The gist
- A cryptocurrency is an entry on a public ledger that many computers keep in sync; whoever controls the private key controls the coins.
- A coin price is set by trading on many separate platforms and says nothing about value on its own: supply and market value matter more.
- Custody failures, irreversible mistakes, scams and extreme volatility are the risks that long-term holders need to plan for.
How crypto works comes down to one idea: instead of a bank keeping the record of who owns what, thousands of computers keep identical copies of a shared ledger and agree, through a set of rules, on which new entries to add. Everything else, from wallets to exchanges to stablecoins, is built on top of that ledger. This long read goes layer by layer.
The ledger
A blockchain is a ledger organised into blocks. Each block lists recent transactions and contains a fingerprint of the block before it, so changing an old entry would mean redoing every block since. The network's participants follow a consensus method to decide who adds the next block. Bitcoin uses proof of work, in which miners spend electricity solving puzzles; Ethereum uses proof of stake, in which validators lock up coins as a guarantee of good behaviour.
The result is a record that anyone can read, nobody controls alone and nobody can easily rewrite. That is its strength. It is also why mistakes are permanent: there is no customer service desk for a blockchain.
Keys, addresses and wallets
Ownership on a blockchain is proven with cryptography. You have a private key, a very large secret number, and a matching public address that others can send coins to. Signing a transaction with the private key proves you are allowed to move the coins at that address.
A "wallet" does not hold coins. The coins stay on the ledger. The wallet holds keys. Most wallets turn the key into a recovery phrase of 12 or 24 words; anyone who has those words can take everything, from anywhere, without your permission.
| Where your crypto sits | Who holds the key | Main risk |
|---|---|---|
| On a trading platform | The platform | The platform fails, freezes withdrawals or is hacked |
| Phone or browser wallet | You | Malware, phishing, a lost phone without a backup |
| Hardware wallet | You, on a dedicated device | Losing both the device and the recovery phrase |
Leaving coins on a platform is convenient and removes the risk of losing your own key, but it replaces it with the risk that the platform is not what it claims. Several large crypto platforms have collapsed with customer assets missing. Self-custody removes that risk and hands you full responsibility instead.
Coins, tokens and stablecoins
- Coins are native to their own blockchain: bitcoin on Bitcoin, ether on Ethereum. They are used to pay transaction fees on that network.
- Tokens are created by software running on someone else's blockchain. They can represent almost anything: a voting right in a project, a game item, a claim on another asset.
- Stablecoins are tokens designed to hold a fixed value, usually one US dollar, backed by reserves held by an issuer. USDT is the largest; our USDT explainer covers how it works and where it can fail.
Bitcoin deserves its own page because of its fixed supply schedule and history; see what is Bitcoin.
What sets a coin price
A coin price is simply the last price at which buyers and sellers agreed on a given platform. Because crypto trades on hundreds of platforms at once, there are hundreds of slightly different prices; data sites publish averages. The price moves with demand and supply, and demand is driven heavily by sentiment, liquidity and news, because most tokens produce no earnings to anchor them.
A common beginner error is to think a coin priced at a few cents is "cheap" and one priced in thousands is "expensive". The price per unit means little without the number of units. Consider an illustrative token priced at $0.50 with 1 billion units in circulation. Its market value is 1,000,000,000 × $0.50 = $500 million. If its rules allow 10 billion units eventually, the fully diluted value at the same price is $5 billion. For that token to reach $5 each, the market would have to value it at $5 billion on today's supply, or $50 billion once all units exist. The unit price hides that.
Volatility is the other thing to absorb. Suppose, for illustration, you buy 0.05 BTC at $60,000, paying $3,000. A 30% fall, which crypto markets have delivered many times, leaves it worth $2,100. Our crypto profit calculator shows the effect of fees on either side of a trade.
How crypto works on a trading platform
Most people buy crypto through a centralised platform. You verify your identity, send money in, and trade against an order book much like a stock exchange's. The coins you buy usually stay in the platform's own wallets, and your balance is a figure in its database until you withdraw to an address you control.
Decentralised exchanges work differently: you connect your own wallet and trade against pools of tokens run by smart contracts. There is no account and no custody by a firm, but there is software risk, since a flawed contract can be drained, and there is no one to appeal to.
Fees appear at every step: trading fees on the platform, a spread, a fee for withdrawing to your own wallet and the blockchain's own network fee. The trading fees guide walks through a full round trip.
Staking and lending
Some platforms offer a yield on crypto held with them. On proof-of-stake networks this may come from staking, where coins are locked to help validate blocks and earn a share of new issuance and fees. Elsewhere it comes from lending your coins to other traders or institutions. Either way, the return is payment for taking a risk: coins may be locked for a period, a validator can be penalised for misbehaving, and a borrower or the platform itself can fail. Several crypto lenders have frozen customer withdrawals in the past. A yield figure on a screen says nothing about how safe it is.
Rules and protections
Crypto regulation is uneven. The EU's Markets in Crypto-Assets regulation now licenses service providers across the bloc; the UK requires firms to register for anti-money-laundering purposes and bans the sale of crypto derivatives to retail consumers; other countries range from strict to almost absent. Deposit insurance that protects bank savings does not normally cover crypto held on a platform. Before using any platform, check that it is authorised where you live, using the regulator's own register; our checklist on choosing a broker or platform explains how.
A long-term view of crypto risk
If you decide crypto has any place in your finances, the questions below are the ones long-term holders ask first:
- Could I cope if this fell 80%? Several major coins have fallen that far from their peaks more than once.
- Where are the keys? If on a platform, what licence does it hold and has it published evidence of its reserves?
- Is my backup safe from fire, theft and me? A recovery phrase written down once and stored securely is better than a screenshot.
- Who told me about this coin, and what do they gain? Promoters, influencers and "mentors" are often paid, and crypto is the favourite vehicle of investment fraud; read how to spot trading scams.
One more habit costs nothing: keep records. Note the date, amount, price and fee of every purchase, sale and transfer. Many tax authorities treat selling or swapping crypto as a taxable event, and reconstructing years of transactions from platform exports, some of which may no longer exist, is far harder than keeping a simple log from the start.
Reader questions
Can a blockchain transaction be reversed?
Generally no. Once a transaction is confirmed, the only way to get the coins back is for the recipient to send them. That is why sending to a wrong address or a scammer is usually permanent.
Is a low coin price a sign that a coin has room to grow?
No. The price per unit depends on how many units exist. Multiply the price by the circulating supply to get market value, and compare that with the fully diluted value if more units will be created.
Is crypto on a platform covered by deposit insurance?
Usually not. Bank deposit insurance schemes typically cover cash deposits at banks, not crypto-assets held by a trading platform. Some platforms advertise their own insurance; read exactly what it covers.
Sources
- European Union, Markets in Crypto-Assets Regulation (MiCA)
- UK Financial Conduct Authority, crypto-asset registration and retail crypto-derivatives ban
- Bitcoin whitepaper, Satoshi Nakamoto (2008)