What are cryptocurrencies?

What are cryptocurrencies?

Table of Contents

Cryptocurrencies are a form of digital or virtual currency that use cryptography for security and operate on a decentralised network, typically a blockchain. Unlike traditional currencies issued by governments (FIAT currencies), cryptocurrencies operate on a decentralised chain of computers. This decentralisation is often achieved through blockchain technology.

What’s blockchain technology?

We need to cover the basics before diving deeper into coins and tokens. A blockchain is a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems. Each block in the chain contains a number of transactions, and every time a new transaction occurs on the blockchain, a record of that transaction is added to every participant’s ledger.

In order to secure the network and reward those who make the blockchain safe, network creators issue a native cryptocurrencies. Many of these have a limited supply capped by mathematical algorithms. For example, the total supply of Bitcoin is capped at 21 million coins, making it a deflationary asset.

Who creates cryptocurrencies?

Cryptocurrencies are created and managed by various entities or individuals, depending on the specific cryptocurrency. These entities often include a mix of developers, blockchain experts, and other professionals. They work on developing the cryptocurrency, its underlying technology, and sometimes related applications and services. In some cases, the creator of a cryptocurrency remains anonymous.

The creation of a cryptocurrency involves not only its technical development but also considerations around its economic model, governance, legal compliance, and community or market adoption. As the field of cryptocurrencies continues to evolve, the processes and entities involved in creating them may also diversify and expand.

How to buy cryptocurrencies?

There are several ways retail investors can buy cryptocurrencies. We’ll cover two methods: crypto exchanges and over-the-counter (OTC) purchases.

Crypto exchanges

A crypto exchange is a platform where individuals can buy, sell, and trade cryptocurrencies. These platforms offer a gateway for converting traditional fiat currencies (like USD, EUR, etc.) into cryptocurrencies (like Bitcoin, Ethereum, etc.) and vice versa. There are two types of exhcanges: centralised and decentralised.

Exchanges are managed by entities and serve as a trusted broker between buyer and seller. Exchanges typically have higher liquidity compared to OTC markets, making it quicker and more accessible to users.

Over-the-counter markets (OTC)

Over-the-Counter (OTC) markets refer to the trading of crypto assets directly between two parties outside of traditional, public exchanges. This mode of trading is distinct from the more familiar exchange-based trading. Trades are conducted directly between two parties — a buyer and a seller — often facilitated by an OTC broker or desk. Unlike exchange transactions, where orders are matched through an automated system, OTC trades are negotiated privately.

OTC trading allows large amounts of cryptocurrency to be bought or sold at a fixed price, reducing market impact. It also offers greater privacy compared to exchanges. Trades are not publicly recorded in an order book, thus providing anonymity and confidentiality, which is often desirable for large-scale traders.

OTC markets play a crucial role in the cryptocurrency ecosystem, especially for institutional investors and high-net-worth individuals who require large trade volumes without the associated market disruption or attention that comes with exchange trading.

What gives value to cryptocurrencies?

The value of cryptocurrencies is determined by several factors, much like traditional currencies or assets. The most fundamental economic principle of supply and demand is a primary driver of cryptocurrency value. Limited supply, combined with increasing demand, can drive up prices. Conversely, lower demand or higher supply can decrease value.

Public perception, influenced by media, market sentiment, adoption rates, and investor outlook, plays a significant role in the valuation of cryptocurrencies.

The degree to which a cryptocurrency is adopted, both by individual users and businesses, can influence its value. Wider adoption, acceptance by payment systems, and integration into financial services can enhance value.

These and many other factors might affect the value of a cryptocurrency. Always do your own research and be prepared to experience high volatility and potentially lose your investment.

How to build a diversified portfolio?

The methods described above offer a solution for users who want to buy cryptocurrencies individually. A common investment practice is to hold a diversified portfolio to align with the general principles of investment risk management and potential reward optimisation.

Since the crypto market is still in a developmental stage, not all projects will succeed. Diversification reduces the impact of the failure of any single project on an investor’s portfolio. Crypto index funds offer a simple solution to access a pre-generated diversified portfolio of coins and tokens.

As always, anyone interested in buying cryptocurrencies (whether via exchanges, OTC or index funds) should conduct thorough research and consider their investment goals, risk tolerance, and market dynamics when diversifying their crypto portfolios.

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