What is a cryptocurrency?
A cryptocurrency is a digital currency that can be used to buy or sell products and services online. It is designed to be secure and, usually, anonymous.
As most cryptocurrencies are decentralised, it means that they have no single overarching authority controlling them, as opposed to the centralised banking systems by which most traditional currencies (such as USD or GBP) are controlled. This enables many cryptocurrencies to exist independently from the influence of governments and financial institutions, which is a key part of their attraction.
Cryptocurrency transactions and balances are verified and recorded using a virtual global ledger, known as a blockchain. Each type of cryptocurrency has its own blockchain. So bitcoin uses the bitcoin blockchain. Each block in a blockchain contains details of balances and transactions to certify the legitimacy of sales and purchases. Once a transaction is added to the ledger it can not be reversed. The blockchain is corroborated across a vast number of computers around the world, making it exceptionally hard to manipulate or hack.
Blocks are added to the blockchain by 'miners', which are high-powered computers on the network. When a miner manages to add a block to the blockchain, by solving an incredibly complex mathematical problem, they receive a reward in coins. On the bitcoin blockchain, that reward is currently 3.125 new bitcoins. On top of that, miners are paid a small fee (worth fractions of a bitcoin, for example) for including transactions on the newly created block. These transactions fees vary based upon demand because the blockchain has a limited capacity at any one point. The fees are used to help maintain the integrity of the network.
That is why blockchain-based cryptocurrencies are touted for their enhanced security. Also, as no one person or entity owns the database it mitigates against it from being manipulated for personal gain.
Cryptocurrency prices are not usually pinned to a physical asset (like gold, for example) so they have no intrinsic value. Their value is determined by supply and demand, making the price of most cryptocurrencies particularly temperamental, unpredictable, and largely at the mercy of public perception.
What are the different types of cryptocurrency?
There are three main 'types' of cryptocurrency. Although cryptocurrency does not start and end with bitcoin, it does make up a large proportion of the cryptocurrency market, so we will start by explaining what a bitcoin is before we delve into the other two.
Bitcoin
It would be quite hard not to have heard about bitcoin by now. Bitcoin was the world's first cryptocurrency and is the most popular type of cryptocurrency. Despite initial apprehension, the world of finance is increasingly starting to view it as a legitimate alternative to traditional money.
Founded in 2009 under the name 'Satoshi Nakamoto' (later revealed to be a pseudonym for an unknown individual or group), bitcoin has surged to the forefront of a technological revolution. Initially used as the primary payment service on the dark web, bitcoin has hit the mainstream in recent years, and increased demand has sent its value skyrocketing.
As of November 2024, a single bitcoin is worth almost $100,000. Impressive as that is, this comes after a 45% fall in its value in a matter of weeks in 2021, demonstrating how volatile its price is.
Altcoins
Altcoins are essentially all the other cryptocurrencies that are not bitcoin. Once bitcoin was launched in 2009, it paved the way for thousands of alternatives, most of which operate in a similar way to bitcoin itself. There are close to a thousand altcoins in existence today.
Like bitcoin, all altcoins are able to operate independently from banks and financial institutions on their own networks. Litecoin, for example, is a peer-to-peer currency and global payment system similar to bitcoin, while ethereum boasts the world’s first programmable blockchain and enables developers to build and deploy decentralised apps and smart contracts. In short, this means that the ethereum blockchain, unlike other blockchains, can be used as a ledger for other assets, not just ethereum coins (known as ether). This opens up opportunities of tokens, as explained in the next section. Other altcoins include the popular dogecoin.
The value of different altcoins can vary vastly, however. A single ether is worth just over $3,300 as of November 2024, but litecoin is worth barely over $90.
Tokens
A token can be used as a form of payment like bitcoin, but the main use of a token is to represent tradable assets or utilities within the wider ecosystem of its parent blockchain. To explain that in simple terms, firstly you must bear in mind that each cryptocurrency operates on its own blockchain (i.e. has its own online ledger of transactions). That means bitcoin operates on the bitcoin blockchain, litecoin operates on the litecoin blockchain, ether operates on the ethereum blockchain and so on.
The ethereum blockchain is what is known as a smart contract blockchain that enables other assets (and not just ether) to be tracked and traded on it. This is where tokens come in. Tokens don't have their own blockchain, they have to operate on an already existing smart contract blockchain like ethereum. Tokens can be created to represent all sorts of things and have a value of their own.
For example, the cryptocurrency exchange platform Binance has a token that allows users to trade cryptocurrency on their system with a 50% reduced fee. But, more interestingly, tokens can be used as a digital representation of a real-world asset such as a share certificate or a property or a piece of art.
This opens up the possibility of creating a token (which is relatively easy to do) on something like the ethereum blockchain to represent a physical asset that you own. Some people even predict that the future will see the house buying process sped up by the wide use of tokens to buy and sell property. You will probably have heard about NFTs (non-fungible tokens), which are are tokens that usually represent unique assets, such as a property or piece of art.
By contrast, a fungible token will represent an asset that is not unique, such as a share certificate. One share certificate for a stake in Apple is exactly the same as another Apple share certificate and therefore interchangeable. In this instance, someone who has 100 (fungible) tokens each representing an Apple share will own 100 Apple shares.
When tokens are created or traded a fee has to be paid to the miners of the blockchain to record the transaction, just as when you trade a cryptocurrency. As this blockchain will usually be the ethereum blockchain (the bitcoin blockchain won't work for anything other than bitcoin transactions) this fee will be paid in ether.
It follows that a token could be used to represent a currency such as the US dollar. These types of token already exist and are called stablecoins. Examples include tether and USDC. The value of one of these stablecoins always equals $1, which makes them a 'stable cryptocurrency' and more useful when making transactions. The biggest drawback of most true coins like bitcoin is that their volatile value makes them less likely to become a mainstream way of paying for things in the wider economy.
What is a cryptocurrency wallet?
To use cryptocurrencies you need a digital wallet, which you can think of as like a bank account.
Every wallet has two keys: a public key and a private key. The public key is used to provide a unique address for the wallet, which works in a similar way to a bank account number and sort code on a traditional bank account. With that information, people can pay coins into the wallet. Essentially, the blockchain is just a list of transactions between different wallets. It doesn't record who owns each wallet. If you want to spend the money in a wallet you have to prove you own it. Think of it as entering the pin number when making a transaction from a traditional bank account.
How you do that is with the unique private key (which is just a very long string of seemingly random letters and numbers) that is associated with the public key for the wallet. Again, it is a similar concept (albeit more secure) to having to enter the correct pin number for your credit card when you go shopping. If you enter a number not associated to that credit card it won't work. Similarly, there is usually only one private key associated with each public key.
That's why it is important to know what your private key is. Unlike current accounts where bank staff can unlock your card if you forget the pin, cryptocurrencies are decentralised and the only way of proving ownership is with the private key. If you eventually forget that private key or lose it, the coins in the wallet will become worthless as they cannot be spent.
To be technically correct, coins don't actually live in a digital wallet. They are technically stored on the blockchain. Your wallet is your means of interacting with the blockchain. The blockchain contains the information to determine the number of bitcoins associated with a wallet address and your private key is your mechanism for proving ownership and then using those coins.
Wallets can be held in software (either online or on your computer or in an app) that is connected to the internet and known as a 'hot' wallet. Alternatively, you can have a wallet on a physical device not connected to the internet (such as a piece of hardware like a USB stick) or in paper format (essentially the private key is not stored on a device but written down). These last two are known as 'cold' wallets because they are offline and are less vulnerable to compromise than hot wallets.
Given the importance of securely knowing your private key, some digital wallets provide a backup means of recovering your private key using something called a seed phrase. This is a list of up to 24 random words (which you need to note elsewhere) that can be used to recover your private key.
Some people simply use a wallet provided by the cryptocurrency exchange (more on those later) in order to trade or use bitcoin and other cryptocurrencies. But do beware when using any online option such as this, as concerns have been raised about some not providing users with the details of their private key, instead just storing this information on the platform which can't be viewed by the user. That could potentially prove problematic as the private key is your only means of proof of ownership. If the exchange is hacked and the key compromised then theoretically your coins can be stolen.
So while the bitcoin infrastructure is secure, the software and exchanges that you may use to interact with it will always be a potential weak point. It is, for this reason, usually advisable to have a wallet that is separate from the cryptocurrency exchange that you use.
For more details on what cryptocurrency wallets are, and which type would be best for you, read our article 'What is a cryptocurrency wallet?'.
Where can I buy cryptocurrency?
Just like when you buy and sell shares to funds you need an investment platform like Hargreaves Lansdown, when you want to trade/buy a cryptocurrency you need to use a cryptocurrency trading platform. There are a number of companies that you can use to buy cryptocurrency, but each platform has its own unique attributes which affect your trading experience.
You can find our top picks on our '5 best crypto exchanges in the UK for hassle-free trading' and read our independent reviews of Coinbase, Gemini and Kraken for more information on their fees, security and features.