Basics of Crypto Security
An explanation of how the arrival of blockchain technology has allowed cryptocurrencies to solve real-world challenges for financial consumers of all types: small and large, speculative and non-speculative.
March 04 2021
Cryptocurrency is a set of technologies used to store and exchange assets digitally in the form of coins, or tokens. Cryptocurrency's marketplace mechanics are decentralized (unlike emerging centralized digital currencies), and its security is supported by cryptography (encryption), which allows it to be both secure and anonymous. Although Bitcoin is the most well-known cryptocurrency in the world, with the largest market capitalization, there are now thousands of cryptocurrencies listed in the price-tracking website coinmarketcap.com. Cryptocurrencies other than Bitcoin are referred to as "Altcoins."
Cryptocurrencies are decentralized, digital money, traded on networks called blockchains.
Bitcoin is the most well-known cryptocurrency, but there are thousands of "alt coins."
Validation of trade transactions is performed by crypto "miners," who are paid a fee in crypto for their efforts.
Large institutions are now investing sizeable sums as part of their investment portfolios.
Some creative investment vehicles allow investors to purchase products that reflect cryptocurrency's value without the consumer actually owning their own cryptocurrency.
Cryptocurrency value is often volatile. Education and risk tolerance are key for crypto investors.
How do blockchains work?
You could think of a blockchain as a global, publicly-transparent property in the form of a shared ledger (database), where lots of digital coins are assigned to people, and locked by their individual encryption keys. People can prove their ownership or confirm a transfer of their coins by initiating a transfer with their unique key (private key).
Why would such a strange-sounding system of exchange come about? Cryptocurrencies were designed to exist outside of central authority or government control. They achieve this independence due to the decentralized nature of blockchains. The fact that anyone can interact with or even have their computer run part of a public blockchain network has made it arguably the most significant disruptive technology since the birth of the internet.
A public blockchain network runs on many different computers at the same time (it is "distributed"), and it stores transactions publicly and permanently as they occur. Because there is no single person or entity in charge of a distributed network, there is no one to regulate, control, or shut it down. Anyone can buy, sell, or send cryptocurrency to others directly, without the aid of any bank or other third party. But just because every transaction on a blockchain is visible for everyone to see doesn't mean you'll know who is sending money to whom - the blockchain record shows the wallet addresses used in a given transaction, not who controls those wallets.
When a new transaction is initiated, multiple "miners" (independent participants who run computer "nodes") perform a technical verification of that transaction and receive a cryptocurrency transaction fee for doing so. Each verification is also validated by other nodes, achieving "consensus," and then transactions are permanently added to the public blockchain. The chances for fraud are minimized - some say eliminated - by the fact that it would be very hard to get thousands of miners in multiple countries to conspire to perform false validations. Miners are financially incentivized to keep the blockchain honest and accurate.
How is the Crypto marketplace changing?
Bitcoin burst into the world offering this transformative mechanism in 2009. Next, cryptocurrencies like Litecoin and Bitcoin Cash appeared, with some variations in how they worked. Many other cryptocurrencies have since been created to fill a wide variety of use cases, such as lending, gaming, and voting. Early cryptocurrencies faced criticism because of the potential for their use in illegal activities, their volatility, and a lack of identifiable infrastructure. However, these negatives were outweighed by their positive qualities of portability (especially across borders), divisibility (you can buy less than one Bitcoin), transparency, and most of all, their popularity.
Although cryptocurrency is still young as an asset class, today it is receiving greater acceptance by the financial community. Publicly-traded corporations have announced large purchases of Bitcoin and other cryptocurrencies, deeming them a necessary diversification, and potentially a better store of value than cash.
Large banks, hedge funds, insurance companies, and institutions that have recently announced their participation in the cryptocurrency market include Fidelity, JP Morgan, Grayscale, Mass Mutual, PayPal, and Square. Michael Saylor, CEO of MicroStrategy, has generated a lot of institutional interest recently through his enthusiastically-shared belief that Bitcoin is "an institutional-grade safe-haven asset."
How Is Cryptocurrency Used?
A primary use case for cryptocurrency is to make secure, online payments. Cryptocurrency can streamline payment processing and lower transaction costs. However, for technical reasons, including a dependency on the consumer having a "smart device," and the fact that transactions are not always immediately confirmed, widespread adoption of paying for goods with cryptos has faced some challenges. If you want to go into a store and buy something with your cryptocurrency, there are few places set up to do that - but it is becoming more common.
In some African countries where a large portion of the population is unbanked, people are using cryptocurrencies to bring commerce to areas that previously had no way to send or receive funds. In China, you can be hard-pressed to find anyone who will accept cash. Even street vendors selling vegetables will only take digital payments using your phone!
Using cryptocurrency for cross-border payments can be life-changing for many people. If you've ever tried to send money from one bank to another bank, or to a person or business in another country, you know how slow the traditional currency transaction system is. It can take days or even weeks to send funds, and can cost a substantial sum - migrant workers can be charged up 20% of their hard-earned paychecks to send money to family members in another country through a traditional service. In contrast, cryptocurrency can be transferred from one person to another within seconds or minutes for almost nothing.
Another use case for cryptocurrency includes acting as a vehicle for short-term or long-term investments. Altcoins are particularly popular with traders looking for short-term trades fueled by high volatility. As a store of wealth, Bitcoin has even been called "digital gold."
Where Do I Keep Cryptocurrency?
Once you have purchased some cryptocurrency, you can either keep it in your crypto wallet or allow a third-party custodian to hold on to it for you. Most cryptocurrency experts recommend that you hold and manage your own coins in a crypto wallet. There is a saying among cryptocurrency experts: "If you don't own your keys, you don't own your crypto."
As the cryptocurrency market matures, traditional and nontraditional financial institutions are creating ways to invest in crypto without having to maintain your own crypto wallet or control your own cryptographic keys. Some crypto exchanges just manage your wallet for you, and some others manage a large pool of cryptocurrency where they may mingle "your" cryptocurrency with the rest of their customers' crypto inside their fund. These third-party fund managers require you to trust them with your investment. Although cryptocurrency was created to make "trust" unnecessary, and instead allow you to be your own bank, trusted custodians are an option for people who do not feel comfortable with the technology required to hold their own cryptocurrency.
Is Cryptocurrency a Safe Investment?
We cannot give you investment advice - only advice about security.
Every investment carries risk, and some experts claim that cryptocurrency is one of the riskier choices. But it also has unique risk characteristics that may aid a diversification strategy, and many experts believe that cryptocurrency is the future of money. Before you get into the market, there are steps that you can take to keep your investment safer.
Volatility (big swings in price/value) can make cryptocurrencies unnerving for newcomers. It's essential to do your own research and to never invest more than you can afford to lose. That said, the risk-to-reward ratio of many cryptos is unlike that of any other investment.
As with everything, stay away from any offer that looks too good to be true. We all know there are hackers and scammers on the internet, and of course, they show up in the crypto space. It's unfortunate, but not exclusive to crypto. There have been many Ponzi schemes in the stock market. Some rich, brilliant people fell for Bernie Madoff's scheme. So why should crypto be any different? Get informed about the threats out there, and protect yourself with that information.
How Do I Secure Cryptocurrency?
The best way to secure your cryptocurrency is to put it into a crypto wallet. There are a few different types of crypto wallet that may be best suited for your investment and exchange needs. You should spend a few minutes learning about them before deciding which type is right for you. see "What is a Crypto Wallet?"
Where Can I Buy Cryptocurrency?
In recent years, cryptocurrencies have become much easier and safer to exchange and store. There are a few ways to buy cryptocurrencies directly: you can buy it on an exchange, inside a self-directed IRA, or with one of many cash apps. If you buy from an IRA, or a cash app, you may not be able to take that crypto from the exchange to store it for yourself.
Learn more in "How to buy cryptocurrency".