.png)
What is Cryptocurrency and How does it Work?
- Cryptocurrencies are digital assets that are collectively issued and maintained, instead of relying on governments or banks.
- Bitcoin was the first crypto to be created, but now there are thousands of different crypto projects.
- Not all cryptocurrencies are meant to be “currency”, and many are designed to unlock new digital services or governance rights.
- Exchanges like Backpack provide secure, non-custodial crypto wallet solutions beyond their core trading features.
What Is Cryptocurrency?
Cryptocurrencies are a type of digital asset that relies on cryptography for security. Unlike traditional currencies issued by governments (like the dollar or euro), cryptocurrencies operate on a technology called blockchain, which is decentralized and distributed across many computers.
This decentralized nature means no single entity controls the entire network, making cryptocurrencies resistant to censorship and interference.
Bitcoin, launched in 2009 by an anonymous entity known as Satoshi Nakamoto, was the first cryptocurrency and remains the most well-known. Since then, thousands of alternative cryptocurrencies (often called “altcoins”) have been created, each with its unique features and uses.
Let’s take a closer look at how this exciting asset class works, and how you can explore the opportunities it offers.
How Does Cryptocurrency Work?
Traditional currencies are controlled by central banks and governments, which regulate their supply and distribution.
In contrast, cryptocurrencies do not rely on a centralized issuer or operator and have different ways to distribute control among their holders and ecosystem participants.
Decentralized Networks
Cryptocurrencies operate on decentralized networks based on blockchain technology. A blockchain is a public ledger that records all transactions across a network of computers, known as nodes.
These nodes are spread across the globe and eliminate the need for intermediaries like banks and payment processors, which are essential in traditional financial systems to facilitate transactions.
Nodes
Nodes are individual computers that participate in the blockchain network. Each node stores a copy of the entire blockchain and helps validate and relay transactions. When a new transaction occurs, it is broadcast to the network, and nodes work to verify its legitimacy.
This process ensures that everyone on the network has the same information, preventing double-spending and fraud.
Consensus Algorithms
To validate transactions and add them to the blockchain, nodes must agree on the state of the ledger. This agreement is achieved through consensus algorithms. The most common consensus mechanisms are Proof of Work (PoW) and Proof of Stake (PoS).
- Proof of Work: Used most famously by Bitcoin, PoW requires nodes (miners) to solve complex mathematical problems to validate transactions and add them to the blockchain. This process is resource-intensive and requires significant computational power.
- Proof of Stake: PoS is a more energy-efficient alternative where validators are chosen to add new blocks based on the number of coins they hold and are willing to "stake" as collateral. Ethereum, the second-largest cryptocurrency, has transitioned from PoW to PoS.
What Makes Cryptocurrency Unique?
Cryptocurrencies are fundamentally different from traditional currencies, offering unique features that set them apart from conventional financial systems. While different types of cryptocurrencies come with distinct benefits and characteristics, the most common features are outlined below.
- Decentralization: Cryptocurrencies are governed and exchanged via peer-to-peer transactions, eliminating the need for central banks and other intermediaries.
- Transparency: All crypto transactions on public networks are visible and verifiable by anyone.
- Immutability: Once a crypto transaction is confirmed, it cannot be altered or deleted. This immutability provides a tamper-proof record of transactions.
- Security: Cryptocurrencies use advanced cryptographic techniques to secure transactions and new token creation. This makes it extremely hard for unauthorized parties to hijack these processes.
Types of Cryptocurrencies
While "cryptocurrency" is often used as a catch-all term for all crypto tokens, it's important to understand the different types that exist. Beyond crypto intended primarily as digital “currency”, there are a variety of other common token types:
- Utility Tokens: These tokens are designed to be used within a blockchain ecosystem, not simply “spent”. Many utility tokens are used to cover their chain’s transaction fees, but also power other services or on-chain features.
- Examples include: ETH (Ethereum), SOL (Solana)
- Examples include: ETH (Ethereum), SOL (Solana)
- Governance Tokens: These tokens give holders the right to participate in the decision-making process of a blockchain project. Holders can vote on proposals that affect the project's future direction. Oftentimes, a project’s utility token will also double as a governance token, meaning that the token gives its holders voting rights, as well as the ability to use the token in other ways within that project’s ecosystem.
- Examples include: UNI (Uniswap), COMP (Compound)
- Examples include: UNI (Uniswap), COMP (Compound)
- Stablecoins: Designed to minimize price volatility, stablecoins are typically pegged to a stable asset like the US dollar. These assets are often used for portfolio balancing and risk management, in addition to straightforward asset transfers.
- Examples include Tether (USDT) and USD Coin (USDC).
The cryptocurrency market features a diverse array of projects varying widely in purpose and scale.
These range from major, widely-known assets like Bitcoin and Ethereum, which focus on decentralized finance and smart contracts, to niche projects targeting specific industries such as gaming and supply chain management. What type(s) of crypto you choose to engage with should therefore reflect your interests.
Cryptocurrency Tokens vs. Coins
Bitcoin, Ethereum, and Solana are examples of coins - digital assets that operate on their own independent blockchain.
Tokens on the other hand, are digital assets that operate on an existing blockchain network. Bonk is an example of a token built on the Solana network.
Why is this important? Well, there are quite literally thousands of different tokens that operate on much fewer blockchains. So when beginning to trade it’s important to think about the underlying infrastructure of your chosen assets.
Popular Cryptocurrency Coins
While Bitcoin (BTC) was the first cryptocurrency to be widely adopted, the blockchain ecosystem has since exploded into a constellation of thousands of different crypto projects. Here’s a quick primer on three of the most well-known coins that you will encounter on your crypto journey.
Created by the pseudonymous Satoshi Nakamoto in 2008 and launched in 2009, Bitcoin (BTC) is the most well-known cryptocurrency.
Bitcoin was created to provide a decentralized, peer-to-peer electronic cash system that allows for secure, transparent, and low-cost transactions without the need for intermediaries such as banks or financial institutions. Bitcoin became widely popular in 2013 as its value surged, paving the way for numerous other cryptocurrencies and blockchain technologies.
Ethereum (ETH) was launched by Vitalik Buterin in 2015. It is designed to enable the creation and deployment of decentralized applications (dApps) and smart contracts.
Unlike Bitcoin, which focuses on digital currency, Ethereum's purpose is to automate complex agreements and processes through self-executing smart contracts, increasing transparency and efficiency by removing intermediaries. Put simply, it was built to be the world's first decentralized computer.
The platform uses Ether (ETH) as its native cryptocurrency. With Ethereum 2.0, Ethereum has transitioned from Proof of Work (PoW) to Proof of Stake (PoS), allowing validators to secure the network by staking ETH.
Solana is a blockchain platform launched by Anatoly Yakovenko in 2020, designed for scalable and decentralized applications. Its primary goal is to provide fast, secure, and low-cost transactions, addressing the scalability issues faced by other blockchains like Ethereum.
Solana achieves this through a combination of Proof of History (PoH) and Proof of Stake (PoS) consensus mechanisms, enabling it to process thousands of transactions per second.
The native cryptocurrency, SOL, is used for transaction fees and staking. Solana supports a wide range of decentralized applications (dApps) and aims to provide an efficient and scalable solution for developers and users in the blockchain ecosystem.
How Big is the Cryptocurrency Market?
Since the start of 2024, the total market capitalization of the entire cryptocurrency market has fluctuated between $2-2.9 trillion USD in value.
Market capitalization, or market cap, is a metric used to determine the total value of a cryptocurrency. It is calculated by multiplying the current price of a coin by its total circulating supply. Market cap helps investors compare the relative size and value of different cryptocurrencies.
For example, if Bitcoin is priced at $30,000 and has 18 million coins in circulation, its market cap would be $540 billion. A higher market cap generally indicates a more established and widely accepted cryptocurrency, while crypto with smaller market caps are often more volatile and risky, but may have more growth opportunities.
Cryptocurrencies are most often traded on CEXs, DEXs, and in the form of ETFs at traditional financial institutions.
While the total size of the crypto market has skyrocketed over the past decade (up roughly 21,500%), this market is still nascent compared to most traditional financial markets.
The global stock market is valued at roughly $100 trillion, and the bond market is even larger, estimated at over $120 trillion. Given that many government regulators and large institutions have only recently begun publicly endorsing cryptocurrencies, it appears there this market is only beginning to reach its full potential.
What Can You Do with Cryptocurrency?
What you can do with your cryptocurrency depends on which cryptocurrency you own. While every major cryptocurrency can be actively bought, sold, and traded in hopes of netting a profit, most cryptocurrencies are designed with specific uses in mind.
Common cryptocurrency use cases include:
Web3 Apps & Services:
- Decentralized Finance (DeFi): In addition to enabling peer-to-peer crypto trades, many DeFi apps let you stake, lend, or otherwise use your crypto to earn additional rewards. Examples include platforms like Aave and Compound, which often offer higher interest rates than traditional banks.
- Real-World Asset Tokenization: Some collateralized cryptocurrencies represent ownership of physical assets like real estate or commodities like precious metals. This process makes it easier for you to buy, sell, and trade these assets globally.
- Digital Art and Collectibles: NFTs (Non-Fungible Tokens) represent ownership of unique digital items, such as art, music, and virtual goods. If you are an artist or a digital creator, platforms like Magic Eden allow you to sell your work directly to buyers without intermediaries.
- Web3 Governance: Within web3, there are thousands of DAOs (decentralized autonomous organizations) based on specific community interests, from crowdsourced scientific research to game development. Each DAO is collectively governed by the holders of a specific cryptocurrency. The more crypto you hold, the more influence you wield in the DAO’s decision-making processes.
Online Transactions:
- Borderless Payments: You can send cryptocurrencies directly to anyone without third-party involvement. This can be useful for international remittances or payroll, via faster and cheaper on-chain transactions compared to traditional money transfer services.
- Purchasing Goods and Services: A growing number of traditional businesses now accept cryptocurrencies as a form of payment, including Microsoft, Overstock, and Shopify.
New cryptocurrency use cases are constantly arising as existing blockchain ecosystems evolve and new projects launch.
How to Safely Invest in Cryptocurrencies
Investing in cryptocurrencies can be highly rewarding but also comes with significant risks. Here are some tips to invest safely:
- Do Your Research (DYOR): Thoroughly research any cryptocurrency before investing. Understand its technology, use case, team, and market potential.
- Diversify: Diversification is key to any good investment strategy.
- Start Small: Begin with a small investment that you can afford to lose. As you become more comfortable with the market, you can gradually increase your investment.
- Use a Reputable Exchange: Choose well-established and reputable exchanges such as Backpack for buying and selling cryptocurrencies. Ensure that the exchange you use meets all your needs and has strong security measures in place.
- Secure Your Crypto: Once you have purchased cryptocurrency, you need to store it safely to protect it from hacks or theft. Hardware wallets are always recommended for longterm storage.
How to Store Your Cryptocurrency
Crypto wallets are a little bit different than traditional wallets. They don’t store cryptocurrency - rather they store our private keys aka our ability to access certain addresses on the blockchain.
This key allows you to send a transaction from yourself to another person on the blockchain without a trusted third party. Protecting this key is very important.
Crypto wallets can be physical devices or online software such as Backpack Wallet, that are used to store the private keys to your cryptocurrencies securely. Some exchanges provide wallet services making it easy for you to store directly through the platform.
There are two categories of wallets, and each has its benefits, technical requirements, and security measures. The wallet you choose should reflect your personal preferences and trading vs. holding habits.
- Hot Wallet: Crypto storage that uses online software to protect the private keys to your assets (often a browser extension or mobile app). These wallets are known for their ease of use but are more susceptible to cyberattacks since they are always internet-connected.
- Cold Wallet: These devices store crypto sans internet connection. These can be physical devices called “hardware wallets” that securely store private keys, or “paper wallets”, which are physical printouts/notes containing private keys. Hardware wallets are much more common than paper wallets these days. Cold wallets are more secure from online threats but can be less convenient to use.
If you’re serious about security you can also use a combination of wallets, called “multi-sig" (multisignature signing). This provides peace of mind for large sums of cryptocurrency.
Closing Thoughts
Cryptocurrency isn't just a new form of money—it represents a massive shift towards financial freedom and collective decision-making.
These unique digital assets have come a long way since the creation of Bitcoin in 2009, and their impact on the global financial system is only beginning to be felt. Now that we’ve covered the main fundamentals of cryptocurrency, you are in a better position to capitalize on the new and exciting opportunities this space has to offer.
Learn more about Backpack
Exchange | Wallet | Twitter | Discord
Disclaimer: This content is presented to you on an “as is” basis for general information and educational purposes only, without representation or warranty of any kind. It should not be construed as financial, legal, or other professional advice, nor is it intended to recommend the purchase of any specific product or service. You should seek your own advice from appropriate professional advisors. Where the article is contributed by a third party contributor, please note that those views expressed belong to the third party contributor, and do not necessarily reflect those of Backpack. Please read our full disclaimer for further details. Digital asset prices can be volatile. The value of your investment may go down or up and you may not get back the amount invested. You are solely responsible for your investment decisions and Backpack is not liable for any losses you may incur. This material should not be construed as financial, legal, or other professional advice.
