Cryptocurrency Explained: Discover How It Works

Cryptocurrency is a form of digital money designed to function as a means of exchange. Over the past ten years, cryptocurrency has gained significant popularity, particularly. Bitcoin turning into the most extensively monitored substitute for traditional money. Usually, cryptocurrency exists solely in digital format and lacks a tangible counterpart—the image displayed here represents an artist's depiction of digital currency.

Many individuals are drawn to cryptocurrency primarily because it can operate independently of a central bank, thus addressing worries related to privacy and illicit activities. Additionally, it attracts interest due to its potential as a store of value that isn’t susceptible to erosion through inflation caused by monetary policies aimed at printing more money. Furthermore, counterfeiting is extremely challenging with this digital asset thanks to the secure blockchain technology overseeing transactions.

Cryptocurrencies have become increasingly popular in the investing community because of their substantial value increase since being initially launched. In 2022, cryptocurrencies experienced considerable drops when the Federal Reserve increased interest rates, affecting high-risk assets like these most significantly. Bitcoin and Ethereum Two of the most widely followed cryptocurrencies dropped by over 70 percent from their peak values in 2022, however, they rebounded in 2023 and surged dramatically in 2024. Bitcoin's value initially surpassed $100,000 mark .

Below is an explanation of what cryptocurrency entails, how it operates, and the major risks associated with it.

How cryptocurrency works

Cryptocurrencies are generated, recorded, and controlled via a system known as a distributed ledger like blockchain In a distributed ledger, the flow of the digital currency is managed by computers within a decentralized network to maintain the accuracy of financial records and the ownership details of the cryptocurrency. Consider it akin to an endlessly expanding receipt containing all the system’s transactions, which is continuously checked by every participant with access to this record.

This distributed system is common among numerous cryptocurrencies, avoiding a centralized governing body. This characteristic contributes to the attractiveness of currencies like Bitcoin—it removes government and central bank involvement from the monetary system, thereby minimizing their influence and political manipulations.

For this reason, certain cryptocurrencies have a capped supply. For instance, with Bitcoin, the protocol is designed such that only up to 21 million bitcoins will ever be created.

However, how precisely does cryptocurrency originate? A significant method involves a process known as mining To employ an analogy tied to the traditional financial system backed by precious metals like gold or silver: powerful machines referred to as "miners" execute computations and facilitate transactions within the blockchain network. As their reward for this work, they receive units of the digital currency, or fractions thereof. This endeavor necessitates substantial computational resources and frequently considerable amounts of electrical energy.

holders of the currency might keep it in a cryptocurrency wallet , a computer application that enables users to use or get the digital currency. For conducting transactions, individuals require a "key," which permits them to record details in the shared ledger, documenting the movement of funds. Although this key might be linked to an individual, their identity isn’t directly connected with the transaction at hand.

One reason why many people find cryptocurrencies appealing is because they offer a degree of anonymity when used.

The potential for cryptocurrency creation knows no bounds. This diversity has become astounding with thousands emerging over recent years, particularly following Bitcoin’s rise to widespread recognition around 2017. Among these, some of the top contenders include various digital coins like Ethereum, Ripple, Litecoin, and more recently introduced tokens such as Cardano and Dogecoin. Bitcoin, Dogecoin, Ethereum, Tether and XRP.

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Top 10 Largest Cryptocurrencies List

The scale of a cryptocurrency is determined by two elements: the total number of coins in circulation and the value of each coin. By multiplying these two figures, one can ascertain the overall worth of the currency. market capitalization , or the combined worth of all these coins. Therefore, when specialists discuss the biggest cryptocurrencies, they're talking about this overall valuation rather than the price of a single coin.

Here are the leading cryptocurrencies And their estimated market capitalization, based on data from CoinMarketCap, around mid-February 2025. Keep in mind that due to the unpredictable nature of cryptocurrencies, these figures might change significantly over very brief intervals.

1. Bitcoin – $1.9 trillion
2. Ethereum  – $330 billion
3. XRP – $159 billion
4. Tether – $142 billion
5. Solana – $98 billion
6. BNB – $94 billion
7. USDC – $56 billion
8. Dogecoin – $40 billion
9. Cardano – $28 billion
10. TRON –  $20 billion

What purposes does cryptocurrency serve?

Cryptocurrencies serve numerous purposes, yet their specific use hinges on their intended design. Although people often associate cryptocurrencies with financial transactions, they function better when viewed as digital tokens granting access to certain activities—much like the coins one uses at an amusement arcade. These tokens allow you to engage in particular actions once inserted into the respective machines—in this case, enabling participation within blockchain-based operations.

For instance, one of Bitcoin’s aims is to facilitate monetary transactions, thereby allowing it to operate as a form of currency. However, despite this capability, only a limited number of retailers truly embrace it as such a means of exchange. Additionally, when comparing transaction speeds with those of alternative payment systems, Bitcoin often appears rather sluggish.

Similarly, the cryptocurrency Ethereum permits users to develop "smart contracts," which are agreements that automatically execute when their conditions are fulfilled. The crypto token known as Internet Computer enables individuals to build applications, sites, and various online services. These digital currencies differ from others. Dogecoin which was developed essentially to mock the absurdity surrounding Bitcoin.

Although these digital currencies might possess practical applications (or they might not), their primary function often lies in speculative activities. Traders oscillate the values of these tokens up and down, aiming to capitalize on profits from participants engaged in buying and selling these assets.

Even though the coins might allow a user to execute a specific function, numerous purchasers are solely focused on reselling them for financial gain. To many people, this is actually the primary application of digital currencies.

Is it possible to change cryptocurrencies into cash?

Cryptocurrencies can be readily exchanged for standard currencies like dollars or euros. If you hold the currency itself, You can swap it through an exchange for fiat money. Or into another form of digital currency instead. Usually, you'll have to pay a substantial fee for these transfers though.

However, you might also possess cryptocurrency via a payment platform like PayPal. CashApp , and you might effortlessly exchange it for cash. You could potentially also utilize a Bitcoin ATM to access dollars.

Individuals holding cryptocurrency through Bitcoin futures can easily liquidate their holdings whenever the market is active; however, you should seek out the best opportunities. top cryptocurrency brokers if you’re trading regularly.

However, if you require immediate access to your funds, you must accept the price offered by the market at that moment, which could be significantly lower than what you originally invested. Cryptocurrency exhibits higher volatility compared to other high-risk investments. Additionally, there are typically considerable charges associated with entering and exiting these markets. you will encounter tax consequences as a result of this action .

Biggest risks of cryptocurrency

Although supporters have compelling narratives regarding cryptocurrencies like Bitcoin, these digital assets come with significant risks, particularly in their current form. This does not imply that one cannot profit from selling them for more than they were bought. Nevertheless, several disadvantages render Bitcoin and similar currencies nearly ineffective as proper mediums of exchange or currency alternatives.

Bitcoin and other cryptocurrencies face genuine critics, among them several of the globe's leading investors like the multibillionaire Warren Buffett. Buffett has referred to Bitcoin as "likely rat poison squared." while his long-time business collaborator Charlie Munger has described cryptocurrency trading as 'simply dementia.' Buffett said In 2022, he stated that he wouldn't purchase all the Bitcoin in existence for $25 because, unlike stocks, real estate, and farmland, it does not generate any value for its holders.

Several major hazards associated with cryptocurrencies encompass the subsequent problems.

Extracting the currency is costly and environmentally damaging.

A major drawback of cryptocurrencies is that they are " mined" using computer systems. This mining process incurs costs since it demands considerable energy consumption to generate coins. As miners utilize and cover expenses related to energy use for their setups, this activity leads to notable environmental contamination and waste production.

If Bitcoin were a country, it would consume more energy than Poland, which has a population of 36.8 million people, based on data from the Cambridge Bitcoin Electricity Index as of late 2024. Regarding greenhouse gas emissions, it would rank 61st globally.

This extensive usage has sparked criticism from individuals who view cryptocurrencies as an unnecessary drain on energy resources during a time when we face significant environmental challenges.

The supply of certain cryptocurrencies is capped.

Supporters of Bitcoin highlight the limited supply of coins as advantageous because they argue this ensures the currency won’t lose value due to actions from central banks, such as overproduction. Nevertheless, capping the overall quantity could mimic a gold-standard system, which might subject economies to severe deflationary pressures if widely adopted.

During economic booms, when funds circulate easily within the system, issues might not surface. However, as conditions deteriorate, both individuals and companies tend to save cash meticulously to safeguard themselves from volatility and potential unemployment. This act of saving can hinder the circulation of currency throughout the economy, which could result in a damaging downward price spiral. In extreme cases, people refrain from purchasing due to expectations that prices will drop further down the line, thereby exacerbating the economic downturn.

This issue is precisely why contemporary nations have shifted away from the gold standard towards fiat currency. Unshackled from the gold standard, Central banks can inject more funds into the economy during difficult periods. , even if consumers and businesses stockpile it, causing the economy to avoid grinding to a halt.

An unstable currency is impractical.

The restricted supply of coins, along with speculative frenzy and an engaging narrative, has led to significant fluctuations in the prices of Bitcoin and various cryptocurrencies. This volatility might suit traders seeking opportunities, yet it renders these digital assets impractical for everyday use as money. For something to function effectively as currency, people must trust that it will maintain its value over time.

Envision visiting an eatery where your dish could cost you $10 today yet spike up to $20 tomorrow. It would likely prompt you to limit spending solely to those cheaper days; however, this doesn’t work at scale for entire economic systems. Economies require a consistent unit of exchange that remains steady, allowing individuals to swap goods and services with clarity regarding their worth.

To the degree that Bitcoin and other cryptos benefit traders—due to their volatility—they become unsuitable as proper currencies.

Rules and entry to cryptocurrencies may differ.

Cryptocurrencies can be impacted by governmental rules, potentially harming certain digital currencies' growth. However, these regulations might also support their development based on how extensive they are.

Government regulations have the potential to severely undermine the effectiveness of cryptocurrencies, particularly through outright prohibitions or those that render them practically unusable. For instance, when China chose this route, it rendered many cryptocurrencies nearly worthless within its borders and subjected violators to possible legal penalties, based on their specific legislation.

Recently, the possibility of Donald Trump's re-election has arisen alongside the expectation of pro-crypto administration has caused crypto prices to soar, pushing Bitcoin to a recent all-time high of nearly $110,000.

Even with backing from the Trump administration, crypto regulation varies Across various government bodies and from one state to another, the classification and definition of cryptocurrencies differ significantly. The Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Internal Revenue Service each employ distinct methods for categorizing these digital assets.

Certain states, including New York, impose strict regulations on cryptocurrency businesses. In contrast, other states, like Wyoming, are more supportive of cryptocurrencies and are even developing their specific stablecoin while aiming to lure cryptocurrency-related enterprises.

Despite their differences, governmental regulations might assist in establishing a fairer competitive environment that is less prone to deceit and misconduct. In such an arrangement, stakeholders within the marketplace could cultivate increased confidence in the system and possess well-defined legal avenues should anything adverse occur. Regulation of this sort can mitigate the "lawless frontier" aspect of cryptocurrencies, rendering them safer for individuals aiming to utilize them with integrity.

Other drawbacks

Cryptocurrencies also come with several disadvantages, such as inadequate protection for digital wallets used to store funds, their involvement in illegal activities, and slower transaction speeds when contrasted with the nearly instant processing offered by conventional systems like Visa and MasterCard.

Furthermore, since the IRS has classified Bitcoin as an asset rather than a currency, each Bitcoin transaction carries the possibility of generate a reportable capital gain This means you have to include it in your tax return. If you use bitcoins valued higher than what you originally bought them for, you will be liable for taxes.

Bottom line

Although cryptocurrency does possess certain advantages, it comes with significant downsides that currently prevent it from being viable as a currency. Given its unpredictability and multiple risks, investors should likely proceed with caution when dealing with cryptocurrencies. Should you wish to experiment with them simply for understanding purposes, maintain a modest investment amount and only allocate funds you could conceivably forfeit.

— Note: ’s Brian Baker and Logan Jacoby had a hand in updating this tale.