The numbers first
- A blockchain is a shared ledger that thousands of computers keep in sync; ownership is proved with a private key, not an account name.
- Coins run their own blockchain, tokens are issued on someone else's, and stablecoins try to hold a fixed value.
- Platforms, keys and smart contracts are where most losses happen; price swings are only part of the risk.
How crypto works depends on which layer you look at. At the bottom is a blockchain, a ledger of transactions copied across many computers. Above it sit wallets that hold the keys to move funds, and above those sit exchanges and apps where most people actually buy and sell. Each layer brings its own costs and its own ways of losing money.
How crypto works at the base layer: blocks, nodes and consensus
A blockchain groups transactions into blocks and links each block to the one before it with a cryptographic fingerprint. Change an old transaction and every later fingerprint breaks, which is what makes the history hard to rewrite. Independent computers called nodes keep a copy of the ledger and check every new block against the network's rules.
Someone has to propose the next block. Networks decide who through a consensus mechanism:
- Proof of work, used by Bitcoin: miners spend electricity on computing puzzles, and the winner adds the block and collects the reward. Rewriting history would require outspending the rest of the network.
- Proof of stake, used by Ethereum since 2022: validators lock up coins as collateral and can lose part of them for breaking the rules.
Keys, addresses and wallets
Crypto ownership is a matter of cryptography. A private key is a secret number that can sign transactions; the matching address is public and is where others send funds. Whoever holds the private key controls the coins. There is no password reset and no bank to reverse a payment.
A "wallet" is software or a device that stores keys. Most generate a seed phrase, usually 12 or 24 words, that can rebuild every key. Anyone who sees that phrase can empty the wallet, which is why no genuine service will ever ask for it.
| Custodial (on a platform) | Self-custody | |
|---|---|---|
| Who holds the keys | The platform | You |
| If you lose your login | Account recovery is usually possible | Lose the seed phrase and the funds are gone |
| If the firm fails | You are a creditor, often with no compensation scheme | Unaffected |
Coins, tokens and stablecoins
A coin is native to its blockchain: bitcoin on Bitcoin, ether on Ethereum. A token is created by a smart contract on an existing chain, so thousands of tokens can live on Ethereum or Tron. A stablecoin is a token designed to hold a steady value, usually one US dollar; the largest, USDT, is covered in what is USDT. For Bitcoin's own design and supply schedule, see what is Bitcoin.
Sending a transaction: fees and confirmations
When you send crypto, your wallet signs a transaction and broadcasts it to the network, where it waits with others until a miner or validator includes it in a block. You attach a fee, and when the network is busy, transactions with higher fees tend to go first. Once included, a transaction gains a confirmation with each new block built on top of it, and platforms usually wait for several confirmations before crediting a deposit. That is why a transfer can show as "sent" in one place and "pending" in another for a while.
Smart contracts and decentralised finance
A smart contract is a program stored on a blockchain that runs exactly as written when called. Contracts power tokens, decentralised exchanges, lending pools and much more, collectively known as decentralised finance or DeFi. They remove the need to trust an intermediary, but they replace it with trust in code: a bug, a flawed price feed or a malicious upgrade can drain funds, and there is often no one to appeal to. Granting a contract permission to spend your tokens is itself a risk if the contract is hostile, which is how many wallet-draining scams work.
Where trading happens
Centralised exchanges run order books much like a stock exchange, but they also hold customers' coins, clear trades internally and often offer derivatives, which bundles several roles that are kept separate in traditional markets. Decentralised exchanges replace the order book with a smart contract holding pools of two tokens, and the price moves as the pool balance shifts. Trades there settle on-chain and you keep custody, but a bug in the contract can put the whole pool at risk.
Because every venue has its own book, the same coin trades at slightly different prices on different platforms. Fees also stack up: a trading fee on each side, a spread, and a network fee when you withdraw. Our crypto profit calculator shows the fee effect on a single round trip.
Professional money: what a crypto hedge fund does
A crypto hedge fund is a pooled investment vehicle, run by a manager, that trades crypto-assets using strategies such as arbitrage between venues, market-neutral positions or directional bets. In most jurisdictions these funds are open only to professional or high-net-worth investors, lock up money for set periods and charge management and performance fees. Some have produced gains and some have collapsed. The label says nothing about quality, and anyone offering you a place in a crypto hedge fund through social media or a messaging app should be treated as a probable fraud; see how to spot trading scams.
Rules and protections
Regulation of crypto is uneven. The EU now licenses crypto-asset service providers under its MiCA framework, other countries run registration regimes, and some have very little oversight. In the UK, the sale of crypto derivatives such as CFDs to retail consumers has been banned since 2021, and in the EU retail crypto CFDs are capped at 2:1 leverage. Deposit and investor compensation schemes generally do not cover crypto holdings.
Why prices swing so much
Most crypto-assets have no cash flows to anchor a valuation, trading never stops, and a large share of activity uses leverage on derivatives platforms. When prices fall, leveraged positions are liquidated automatically, and the forced selling can push prices lower still. Thin order books on smaller tokens mean that even modest orders can move the price several percent.
Records and tax
In many countries, selling, swapping or spending crypto can be a taxable event, and each trade may need its own record of date, amount, value and fees. Platforms do not always provide complete histories, especially once coins move between wallets, so keeping your own records from the first trade saves problems later. Rules differ widely and change often; check the guidance of your own tax authority.
Before a first purchase
- Check that the platform is registered or licensed where you live.
- Understand who will hold the keys, and what happens if the platform fails.
- Add up the fees: trading fee on each side, spread and withdrawal fee.
- Decide in advance how much you could lose entirely without real harm.
A worked example of volatility
Illustrative only. Buying 0.05 BTC at $60,000 costs $3,000 before fees. A 20% fall, which bitcoin has seen in short periods many times, takes the price to $48,000 and the holding to $2,400: a $600 loss. A move that size in a major currency pair would be extraordinary; in crypto it is not unusual. That is the reason for the lower leverage caps regulators apply to it.
Reader questions
Is crypto money?
Some people use it for payments, but most crypto-assets swing too much in value to work as a stable unit of account. Stablecoins try to solve that by tracking a currency such as the US dollar.
What happens if I send crypto to the wrong address?
Blockchain transactions cannot be reversed by the network. Unless the owner of the receiving address agrees to send the funds back, they are usually lost.
Can I invest in a crypto hedge fund as a retail investor?
In most places, no: these funds are usually limited to professional or wealthy investors. An unsolicited offer to join one is a common opening line in investment scams.
Sources
- Bitcoin whitepaper (Satoshi Nakamoto, 2008)
- Ethereum Foundation documentation on proof of stake
- UK Financial Conduct Authority, ban on crypto-derivatives for retail consumers (2021)
- EU Markets in Crypto-Assets Regulation (MiCA)