Cryptocurrency, or simply crypto, has taken the world by storm since its inception in 2009 with Bitcoin (BTC). Despite its growing popularity, many people are still unfamiliar with the underlying technology and how crypto works. In this article, we will dive into the basics of cryptocurrency and explain how it operates, including the concept of blockchain, mining, and digital wallets.
Cryptocurrencies are digital assets that use cryptography—the science of securing transactions using encryption—to generate currency units, manage the transfer of funds, and verify transaction records.
The very first cryptocurrency is Bitcoin (BTC), which was created in 2009 by an anonymous person who went by the name of Satoshi Nakamoto. Since then, many other cryptocurrencies have been created. Most of these cryptos work similarly to Bitcoin (BTC) and are referred to as “altcoins”—alternative coins.
Cryptocurrency transactions use consensus networks to agree on definitive sources of truth about balances and transactions. A consensus network is a group of computers, called nodes, that agree to use the same set of rules to determine the truth.
When a transaction takes place, it is broadcasted to all the nodes in the network. Each node will then check if it follows all the rules and if it does, they add it to their version of the ledger. There is an ever-growing list of consensus mechanisms, but the most popular is proof-of-work (POW).
In a POW system, computers compete to solve complex tasks in order to confirm transactions and add them to the ledger. The computer that first completes the task is rewarded with cryptocurrency for its work. This process requires significant amounts of electricity and computing power, so it is not a cheap process.
Blockchain technology is a crucial part of how crypto works. Essentially, blockchain functions as a public ledger that records every transaction made with the cryptocurrency.
Each time someone makes a cryptocurrency transaction, the details are securely stored in a blockchain, which is an ever-growing list of records (blocks). Each block contains information about the transactions it represents, as well as a unique code, called a hash, that identifies it. This helps to ensure the accuracy and security of the transactions.
It is thanks to blockchain technology that cryptocurrencies are able to function without a central authority, such as a government or bank. Instead, the transactions are verified by the community of users and miners in the network. This decentralized system increases transparency and reduces the risk of fraud.
We may understand how crypto works, but how is the value of cryptocurrency determined? Like other currencies, the value of cryptocurrencies is based on supply and demand. When more people are buying a currency, its price will increase. When fewer people are buying it, its price will decrease.
The value of a cryptocurrency is determined by market capitalisation, which is the total value of all units in circulation. Market capitalisation is calculated by multiplying the price per unit by the number of units in circulation.
There are many factors that can influence the price of a cryptocurrency, including market sentiment, news, and regulations. The price of a given cryptocurrency usually rises or falls based on speculation about its future potential.
To understand how crypto works, especially Bitcoin (BTC), it’s important to know about the concept of mining. Cryptocurrency mining is the process of verifying and adding transaction records to a public ledger (blockchain). Miners use specialised computers and software to solve complex mathematical problems, which helps to confirm transactions and add new blocks to the blockchain.
Solving the mathematical problem first comes with rewards in the form of cryptocurrency. This reward is halved after a certain number of blocks are mined, which helps to control the release of new units into circulation.
Cryptocurrency mining can be done by anyone with the right hardware and software. It is a competitive process, so it requires significant computing power and energy consumption. As more people join the mining process, the difficulty of solving the puzzles increases, making it more difficult to be profitable.
Cryptocurrency is stored on the blockchain, but accessed via digital wallets that hold private and public keys. The private key is used to access the funds and authorise transactions, while the public key is used to receive funds.
There are several types of wallets, including hardware wallets, software wallets, and paper wallets. Each wallet offers different levels of security, so it is important to choose the one that best suits your needs. It is also important to back up your wallet in case you lose access to it.
Cryptocurrencies consist of coins and tokens. Coins are digital currencies that are built on their own blockchain and are used as a means of exchange. Tokens, on the other hand, are digital assets that exist on top of an existing blockchain and have specific use cases.
For example, BTC (Bitcoin) is a coin that is used as a form of digital currency, while ERC-20 tokens are built on the Ethereum (ETH) blockchain and have different use cases. In fact, tokens can be used to represent anything of value, from stocks and bonds to commodities and loyalty points.
We have now gone over the basics of how crypto works, but how does the law treat this new asset class? The taxation of cryptocurrencies is still a grey area in most countries, but profits from cryptocurrency investments are generally subject to taxation.
In the UK, for example, any profits from trading or exchanging cryptocurrencies are subject to Capital Gains Tax. This means that HMRC will need to receive a self-assessment tax return from anyone with crypto gains above the annual allowance.
Navigating the ever-changing tax laws can be tricky and the consequences of non-compliance can be severe. Plus, declaring crypto taxes usually involves hours of calculations and can be complicated for non-experts.
This is where Cryptiony enters the picture. As the leading cryptocurrency tax service in the UK, Cryptiony offers proprietary software that automates the calculation and filing of crypto taxes, allowing users to generate tax reports with a click of a button.
The great news is that new users of Cryptiony can sign up for a free trial to try out the platform and get their crypto taxes done in minutes. This makes it easy to stay compliant while trading cryptocurrencies.
To sum up, crypto is a form of digital currency and asset that uses cryptography for security and decentralization. The creation of cryptocurrency has given rise to a new asset class that operates independently of traditional financial institutions, allowing for faster and more secure transactions.
We hope this article has helped you understand the basics of how crypto works, as well as its storage and tax implications. As always, it’s important to stay up to date with the latest developments and get help if needed.
By taking these steps, you can rest assured that you are staying compliant with the law and maximizing your profits when trading crypto. Good luck!