amount or number of coins. Strictly speaking, you do not own a cryptocurrency, but instead a data record as proof of your ownership rights to a certain amount of a digital currency.
The technical foundation of a cryptocurrency: The blockchain
The blockchain ensures the decentralized character of a cryptocurrency. The blockchain is a chained list and functions as a database. All transactions ever made in a crypto protocol are stored forever in the blockchain. So you can still view every Bitcoin transaction today. The special thing about it: the blockchain is public and therefore visible to everyone.
Unlike a central server, the blockchain is maintained by thousands of computers worldwide that are linked together. A copy of the blockchain is stored by nodes. These are distributed nodes through which the network is ultimately decentralized.
Consensus mechanisms of cryptocurrencies: Proof of Work and Proof of Stake
How a cryptocurrency transaction is validated depends on the consensus algorithm of a cryptocurrency. Here we distinguish between Proof-of-Work and Proof-of-Stake. The first cryptocurrencies were based on a proof-of-work consensus algorithm. In a very energy-intensive process called mining, highly complex tasks are solved by so-called miners. Miners in this case are special hardware (initially this was also possible via your own computer). As a reward for solving a task, the miners receive mining rewards in the form of the mined cryptocurrency.
With Proof-of-Stake, transactions are validated by proof of stake. In this case, the so-called stakeholders receive passive crypto income by locking their coins and making them available to the network.
Why do cryptocurrencies exist?
The original idea behind cryptocurrencies is that they should be a real and practical alternative to the classic banking system in the area of payment transactions, which – from the point of view of the supporters of cryptocoins – is susceptible to influence and threatened by crises. For a long time, however, it was lacking in a broad-based implementation, but more and more local shops and online shops are now accepting cryptocurrencies as a means of payment. In El Salvador, Bitcoin has even been legal tender alongside the US dollar since September 7, 2021.
What Cryptocurrencies are there?
The selection of digital currencies has increased dramatically in recent years. Many of these cryptos have always been worthless or have failed after a few weeks and months. Not a few of the published cryptocurrencies also offer no added value or have been published as a pure fraud (scam). The most important cryptocurrencies include the following cryptos:
The number of cryptocurrencies will continue to increase rapidly in the coming years. How many of these cryptos will offer added value, on the other hand, is written in the stars.
What are cryptocurrencies used for?
Nowadays, cryptocurrencies have various functions, which primarily depend on the type of cryptocurrency.
Cryptocurrencies as a Means of Payment
The first obvious function of cryptocurrencies is payment. Today, you can use cryptocurrencies as a means of payment in numerous online shops, as well as at brick-and-mortar retailers.
Applications & protocols (dApps)
While Bitcoin still pursued the goal of establishing itself as an alternative means of payment, cryptocurrencies are only a means to an end for many new crypto protocols. Instead, many coins are now needed to use a decentralized crypto protocol – so-called dApps. These are a wide variety of applications such as streaming services, social networks or credit platforms. All have in common that the project is based decentrally on a blockchain. The cryptocurrency in such a crypto protocol is then the means of payment within this crypto protocol.
Crypto as an investment & for speculation
Cryptocurrencies therefore serve on the one hand as a means of payment like fiat money, but also as a means of payment within decentralized crypto applications in order to be able to use corresponding services. In recent years, cryptocurrencies have also risen to become an asset class. Nevertheless, many investors see cryptocurrencies only as speculation objects.
The situation is different with the cryptocurrency Bitcoin. Here, companies and celebrities swear that Bitcoin as a store of value has the potential to be an alternative to gold. Whether Bitcoin can take on the role of inflation protection in the long term remains to be seen.
Sending Cryptocurrencies for Beginners
You can pay with cryptocurrencies. To do this, you need to send your coins. First of all, you need a crypto wallet for this. A crypto wallet contains a public key. This is your wallet address and something like your bank details. Anyone can view your wallet address and also see what balance you have. However, it is not easy to see who owns this wallet address.
In addition to this, there is a private key – the Private Key (for the article about the Private and Public Key). You must never pass this on to another person. It is best not to store it digitally either. There are wallets where you cannot view the private key. Then the coins are owned by the wallet provider. We generally advise against such providers.
To send coins, you need the recipient’s public wallet address. Depending on the provider, the layout may differ, but the process is always the same. You click on the “Send” button, enter the public wallet address and the amount you want to send and select a fee that you are willing to pay. For most cryptocurrencies, the higher the fees, the faster your transaction will be processed. If you choose a network fee that is too low, your transaction may not be executed or may be executed very late. As a rule, you can find out about the currently regular fees depending on the cryptocurrency.
Buying and Selling Cryptocurrencies: Trading Cryptos
If you want to own cryptocurrencies yourself, you can buy them on regulated trading venues or even produce them yourself depending on the cryptocurrency. We call the process of manufacturing mining – inspired by gold mining. However, nowadays it is no longer profitable to mine them yourself for most cryptocurrencies. Most new cryptocurrencies are also setting staking anyway.
There are many different ways to buy cryptocurrencies. Cryptocurrencies are most often traded on crypto exchanges. On a crypto exchange, buyers and sellers of a cryptocurrency come together and make a price among themselves. They do not come into direct contact with each other, but create purchase or sale orders. The most well-known crypto exchanges worldwide are Binance and Coinbase. In Europe, trading venues such as Bitpanda or Bitvavo are particularly popular. In our comparison of the best crypto exchanges you will find our recommendations for buying cryptocurrencies.
Another way to participate in the performance of cryptocurrencies is via crypto CFDs. With crypto CFDs, you do not buy the cryptocurrency, but only speculate on a falling or rising price of the coin. A higher risk arises above all from the leverage effect of CFDs. You also cannot use the coins technically. For beginners, however, there is the advantage of not having to worry about the complicated storage of cryptocurrencies.
Conclusion on Cryptocurrencies
Cryptocurrencies were created as an alternative to central bank currencies. Today, however, cryptos are much more than that, as protocols like Ethereum and Co. prove. The most important cryptocurrencies temporarily had a market capitalization of more than three trillion US dollars, but price crashes of over 90 percent are not uncommon.
It remains exciting to see how the crypto sector develops in the future. However, it has been shown in recent years that it is not so difficult for laypersons to understand cryptocurrencies. Once you start to deal with the matter, it is very easy to buy, send and store cryptocurrencies.
The Best Crypto Exchanges!
The best crypto exchanges compared:
- Safety
- User-friendliness
- Fees
- Deposit and withdrawal methods
- Trading offer
- Are Cryptocurrencies the Future?
Making a prediction about the future of cryptocurrencies is very difficult. The fact is that blockchain technology, on which most cryptocurrencies are based, is continuing to find its way into the real economy.
In addition, we can assume that cryptocurrencies are here to stay as an asset class. In contrast to stocks, bonds, or precious metals, they offer enormous growth potential. However, this comes with a high risk. Anyone who invests in cryptocurrencies should not risk needed savings to speculate on high profits.
- What Taxes Apply to Cryptocurrencies?
The taxation of cryptocurrencies is regulated differently from country to country. We have summarized the taxation of cryptocurrencies in the DACH region for you in individual articles:
