The picture in three lines
- A cryptocurrency is an entry on a shared public ledger, and whoever controls the private key controls the coins.
- Exchanges hold coins for you unless you withdraw them; that is convenient but makes you a creditor of the exchange.
- Price swings are large, and losses are harder to recover from than they look: a 50% fall needs a 100% gain to get back.
How crypto works comes down to one idea: instead of a bank keeping a private record of who owns what, thousands of computers keep a shared public record and agree on every change to it. Coins are not files sitting on your phone. They are balances on that ledger, and the ability to move them depends on holding the right secret key.
The ledger: blocks and confirmations
A blockchain is a chain of blocks, each one a batch of transactions linked to the one before by a cryptographic fingerprint. Changing an old transaction would change its block's fingerprint and break every link after it, which the rest of the network would reject. That is what makes the history hard to rewrite.
Fig. 1 · What happens when you send crypto
- SignYour wallet signs the transfer with your private key.
- BroadcastThe signed transaction is sent to the network's nodes.
- IncludeA miner or validator adds it to a new block, usually picking the transactions paying higher fees first.
- ConfirmEach later block adds a confirmation; the transfer becomes practically irreversible.
Different networks agree on new blocks in different ways. Bitcoin uses proof of work, where miners spend computing power to earn the right to add a block. Ethereum and many newer networks use proof of stake, where validators lock up coins as a deposit they can lose if they cheat.
Keys and wallets
A wallet does not store coins; it stores the private key that proves you may move them, and it usually derives that key from a recovery phrase of 12 or 24 words. Anyone who sees the phrase can take everything, and if you lose it with no backup, nobody can restore access.
| Custodial (exchange account) | Self-custody (your own wallet) | |
|---|---|---|
| Who holds the key | The exchange | You |
| If you forget your password | Account recovery is usually possible | Only the recovery phrase can help |
| If the provider fails or freezes withdrawals | Your coins may be stuck or lost | Not affected |
| Main risk | The provider | Your own mistakes, phishing and malware |
Coins, tokens and stablecoins
- Coins are native to their own blockchain, such as bitcoin on Bitcoin or ether on Ethereum, and pay that network's fees.
- Tokens are created by programs, called smart contracts, running on an existing chain. Anyone can issue one, which is why so many exist and why many fail.
- Stablecoins are tokens designed to track a currency, usually the US dollar, backed by reserves the issuer says it holds. USDT is the largest example.
How crypto works on an exchange
An exchange matches buyers and sellers in an order book, much like a stock exchange, but it also holds customers' coins and cash. When you "buy bitcoin" on an exchange, your balance changes in the exchange's internal database; nothing moves on the blockchain until you withdraw. Most regulated exchanges ask for identity checks before you can deposit or withdraw.
Exchanges may also offer derivatives such as futures and perpetual contracts with high leverage. In the UK these cannot be sold to retail consumers, and in the EU crypto CFDs for retail clients are capped at 2:1. Our checklist for assessing a trading firm applies to crypto venues as well.
Crypto inside payment apps
Some payment and banking apps now let customers buy and hold crypto without joining an exchange, and PayPal crypto services are one well-known example in some countries. The convenience is real, but check three things before using any such feature: whether you can move the coins out to your own wallet, how much spread is built into the price you are shown, and whether the app's usual protections for payments apply to crypto holdings. Often they do not.
Where a crypto price comes from
There is no single official price for a coin. Each exchange has its own order book, and the "price" it shows is the last trade or the midpoint between the best bid and ask there. Price websites calculate averages across many venues. On large coins the differences between venues are small because traders buy where it is cheap and sell where it is dear, closing the gap. On small tokens with few buyers and sellers, the quoted price can be far from what you could actually sell a meaningful amount for. Always look at the depth of the order book, not only the last price.
Stablecoins and decentralised finance in brief
Beyond exchanges, many crypto activities happen through smart contracts known as decentralised finance, or DeFi: lending pools, automated trading venues and staking services that run without a company in the middle. They can be used directly from a self-custody wallet. The risks are different rather than smaller: bugs in the contract code, manipulated price feeds and simple scams disguised as new projects. Stablecoins are the main currency in that world, which is one reason their reliability matters so much.
A related point applies to any app that shows crypto next to ordinary money: the balance may be displayed in dollars or pounds, but the value underneath is still a crypto-asset whose price can fall sharply overnight, including at weekends when banks and stock markets are closed.
Where the fees sit
A crypto purchase can involve a trading fee, a spread, a card or deposit fee, a withdrawal fee and a network fee paid to miners or validators. Illustrative example: you buy $500 of bitcoin at $62,500 with a 0.5% trading fee. The fee is $2.50, leaving $497.50 to buy with, which gets you 0.00796 BTC rather than the 0.008 BTC the headline price suggests. The crypto profit calculator applies the fee on both the buy and the sell.
Spot, futures and the leverage question
Buying a coin on an exchange, known as spot trading, means you own it, or at least the exchange owes it to you. Futures and perpetual contracts are bets on the price, settled in cash or stablecoins, and often offered with very high leverage. Perpetual contracts have no expiry and use periodic "funding" payments between buyers and sellers to keep their price near the spot market. With high leverage, a move of a few percent can close a position automatically and take the whole margin with it.
Custody checklist for a first purchase
- Check the exchange or app is authorised or registered where you live, using the regulator's own register.
- Turn on two-factor authentication with an authenticator app rather than text messages where possible.
- Add a withdrawal address allow-list if the platform offers one.
- If you move coins to your own wallet, write the recovery phrase on paper, store it offline and never type it into a website.
- Keep records of every purchase, sale and swap with dates, amounts and prices; many countries tax disposals, including swapping one coin for another.
Volatility, and why losses are hard to recover
Crypto prices can move more in a day than a major currency pair moves in a month. The arithmetic of recovery is unforgiving: after a fall, you need a larger percentage gain just to get back to where you started.
Formula: required gain = 1 ÷ (1 − fall) − 1. Applies to any asset, not only crypto.
The main risks in one list
- Price risk: large, fast falls, especially in smaller tokens.
- Platform risk: exchanges have failed, been hacked or frozen withdrawals.
- Key risk: lost recovery phrases and signed malicious transactions cannot be undone.
- Scam risk: fake apps, impersonators and "guaranteed return" schemes. See how to spot trading scams.
- Rule risk: tax treatment and legal status differ by country and continue to change.
Asked and answered
Is crypto anonymous?
Mostly not. Public blockchains record every transfer between addresses for anyone to see, and regulated exchanges link accounts to verified identities. It is better described as pseudonymous.
Can a crypto transfer be reversed?
Once confirmed on the blockchain, no. There is no bank to call back a payment, which is why checking the address and network before sending matters so much.
Do I need to buy a whole bitcoin?
No. Bitcoin divides into 100 million units called satoshis, and exchanges let you buy small fractions.
Sources
- UK Financial Conduct Authority, ban on crypto-derivatives for retail consumers (2021)
- European Securities and Markets Authority, CFD product intervention measures
- Bitcoin and Ethereum protocol documentation