DeutschRegardless of whether the prices of cryptocurrencies rise or fall: digital currencies are on everyone’s lips. And although the first cryptocurrency has been around for over 14 years, many people still don’t know what a cryptocurrency is. Technically, they are quite complicated. The good thing is that even beginners can understand cryptocurrencies. In this article, we’ll give you an explanation of what a cryptocurrency is, what technical characteristics distinguish it, and how you can trade cryptos.
Cryptocurrency: Definition & Explanation for Beginners
A cryptocurrency combines the properties of a currency with those of cryptography. But it is much more than encrypting an existing currency like the US dollar, Swiss franc or the euro. First and foremost, cryptocurrencies are digital currencies. This means that, unlike our cash, they only exist digitally. You can transfer cryptocurrencies and pay with them. 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. There are now more than 22,000 cryptocurrencies. Accordingly, the functionalities of cryptocurrencies also differ in detail. Nevertheless, many cryptocurrencies are similar. This is due to the underlying distributed ledger technology.
Cryptocurrencies Operate in a Decentralized Manner
Cryptocurrencies are decentralized. Because, unlike the Swiss franc or US dollar, cryptocurrencies are fundamentally not under the control of a state authority. In the case of the fiat currencies just mentioned, there is a central bank behind them, which has the goal of maintaining the value of the currency. It aims to avoid excessive inflation. Because inflation causes our money to lose more and more value.
In contrast to the usual central bank money, for example the Swiss franc, cryptocurrencies are exclusively digital money. Since digital currencies are based on the encryption principle of cryptography, they are accordingly referred to as cryptocurrencies. We call the coins Coin or Token. The creation of coins is exclusively the responsibility of private individuals or smaller companies from the private sector. In German-speaking countries, cryptocurrencies are often alternatively referred to as Kryptogeld.
If there is no authority that controls cryptocurrencies, how can the system work? An important basis of all digital currencies is that the necessary data is kept decentralized. In combination with the encrypted protocols, this is the technical basis for the functioning of cryptocurrencies and at the same time a prerequisite for the fact that no central instances are required, as is the case with central bank money, for example. The cryptographical key, which is also stored decentrally, is proof for the owner of his ownership of a certain amount / number of cryptocoins. Strictly speaking, you do not own a cryptocurrency, but instead a record as proof of your ownership of a certain amount of a digital currency.
The Heart of a Cryptocurrency: the Blockchain
The blockchain ensures the decentralized character of a cryptocurrency. The blockchain is a linked list and functions as a database. All transactions that have ever been 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.
In contrast to a central server, the blockchain is maintained by thousands of computers worldwide that are linked to each other. A copy of the blockchain is stored by nodes. These are distributed nodes, which ultimately make the network more decentralized.
The Consensus of a Cryptocurrency
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.
Cryptocurrencies are Intended to Serve as an Alternative to Central Bank Money
The original idea behind cryptocurrencies is that they should provide a real and viable alternative to the – from the point of view of the supporters of Cryptocoins – influenceable and crisis-prone classic banking system in the area of payment transactions. So far, however, it has been lacking in a broad-based implementation, because only a few local shops and online shops accept cryptocurrencies as a means of payment to date. If at all, it is almost exclusively Bitcoins with which you can pay in some shops and on the Internet at retailers in 2017. 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, especially in the five to six 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 scheme (scam). As of February 2023, the most important cryptocurrencies include the following cryptos without stablecoins:
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.
Function of Cryptocurrencies
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.
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 keep this 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 primarily 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. Nowadays, however, cryptos are much more, as protocols like Ethereum and Co. prove. The most important cryptocurrencies temporarily had a market capitalization of more than one 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:
