What is cryptocurrency? And how do you invest in it?

Time will tell if crypto is the way of the future, but as more investors, companies and countries start taking it seriously, now is a good time to learn about this new asset class—and the investing opportunities it represents.

Here’s your essential guide to cryptocurrency, and what to look for if you’re thinking about investing.

What is cryptocurrency?

Cryptocurrency is a form of currency that exists digitally, or virtually. Individual units of cryptocurrency are referred to as coins or tokens.

The world’s first cryptocurrency, bitcoin, was created to facilitate peer-to-peer digital payments—meaning money transfers without the involvement of a central authority or other intermediaries, such as banks or credit unions. With cryptocurrencies, you can send and receive value to and from anyone and anywhere in the world using nothing more than a computer and an internet connection.

What are crypto consensus mechanisms?

Blockchains—the digital ledgers underlying cryptocurrencies—use consensus mechanisms to prevent people from “double spending” their coins, which would devalue a currency. 

The two main consensus mechanisms are the proof-of-work (PoW) model and the proof-of-stake (PoS) model. These are different approaches to “mining,” or creating, digital coins, but they both verify blockchain transactions and maintain security. (More on blockchain technology below.)

• Proof-of-work (PoW) is used widely in cryptocurrency mining to validate transactions and mine new coins. To participate, miners use specialized computers to solve complex math puzzles in order to create a new “block” of verified transaction data, which is then added to the crypto’s blockchain. Whoever solves the puzzle first gets a reward. Bitcoin uses the PoW consensus mechanism.
• Proof-of-stake (PoS) is a more energy-efficient alternative to PoW, used to validate a blockchain and add new blocks. To participate, miners stake, or lock in, their coins in the hopes of being selected to validate blocks of transactions. Validators are chosen at random, removing the competitive aspect of the PoW process. Ethereum is currently transitioning from a PoW model to a PoS model, a dramatic change that will cut ETH’s energy usage by as much as 99%.

What is blockchain technology?

Blockchain is the technology that securely and permanently records peer-to-peer crypto transactions. It works as a digital ledger, “distributed” or shared via a network of computers.

“[Blockchain is] most notable for being the foundation for cryptocurrencies, but because of its decentralized nature, encryption and immutability—meaning every transaction or change is permanently recorded on the ledger—blockchain technology has found use in voting, payments, transferring assets, proof of ownership, contracts and more,” says Mark Connors, head of research at Canadian investment fund manager 3iQ Corp Digital Asset Management, in Toronto.

Blockchain allows users to send money anywhere in the world without paying an intermediary, like a bank or wire service, to convert the currency or handle the transaction process.

“Once a transaction is recorded on blockchain, its decentralized nature and cryptographic algorithm make it virtually impossible to tamper with it,” says Connors. Cryptography refers to techniques used to keep information and communications secure and private, limiting access to just the sender and recipient.

How is crypto used?

Crypto adoption is still in its early stages, and crypto coins are not widely used as currency—at least, not yet. However, companies worldwide are increasingly interested in these new digital assets, using them for investment products, money transfers and business transactions. It’s also used in decentralized applications (dApps), which offer crypto-enabled financial products and services, such as lending, insurance and smart contracts.

“The primary use for cryptocurrencies is a method of storing value and sending and receiving payments at low cost and high speed, with no intermediaries, unlike current payment rails,” Connors says. He adds that ultimately, cryptocurrencies could be used for any financial transaction.

What are altcoins?

Since the launch of bitcoin (BTC for short) in 2009, thousands of other crypto coins have appeared, with many of their developers trying to improve on bitcoin’s features and functionality. These are collectively referred to as “altcoins,” or alternatives to bitcoin.

BTC is still the most dominant digital coin, in terms of both size and adoption—it accounts for about 40% of crypto’s market capitalization. Bitcoin is followed by ether (ETH), the native coin of the Ethereum blockchain. Other cryptocurrencies gaining traction and market value include ADA (Cardano blockchain), SOL (Solana), LTC (Litecoin), XLM (Stellar), MATIC (Polygon), DOT (Polkadot), USDC (USD coin) and AVAX (Avalanche), as well as the memecoins DOGE (Dogecoin) and SHIB (Shiba Inu).  

“Cryptocurrencies differ in their underlying cryptography, technology and networks, but what they do have in common is they all provide utility as a digital or virtual currency alternative to traditional fiat currency,” asserts Connors.

Today, the crypto market is flooded with thousands of different digital coins. Some crypto investors prefer to stick to “blue chip” coins such as bitcoin, ethereum and cardano. Others may be drawn to smaller, less established coins, including memecoins such as dogecoin and shiba inu.

“The most important thing to keep in mind before investing in any cryptocurrency is to do your research and understand the inherent risk in any type of investment, and ensure you are making an informed decision that is in line with your risk appetite,” says Connors.

Crypto risks to consider

Historically, one of the biggest risks for crypto investors has been price volatility. “While cryptocurrencies have been the best-performing asset class over the long term, prices can fluctuate wildly from week to week,” cautions Connors.

Crypto also has technological risks such as security breaches, hacks and heists, transfer errors and human errors—including the loss of private keys. Each of these events can lead to huge financial losses and trigger price volatility.

“If you buy cryptocurrency and hold it directly in your own wallet, you should safeguard your wallet from theft or loss by storing your private key in a secure place,” says Connors. “If you purchase your cryptocurrency via a crypto buying exchange and hold it via a third-party wallet, you have the risk of not directly owning your cryptocurrency and potential issues with accessing the crypto or being exposed to bad actors should the third party get hacked or collapse.” (Learn more about crypto wallets.)

Be sure to do your due diligence on the security controls of any exchange or third party you engage with, he adds.

Other crypto-related investments

Apart from directly buying crypto and holding it long-term, there are other ways to get into the crypto market. One of the fastest-growing areas of the blockchain economy is decentralized finance, or DeFi. As a friction-free, cheaper and faster alternative to the current financial system, DeFi is drawing attention and dollars from crypto investors. Here’s an excellent primer on DeFi and how to invest in it.

And then there are non-fungible tokens, or NFTs. Crypto’s newest growth frontier, NFTs are digital assets that range from art and music to fashion, sports memorabilia and virtual real estate. NFTs are now a multi-billion-dollar industry. Here’s a primer to help you understand how NFTs work.

Investors can gain indirect exposure to crypto through exchange-traded funds and stocks. 

Lastly, crypto investors can earn rewards for staking certain digital coins. Staking is the process of pledging or locking up crypto holdings in exchange for rewards or interest payments, typically in the form of additional coins. Learn more about crypto staking.

How to get started in crypto investing

If you want to buy crypto directly, a convenient and beginner-friendly option is to use a crypto trading platform.

When choosing a platform, look for one with strong security features, an easy-to-use interface and a range of currencies. One such option is CoinSmart, Canada’s first fully regulated crypto platform. The platform has a simple and transparent fee structure, and customer support is available 24/7. Its security features comprise two-factor authentication and offline cold storage.

Opening a CoinSmart account is straightforward, and investors can access their funds the same day they make a deposit. Sign up for an account* with the code money30 and you’ll receive CAD$30 in bitcoin when you deposit a minimum of CAD$100. 

Read more on crypto:

• What records do crypto investors need for taxes?
• Watch: 10 cryptocurrencies you need to know about
• Should you mine cryptocurrency?
• How to buy Polygon (MATIC) in Canada