Three points to keep
- A cryptocurrency is an entry on a shared ledger, and whoever controls the private key can move it; there is no bank to reverse a mistake.
- Exchanges hold keys on your behalf, which is convenient but turns your coins into a claim on the exchange.
- Prices are driven by supply rules, demand and sentiment, with no earnings behind most tokens, so large falls are normal.
How crypto works can be summarised in one idea: instead of a bank keeping a private record of who owns what, a network of computers keeps a public record that anyone can check and no single party can quietly change. Everything else, from wallets to mining to stablecoins, is machinery built around that shared ledger. This guide goes through the machinery in the order a transaction touches it.
The ledger and the blocks
A blockchain is a ledger split into blocks. Each block lists recent transactions and contains a cryptographic fingerprint of the block before it, so altering an old entry would change every fingerprint after it and be rejected by the network. Thousands of independent computers, called nodes, keep full copies and check every new block against the rules.
Someone has to propose each new block. Two main methods decide who:
- Proof of work (used by Bitcoin): miners spend computing power searching for a valid block. The winner earns newly issued coins plus fees. Rewriting history would require outspending the rest of the network.
- Proof of stake (used by Ethereum since 2022): validators lock up coins as a bond and are chosen to propose and attest blocks. Dishonest behaviour can cost them part of that bond.
Keys, addresses and wallets
Ownership on a blockchain is not recorded by name. Coins sit at an address, and moving them requires a digital signature made with the matching private key. Whoever has the key can move the coins; whoever loses it loses access permanently.
A wallet is software or a device that stores keys and signs transactions. It does not store coins, which always stay on the chain. Wallets come in a few forms:
- Custodial: an exchange or app holds the keys. You log in with a password; recovery is possible, but you depend on the firm's security and solvency.
- Self-custody software wallets: keys live on your phone or computer, backed up by a recovery phrase of 12 or 24 words.
- Hardware wallets: keys live on a dedicated device that signs transactions without exposing the key to your computer.
How crypto works when you press send
- Your wallet builds a transaction: the recipient's address, the amount and a fee.
- It signs the transaction with your private key and broadcasts it to the network.
- The transaction waits in a pool with others. Block producers generally pick the ones paying higher fees first.
- Once included in a block, it has one confirmation. Each later block adds another and makes reversal less likely.
Two practical consequences follow. First, transfers cannot be cancelled once confirmed, and there is no chargeback. Second, the network you send on must match the network the recipient expects: a token sent on one chain to an address expecting another may be unrecoverable. Stablecoins such as USDT exist on several networks, which makes this mistake common.
Coins, tokens and stablecoins
A coin is native to its own blockchain: bitcoin on Bitcoin, ether on Ethereum. A token is created by a smart contract running on an existing chain and follows that chain's rules. Tokens can represent almost anything, from a governance vote to a claim on an off-chain asset.
Stablecoins are tokens designed to hold a steady value, usually one US dollar. The large ones are issued by companies that say they hold reserves to back each token. Their stability depends on those reserves and on the issuer honouring redemptions, which is a very different kind of risk from bitcoin's price swings.
Exchanges: where most people meet crypto
Most people buy crypto through a centralised exchange. You deposit money, the exchange credits your account, and trades happen in the exchange's internal order book; nothing touches the blockchain until you withdraw. Deposits and withdrawals are the only moments your coins actually move on-chain.
That model is efficient, but it concentrates risk. Exchanges have been hacked, have frozen withdrawals and have collapsed with customer assets missing. Licensing and supervision now exist in several jurisdictions, including the EU's MiCA framework, but coverage is uneven and compensation schemes rarely apply. Checking a platform covers what to look for.
Decentralised exchanges replace the order book with smart contracts and let you trade from your own wallet. That removes the custodian but adds contract risk, and you carry full responsibility for every transaction you sign.
Using crypto for payments
Some merchants let you pay with crypto directly, and some card products convert crypto to local currency at the till. It is worth knowing what happens underneath. With a direct payment, you send coins from your wallet and pay a network fee; the transfer is final. With a crypto card, the provider sells your coins when you spend, which can be a taxable disposal in many countries and usually involves a conversion spread. Stablecoins are more common than volatile coins for payments, because neither side wants the price to move between invoice and settlement.
Staking, lending and "yield"
Platforms often advertise a percentage return for holding coins. It is worth tracing where that return comes from, because it decides the risk.
- Staking rewards on proof-of-stake networks come from newly issued coins and fees paid to validators. You are paid in the same coin, so a falling price can outweigh the reward, and staked coins may be locked for a period.
- Lending yields come from borrowers, often traders using leverage. If borrowers or the platform fail, lenders can lose principal; several crypto lenders have collapsed with customer funds frozen.
- Liquidity-pool fees on decentralised exchanges come from traders. Providers of liquidity are exposed to price divergence between the pooled tokens and to smart-contract bugs.
A useful rule: if the source of the yield cannot be explained in a sentence, or the rate is far above what regulated savings pay, assume the risk is correspondingly higher.
What moves crypto prices
Most tokens produce no earnings, so there is nothing like a company's profits to anchor their value. Prices are set by supply rules (fixed caps, issuance schedules, token unlocks), demand from users and investors, liquidity, regulation and sentiment. That is why daily moves of several percent are ordinary and falls of more than half from a peak have happened repeatedly, including in bitcoin.
An illustrative cost check
Buying $500 of a coin with a 0.1% trading fee costs $0.50 on the way in, and the same rate applies on the way out. A spread of a few tenths of a percent, a withdrawal fee and any card or conversion charges can add more than the headline trading fee. Our crypto profit calculator shows how fees on both sides move your break-even price.
Liquidity matters too. Large coins trade on many venues with deep order books; small tokens may trade on only a few, where one large sell order can move the price sharply and the displayed price may not be achievable in size.
Risks that remain with the holder
- Volatility: prices can fall sharply with no floor.
- Custody: lost keys are permanent; exchange failures can lock balances.
- Operational mistakes: wrong address, wrong network, malicious approvals.
- Regulatory change: rules on exchanges, stablecoins and tax continue to evolve.
- Scams: fake platforms, impersonation and "guaranteed return" schemes are widespread.
Next, see what bitcoin is and how its supply works, or compare crypto with other markets in financial markets explained.
Reader questions
Is crypto anonymous?
Most blockchains are pseudonymous rather than anonymous. Addresses are not labelled with names, but every transaction is public, and exchanges that verify identity can link addresses to people.
What happens if I send crypto to the wrong address?
A confirmed blockchain transaction cannot be reversed by the network. If the address belongs to an exchange or a person who cooperates, they may return it; otherwise the coins are usually lost.
Can I pay with crypto in ordinary shops?
A minority of merchants accept crypto directly, often through a payment processor that converts it instantly. Crypto debit cards are more common; they sell your coins at the point of sale, which can trigger fees and tax.
Sources
- UK Financial Conduct Authority, ban on sale of crypto-derivatives to retail consumers
- European Union, Markets in Crypto-Assets Regulation (MiCA)
- Bitcoin whitepaper (Satoshi Nakamoto, 2008)
- Ethereum Foundation documentation on proof of stake