Ever since the official release of bitcoin in January 2009, cryptocurrencies have been making waves. This guide explains how they work, how to use them and why they’re so important.
Why are cryptocurrencies such a big deal?
Cryptocurrencies aren’t just future technology. They’re already being used today and doing things that were impossible just a few short years ago.
Imagine sending New Zealand dollars to the USA, having it automatically converted to US dollars and deposited in the account of your choice. Now imagine doing it almost instantly and anonymously, at competitive exchange rates, all while paying just a couple of dollars or less in fees.
That’s not a hypothetical example. That’s something you could do today if you wanted, and it’s just the tip of the iceberg.
Most cryptocurrencies are built for a specific purpose and with the specific intention of being able to do it better than anything else ever could. This makes them the perfect disruptors of existing industries.
What do I need to get started?
Getting involved in the world of cryptocurrencies is easier than it looks. It involves three simple steps.
Choose a cryptocurrency
Bitcoin and Ethereum are just the beginning. There are over a thousand different cryptocurrencies in existence, and they’re all different. A lot of people start with bitcoin or Ethereum, and then spread it into a more diverse portfolio for more security in case the price of a coin crashes.
Check out our coins page for guides on some of the most commonly traded cryptocurrencies on the market today.
Get a wallet
Where do you hold crypto-money? In a crypto-wallet of course.
Most of these wallets take the form of computer programs you can quickly download to your phone or PC, although physical devices called hardware wallets are recommended for long-term storage.
But not all wallets can hold all coins. Before buying, check whether your wallet can hold your chosen cryptocurrency or whether you can leave the coin in storage on the exchange you purchased it at.
We’ve listed some of the compatible wallets for each currency on our coin pages. Or you can learn more about choosing the best for your needs below.
Buy from an exchange
The third step is buying your cryptocurrency. The first purchase will usually involve exchanging fiat currency (such as USD, NZD or EUR) to your chosen cryptocurrency.
After that, you might find it easier to trade cryptocurrencies for each other.
Buying for the first time usually involves:
What exactly is cryptocurrency?
Cryptocurrencies are digital tokens that have a value, just like a $10 note is a physical token that happens to have $10 worth of value.
The problem with digital currencies is that they’re purely electronic. Just like a photograph on the Internet can be copied and replicated over and over again until the original is worthless, the same thing could happen to a coin.
In order for a cryptocurrency to have value, a coin needs to be unique and unreplicable.
This was made possible by the invention of blockchain technology.
What is the blockchain?
A blockchain is simply a ledger that contains the entire history of a certain cryptocurrency. By tracking all the movements and the entire history of a currency, it’s impossible to make any counterfeits.
To prevent tampering, most blockchains are open source and decentralised.
- Open source – The programming is made publicly available so anyone can see exactly how it works. This prevent tampering from inside.
- Decentralised – The blockchains are operated by different people all around the world. With public blockchains such as bitcoin, anyone can start operating a “node” on the blockchain whenever they want. This prevents anyone from taking over the network and prevents tampering from outside.
The name blockchain refers to the particular way it assembles data in the ledger.
Each block is like a container for transactions. Transactions on the blockchain are collections of data, usually including the wallet address of the coin sender and receiver, and the amount sent.
When you make a transaction, this information is packed into a block. Once the transaction is added to a block it cannot be edited and cannot be removed. This ensures the security and reliable of the blockchain.
When a block is ready to go, it’s added to the blockchain. This is like having the package sent.
Each block is digitally strung together like the links in a chain. It’s attached to the one that comes before it and the one that comes after, creating an unbroken and tamper-proof history of every single transaction executed in the history of the cryptocurrency. Each block is given a number, and anyone can look back and see the transactions that were carried on each block.
As of December 2017, there have been roughly 500,000 blocks in the history of bitcoin. You can see the most recent blocks here, including how many bitcoin were carried on that block.
Most blockchains are simply one unbroken chain. But others are more complicated and might run other chains off the side of the main blockchain or might try assembling blocks in a web-like structure rather than a single chain.
Not all blockchains work exactly the same, and not all cryptocurrencies even use a blockchain. But the basic principles and their implications remain the same.
Where to buy, sell and exchange cryptocurrency
It takes computing power to operate the blockchain, verify the transactions and add more blocks to the chain. This is usually called mining.
Miners use the computing power to package transactions into blocks, link blocks to the blockchain and secure the network against outside tampering.
Different cryptocurrencies can have very different mining systems. Two of the most popular are:
- Proof of work: This involves having miners solve a cryptographic puzzle to determine the nature of the upcoming block. If the answer is correct, it proves they’ve found the right block and can safely add it to the chain. It’s a relatively simple and secure mining system, but it’s also very inefficient. Miners are competing with each other to solve the puzzles, so it often ends up using a huge amount of energy and computing power. This is the kind of system that bitcoin uses.
- Proof of stake: This type of mining involves asking coin owners to hold special wallets holding coins online. The coins in their wallets will then automatically interface with the network and mine new blocks. This is a relatively efficient way of mining coins. The main downside is that it’s relatively complicated and can encourage unusual hoarding of coins. Ethereum will be switching from proof of work to proof of stake.
Cryptocurrencies will almost always offer miners some kind of reward to encourage people to dedicate their computing power to the blockchain. This reward will often be newly created coins of the type they just mined or transaction fees paid by everyone whose transaction was packaged into the newly-mined block.
Some coins will use proof of work or proof of stake, while others might switch between them or use variations of either.
When you’re researching a coin, you should pay attention to the mining system. This is because it can directly affect coin prices. For example, higher mining rewards can mean more inflation and a declining coin value. Or news of an upcoming switch to proof of stake might drive prices upwards as everyone starts buying coins to mine with after the switch.
Popular altcoin cryptocurrencies
Many cryptocurrencies simply try to replicate bitcoin’s success, while many more go their own way by creating completely different coins. Traditionally, all cryptocurrencies other than bitcoin were known as “altcoins,” but today bitcoin is just one cryptocurrency among many.
Here are just a handful of popular cryptocurrencies to help you get a sense of what’s out there.
- Ether (ETH) or Ethereum. Ethereum was specifically created to utilise the potential of blockchain technology by introducing “smart contracts.” These allow for foolproof and 100% trustworthy automation of computer tasks without any third party required.
- Ripple (XRP). Ripple was developed by a privately owned company with the specific purpose of facilitating international money transfers. It allows for extremely quick and cheap movement of actual value around the world almost instantly. It’s being used by banks, money transfer services and multinational companies to make international payments a lot cheaper and quicker.
- Dogecoin (DOGE). This coin was based on a meme and created to be a joke. It was mostly to tip people on the Internet and never taken seriously. It still grew in value and built a market cap over a billion dollars though.
- Golem (GNT). In simple terms, Golem uses blockchain technology to let almost anyone turn their home PC into a supercomputer on demand. It does this by assembling and monetising a worldwide supercomputer network, made up of phones and home PCs. Blockchain technology means this can be done with complete security and safety for all involved.
- Monero (XMR). Monero was designed to be a completely secure, private and untraceable cryptocurrency that lets anyone make completely untraceable and anonymous payments as needed.
- IOTA (IOTA). An extremely ambitious project, IOTA wants to become the currency of the “Internet of Things” and the next generation that comes after the blockchain. It aims to create a global machine-to-machine network of connected systems, allowing microtransactions and seamless communication between all kinds of devices. Someday you might use IOTA to pay a stranger for their parking spot if you’re in a hurry or top up your phone battery by quickly buying someone else’s excess power and a whole lot more.
Where can I use cryptocurrencies?
- There are a few different ways to use cryptocurrencies.
For their intended purpose
If nothing else, you can always use a cryptocurrency exactly as intended. For bitcoin, this might simply be holding onto it or using it to buy other cryptocurrencies.
For Ethereum, this might be powering smart contracts, which consumes small amounts of Ether as a sort of transaction fee.
And for the 1,000+ other cryptocurrencies in existence, this might be almost anything.
Purchase products or services
Are you paying with cash, credit or cryptocurrency?
A lot of merchants today accept popular cryptocurrencies as payment, especially if you’re paying with a popular currency like bitcoin.
These merchants might be as small as someone selling used furniture on Gumtree or as big as Microsoft. In brick and mortar stores that accept cryptocurrency, you’ll often see QR codes printed and pinned next to the cash registers. These are scanned to make crypto payments.
Money transfers and cryptocurrency tipping
Some cryptocurrencies are specifically designed to make transfers as quick and cheap as possible. For example, Nano (formerly RaiBlocks) lets you make 100% secure transfers in a couple of seconds flat without any fees whatsoever.
Or if you’re sending money to someone who doesn’t do crypto, you might use Stellar Lumens instead. This coin lets you make quick and cheap transfers, while simultaneously converting money from cryptocurrency to your fiat currency of choice.
Transferring cryptocurrencies is often so quick and easy that some coins (eg, Dogecoin) have even built tipping platforms for themselves. With the press of a button, users tip each other with coins for entertaining or informative posts on Reddit, Twitter and other social media.
That might not sound like a big deal, but blockchain technology allows people to send amounts as little as 5 or 10 cents to someone on the other side of the world for the first time in history. Previously, these kinds of transfers would be eaten up by international transaction fees.
What to watch out for
Cryptocurrencies are not without their pitfalls and you will need to be careful when handling your digital currency.
Before jumping into cryptocurrency, do your research. No single guide will ever be able to cover everything you need to know about all cryptocurrencies and you’ll always be able to find two sides to any argument. Additionally, you will need to understand how exchanges and wallets work.
Before you make a decision, make sure you’re informed. Read guides, find reviews and test drive with small, disposable amounts of money before making bigger purchases.
There is no safety net when working with cryptocurrencies. It’s still largely unregulated and you typically won’t be able to make a police report if your cryptocurrency gets stolen.
The freedom to go beyond the banks and outside of government money comes with a lot of responsibility. Here are a few tips:
- Before you send cryptocoins to someone, always double check their wallet address.
- Never hand over products or services before the transaction on the blockchain is verified. This might take up to 10 minutes on some blockchains.
- Always keep the computer on which your wallet is installed safe and clean from viruses and malware.
- Never lose your wallet password. You might not be able to get it back and every cryptocoin you own will be lost.
Bitcoin and cryptocurrencies in general often suffer from sudden dips in value. Whenever purchasing cryptocoins, always be aware that the value of your holdings can fall.
Of course this could work in your favour if it goes the other way. Always be aware that the cryptocurrency market is extremely volatile and past performance is not indicative of future performance.
A to H
cryptocurrency. A digital currency for which encryption techniques are used to regulate its use and generate its release. Unlike fiat currency — like US dollars, euros and yen — cryptocurrency is not regulated or controlled by any government or agency.
bitcoin. A digital cryptocurrency using peer-to-peer technology for nearly instant payments. Bitcoin was invented by an unidentified programmer, or group of programmers, under the pseudonym Satoshi Nakamoto.
bitcoin address. Also called a key, a string of alphanumeric characters used to receive bitcoin. Whereas public addresses typically begin with a 1 or 3, private addresses — or addresses that aren’t visible to all users — typically begin with a 5 or 6.
bitcoin exchange. An online website or platform that allows users to buy and sell bitcoin for other currencies.
blockchain. A public digital ledger in which the entire history of a cryptocurrency is recorded chronologically.
block reward. The amount of cryptocurrency mined after a “miner” has succeeded in solving a hash.
digital wallet. Sometimes called an e-wallet, an electronic system or app that securely stores personal information, payment details and passwords so that a consumer can make digital payments online or at retail stores that accept it.
hash. A computational puzzle that a cryptocurrency “miner” must solve in order to add the next block on a blockchain.
I to O
mining. A process by which a cryptocurrency is released into the world. “Miners” complete a computational puzzle to be rewarded with a block of currency along the public blockchain.
node. A computer connected to the bitcoin network.
P to Z
proof of work. A hash — or computational puzzle to unlock a cryptocurrency — that is so difficult, it could only have been solved through significant work or power.
proof of stake. A system that replaces the concept of “mining” a cryptocurrency with a consensus algorithm, whereby miners put up a stake of their currency to verify a block of transactions.
A brief history of cryptocurrency
The road to cryptocurrencies started in the 1980s. In an effort to protect the cash of small shops and gas stations, banks began investigating and pushing the idea of points of sale, where a customer can use a credit card instead of cash to pay for products.
Later, in the 90s, came a web-based payment system still used today: PayPal. This gave merchants the power to accept credit card payments online and it introduced the idea of transferring fiat currencies directly between end users entirely online. With PayPal proving that the web is a viable medium for transferring currency, similar services were created, such as WebMoney (a Russian PayPal alternative) and e-Gold, an American corporation that let users buy gold online – gold that it would then hold for them.
In the 2000s, after the FBI shut down e-Gold, cryptocurrencies began popping up in the cryptography community and mailing lists. Known as the Cypherpunks, people like Julian Assange, the founder of WikiLeaks, and Jacob Appelbaum, the developer of Tor, were members.
Unfortunately, none of these cryptocurrencies could gather the necessary momentum to push them into the public’s consciousness until, in 2008, Satoshi Nakamoto published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.
In the years to come, bitcoin grew to become not only the number one cryptocurrency available on the market, but a household name among even those who have no interest in cryptocurrencies.
Bitcoin eventually gave rise to hundreds of cryptocurrencies, known collectively as altcoins. Some of these altcoins are little more than copies of bitcoin, but others are attempting to do things with the underlying blockchain technology that not only disrupt the financial sector but also our understanding of apps and website services, all in an attempt to fix today’s problem of centralisation.
The problem with centralisation
Read any literature relating to bitcoin and cryptocurrencies and you’ll eventually stumble upon the concept of decentralisation. To understand decentralisation, you first need to understand centralisation.
If we take a close look at the world we inhabit today, a world of information and data about who we are, what we do and what we like, we realise that our information is held by a few large organisations: private and public corporations and the government. The dataset representing you (financial records, emails, Facebook messages and likes etc) is held on servers that exist in a central location. For example, your financial records, every transaction you’ve ever been a part of, your current balance and all your loans, exist on your bank’s servers. Your bank might have multiple servers for backup and audit purposes, but it still all exists in virtually one location: your bank.
So let’s say a cracker – a malicious hacker – attacks your bank’s servers and tampers with your account reducing your balance to $0. How can you prove that you didn’t just withdraw all your money? How can your bank verify your claim that you were hacked?
The Cypherpunks, the community from which cryptocurrencies first arose, understood this bleak scenario and aimed to fix it. Cryptocurrencies are said to be decentralised systems because every user of a cryptocurrency keeps a copy of everyone’s transaction history. The moment you join a blockchain you receive the entire history of that cryptocurrency, including all transactions ever made. If a user disagrees with a transaction (say a cracker changes their wallet value from 1 BTC to 1,000 BTC), a consensus must be reached by at least 51% of the users of that cryptocurrency. That 51% then decides what the correct amount should be.
This automatic consensus is the beauty behind cryptocurrencies and decentralisation. There is no one server that crackers can attack. They would need to convince 51% of all users because every user keeps a copy of the blockchain.
Frequently Asked Questions