What are Cryptocurrencies?

The Basics of Cryptocurrencies 

Cryptocurrencies are digital assets that have gained massive popularity over the past decade. Whether it's Bitcoin or tokens used in decentralised finance (DeFi), cryptocurrencies are transforming how we view money, ownership and investing. So, what exactly are cryptocurrencies, and why are they so important for investors? This guide breaks down the basics, how they work, and their relevance to retail investors. 

Cryptocurrencies are digital assets created, stored and traded on Distributed Ledger Technology (DLT) or a blockchain—a decentralised ledger that records transactions across a network of computers. This setup makes cryptocurrencies secure, transparent and decentralised, meaning they aren’t controlled by any central authority like banks or governments. 

Types of Cryptocurrencies: 

1. Cryptocurrencies (Store of Value): 
   These are digital currencies designed to act as a medium of exchange or a store of value. Bitcoin (BTC), the first cryptocurrency, is often compared to digital gold due to its scarcity and store-of-value characteristics. Ethereum (ETH), on the other hand, powers a wide range of decentralised applications (DApps) and smart contracts. 
2. Utility Tokens
   Utility tokens do exactly what they promise—they provide functionality within a network. But what does that really mean? They can be used to pay transaction fees, secure networks through staking and power smart contracts. Over time, projects have continuously innovated and expanded token utility, introducing unique features and capabilities to enhance their ecosystems. 
   

How Do Cryptocurrencies Work? 

Cryptocurrencies rely on DLT or blockchain technology to function. Each cryptocurrency operates on its own DLT/blockchain, or sometimes on a shared one, that records all transactions and ensures transparency and security. For example, the Bitcoin blockchain logs every Bitcoin transaction ever made, allowing anyone to verify ownership and the movement of coins. 

Most cryptocurrencies are created through a process called mining or staking. Bitcoin is mined using proof-of-work, where computers solve complex puzzles to validate transactions and add new blocks to the chain. Other cryptocurrencies, like Ethereum, use proof-of-stake, where users stake their coins to help secure the network and earn crypto rewards. 

Benefits and Uses of Cryptocurrencies 

Investment Potential 

Many investors view cryptocurrencies as a new investable asset class, as seen by the shift in perception in the most recent years from the traditional finance world with the launch of the Bitcoin and Ethereum ETFs. The ETFs marked a significant moment in crypto’s history as it made BTC and ETH much more widely available to a large group of people, and capital.  

ETFs aside, the crypto industry has made significant progress year on year – new projects are well capitalised and are not afraid to be innovative to really push the boundaries of what is possible. This rapid pace of technological growth and attention lead to people seeing cryptocurrencies as an investment opportunity. However, it’s important to note that the market is highly volatile, and prices can change dramatically in a short time, there is a chance you will lose all your money. 

Access to Decentralised Finance (DeFi) 

DeFi is a blockchain-based financial system that doesn’t rely on third party intermediaries. Cryptocurrencies enable users to lend, borrow, trade and earn interest on their assets on platforms such as Aave, and many more. 

Lower Transaction Costs: 

Cryptocurrencies can be sent directly between people and institutions at a lower cost, especially for cross-border payments. Transaction costs depend on what blockchain networks the cryptoassets are sent on.  

Ownership and Control 

With cryptocurrencies, users have direct ownership and control over their funds, there’s no need for a middleman to manage or hold assets. While this is a benefit, it does place the risk on the person to securely manage their own funds, which can have its downside such as losing your seed phrase, wallet and more. 

Risks of Cryptocurrencies 

While cryptocurrencies offer many opportunities, they also come with risks, especially for retail investors: 

Volatility 

Cryptocurrencies are highly volatile, meaning prices can rise or fall significantly in short periods, leading to potential gains or losses. It’s extremely important to know this before you choose to invest or use cryptocurrencies. 

Security Risks 

As mentioned above, users are responsible for safeguarding their private keys. If keys are lost or stolen, the associated cryptocurrencies are unrecoverable. 

Regulatory Uncertainty 

The legal status of cryptocurrencies is still evolving in many countries, and future regulations could impact their value or usability. 

As with any investment, it’s crucial to DYOR (Do Your Own Research). Research a cryptocurrency’s history, team, whitepaper, community and tokenomics (how the token is structured). This helps ensure that you're making informed decisions. 

To Sum It Up 

Cryptocurrencies are digital assets that operate on blockchain networks, with popular types including store of value assets like Bitcoin and utility tokens like AVAX. They offer new opportunities for investment, but retail investors should be mindful of the risks, including volatility and the importance of secure asset storage.