The short version
- A cryptocurrency is a balance recorded on a shared public ledger called a blockchain.
- Whoever controls the private key controls the coins; platforms that hold keys for you add their own risk.
- Prices are driven by demand rather than profits, so large swings in both directions are normal.
To understand how crypto works, forget about coins as objects. Nothing is stored in your phone or wallet except a secret number. What exists is a shared record, copied across thousands of computers, stating which addresses hold which balances. Sending crypto means asking that network to update the record, and proving with your secret number that you are allowed to.
The blockchain: a shared ledger
A blockchain is a list of transactions grouped into blocks, each linked to the one before it by a cryptographic fingerprint. Change an old transaction and every fingerprint after it breaks, which makes tampering obvious. Copies of the ledger are held by many independent computers (nodes), so there is no single database for anyone to edit or switch off.
The network needs a way to agree which new block comes next. Bitcoin uses proof of work: miners spend electricity solving a puzzle, and the winner adds the block and collects newly issued coins plus fees. Ethereum and many newer networks use proof of stake: validators lock up coins as collateral and can lose part of them if they misbehave. Both approaches make it expensive to cheat.
Keys, addresses and wallets
Every crypto account is built on a pair of keys. The private key is a secret number that authorises spending. The public address, derived from it, is what you share so others can pay you. A "wallet" is simply software or a device that stores the private key and signs transactions for you.
- Custodial: a platform holds the keys and shows you a balance. Convenient, but you depend on that firm staying solvent and honest.
- Self-custody: you hold the keys, usually backed up as a 12 or 24-word recovery phrase. No firm can freeze or lose your coins, but if you lose the phrase, or someone else sees it, the coins are gone for good.
No genuine support team will ever ask for your recovery phrase. Anyone who does is trying to steal from you; see our scam guide.
Coins, tokens and stablecoins
A coin is the native asset of its own blockchain, such as bitcoin on Bitcoin or ether on Ethereum; it pays for transaction fees on that network. A token is created by a program (a smart contract) running on an existing blockchain. Tokens can represent almost anything: voting rights in a project, points in a game, or a claim on a dollar.
Stablecoins are tokens designed to hold a steady value, usually one US dollar, backed by reserves the issuer says it holds. They are widely used to move money between platforms. Our guide to USDT explains how the largest one works and where it can fail. For the original cryptocurrency, see Bitcoin explained simply.
How a transfer works, step by step
- You enter the recipient's address and the amount in your wallet.
- The wallet signs the transaction with your private key and broadcasts it to the network.
- The transaction waits, with others, to be included in a block. A higher fee usually means faster inclusion.
- Once included, it gains confirmations as further blocks are added on top. Platforms receiving deposits typically wait for a set number of confirmations.
There is no "undo". If you send to the wrong address, or on the wrong network, recovering the funds depends entirely on whoever controls the receiving address.
Where crypto companies fit in
Blockchains themselves are run by open networks, but most people touch crypto through businesses. Crypto companies include trading platforms that match buyers and sellers, custodians that hold keys for clients, wallet developers, payment processors, mining firms and stablecoin issuers. Some are regulated in their home country; many operate across borders with light oversight.
This matters because the biggest crypto losses for ordinary users have often come not from blockchains failing but from the companies around them: platforms that mixed customer funds with their own, lent them out or were hacked. Before trusting any firm, check whether it is authorised by your own regulator and how client assets are held. Our checklist on choosing a platform applies here too.
What drives prices
A share can be valued against the profits of a business. Most crypto-assets have no profits to point to, so their price rests on supply rules, adoption and sentiment. That produces large swings. As an illustration, if a coin falls 40% and then rises 40%, you are not back to where you started: $100 becomes $60, and then $84, a 16% loss overall.
Leverage multiplies this. In the UK and EU, retail leverage on crypto CFDs is capped at 2:1, and in the UK the sale of crypto-derivatives to retail consumers is banned outright. Platforms elsewhere may offer far more, which is one reason liquidations are so common.
Staking, lending and "yield" offers
Many platforms advertise a return for depositing crypto. The source of that return varies. Staking rewards come from a proof-of-stake network paying validators for securing it; they are paid in the same token, whose price can fall faster than the reward accumulates. Lending products pass your coins to borrowers, which means you now depend on those borrowers and on the platform's risk management. Several large crypto lenders have collapsed, leaving depositors waiting years for partial repayment or receiving nothing.
Before accepting any yield, ask: where does the return come from, who holds the coins, can I withdraw at any time, and what happens if the platform fails? A high fixed rate with vague answers is a reason to walk away.
A checklist before your first purchase
- Can you explain, in your own words, what the asset is and why anyone would want it?
- Have you decided the maximum you are prepared to lose, and is it money you do not need?
- Is the platform you plan to use authorised in your country, and how does it hold client assets?
- Do you know how you will store the asset, and have you practised with a small test transfer?
- Have you checked the total cost, including spread, trading fee and withdrawal fee?
- Do you know how gains will be taxed where you live?
If any answer is "no", pause. Nothing about crypto requires you to buy today.
Crypto and the rest of your portfolio
For someone whose main goal is long-term saving, crypto raises a sizing question more than a selection question. Because prices can fall by most of their value, many people who choose to hold any keep it to a small portion of their overall investments, an amount whose total loss would be painful but not life-changing. It is also worth knowing that crypto has at times fallen at the same moments as shares, so it cannot be relied on to cushion a stock market decline. Build the foundations first: an emergency fund, no expensive debt and a diversified core such as a broad index fund.
Tax, records and practical habits
In many countries, selling, swapping or spending crypto can create a taxable gain. Keep a record of every purchase, sale, fee and transfer, including dates and values in your home currency. Other sensible habits: start with small test transfers, double-check addresses character by character, turn on two-factor authentication, and be wary of anything that promises fixed returns.
To see what a trade actually made after fees on both sides, use the crypto profit calculator.
Reader questions
Is crypto money or an investment?
It can be used as either, but most people buy it as a speculative asset. Its price is volatile and it produces no income by itself, which is very different from a share or a bond.
Can a blockchain be hacked?
Large, established blockchains have proved very hard to alter. Most thefts target people and platforms instead: stolen recovery phrases, fake apps and hacked trading services.
Do I need a platform to own crypto?
No. You can hold crypto in a self-custody wallet, although most people use a platform to buy it first. Self-custody removes platform risk but makes you fully responsible for your keys.
Sources
- UK Financial Conduct Authority, ban on the sale of crypto-derivatives to retail consumers (2021)
- European Securities and Markets Authority, CFD product intervention measures