How cryptocurrency works
Cryptocurrency uses cryptography to secure and verify transactions, and to control how new coins are created. Since it operates independently of a central bank or government, it is not controlled by any single entity (you’ll often hear it called ‘decentralised’).
When you want to trade or pay with a cryptocurrency, you’re basically sending a request to the network of computers that maintain the cryptocurrency’s blockchain. The request contains information about the transaction, such as the amount and your address. The information is then verified by the network, which uses complex algorithms to ensure that the transaction is right and that you have the necessary funds.
Once the transaction is verified, it is added to a block of other transactions, which is then added to the blockchain. This creates a permanent, unalterable record of the transaction that is visible to everyone on the network.
To keep the network running, cryptocurrency systems often offer rewards to people who successfully add a block to the blockchain by validating and processing transactions. These rewards are typically newly created cryptocurrency coins. This is what Bitcoin ‘miners’, for example, are doing – supporting the network and receiving new Bitcoin in return.
The lure of cryptocurrency is that it is a secure and decentralised way to transact without the need for a central authority. But it still relies on a certain amount of trust, and crypto exchanges, for example, have tended to become centralised anyway.
The short of it is: do as much research as possible before you buy into this virtual economy.
Also, it’s important to know that the crypto economy has real-world tax implications when you buy and sell. For more, see Inland Revenue’s website.
Prices for cryptocurrency swing wildly
Cryptocurrencies are high risk and highly volatile – their price can spike or fall off a cliff very quickly. Most coins unfortunately become worthless sooner or later.
So far, the price of the more established cryptocurrencies, such as Bitcoin or Ethereum, has tended to swing wildly in line with other risky investments such as shares. So if the sharemarket is falling and you’re looking to avoid losing money by owning cryptocurrency instead, it probably won’t work.
If you’re feeling FOMO about everyone else making money in the crypto world, know that hype influences the perceived value of crypto coins and NFTs. Celebrities and influencers are able to affect how much cryptocurrency or NFTs are worth, so they are quite active in this space.
Unfortunately, markets can be manipulated in order to give the impression of success, pump up the price of cryptocurrency or earn rewards.
Cryptocurrency is too often a scam
The virtual economy is a high-risk, unregulated space. Scams are rampant.
Cryptocurrencies, crypto exchanges and the people who use them are often the targets of hacking, online fraud and scams. Exchanges are targeted by aggressive, sophisticated cyber-attacks – attracted by the larg ometimes even collusion (cooperating secretly to defraud people).
Remember, if something seems too good to be true, it’s probably fraud. And the moment you send your money overseas, you lose any leverage to get it back.