What Is Cryptocurrency?
Cryptocurrencies are digital or virtual currencies that leverage cryptography for security. They operate on decentralized networks, most commonly using blockchain technology.
Cryptocurrency Definition
Cryptocurrencies are essentially digital assets, often built on blockchain technology. This technology uses cryptography to secure online transactions, making counterfeiting or double-spending highly difficult. A key feature is that they typically aren’t issued by a central authority, which theoretically protects them from government interference or manipulation.
Key Takeaways:
- A cryptocurrency is a digital asset that relies on a distributed network.
- This decentralized structure allows them to operate outside the control of governments or central authorities.
- Blockchain and related technologies are expected to disrupt many industries.
- Advantages include faster and cheaper money transfers and resistance to single points of failure.
- Disadvantages include price volatility, high energy consumption, and potential use in illicit activities.
Understanding Cryptocurrency Types
Cryptocurrencies are underpinned by cryptographic systems allowing secure online payments without intermediaries. The “crypto” aspect refers to encryption algorithms and cryptographic techniques like elliptical curve encryption, public-private key pairs, and hashing functions. The core of Bitcoin and other cryptocurrencies lies in blockchain technology. A blockchain is a series of connected blocks of information on an online ledger; This ledger is immutable and publicly available.
Experts suggest that blockchain technology has applications across multiple industries, supply chains, and processes such as online voting and crowdfunding. Financial institutions are already adopting blockchain technology to reduce transaction costs.
Types of Cryptocurrency
Many cryptocurrencies serve specific roles on the blockchain platform they’re built on. For example, Ether (ETH), used by the Ethereum network, is used to validate transactions and open blocks.
With numerous cryptocurrencies available, understanding their types is essential. Knowing a coin’s purpose can help determine its investment potential.
Here are some common types:
- Utility Tokens: Tokens that offer specific functions on their blockchains (e.g., XRP, ETH).
- Transactional Tokens: Designed as a means of payment (e.g., Bitcoin).
- Governance Tokens: Tokens representing voting or other rights on a blockchain (e.g., Uniswap).
- Platform Tokens: Tokens used to support applications on a blockchain (e.g., Solana).
- Security Tokens: Tokens representing ownership of an asset, such as a tokenized stock.
How to Buy Cryptocurrency
To use cryptocurrency for purchases, you’ll need to use a cryptocurrency exchange where you can buy and sell cryptocurrencies from other users. The process is similar to trading stocks, where you’ll trade at the current market price. Once you’ve bought the coins, you’ll then transfer them to a digital wallet or use third-party services like Coinbase to store your crypto. If you’re using cryptocurrency as an investment, your brokerage might offer options to invest – Robinhood allows users to invest in Bitcoin and other cryptocurrencies. However, you might not be able to move the crypto off the platform if you choose to purchase it on the brokerage. Additionally, there are crypto ETFs that provide exposure to the crypto market without needing investors to keep their own wallets. In May 2024, investors could choose to hold Bitcoin futures ETFs along with Ether spot shares, which are approved by the SEC.
Is Cryptocurrency Legal?
Fiat currencies get their power from governments or monetary authorities. For example, in the United States, The U.S. dollar is recognized and issued by the government as the official currency of the United States. Cryptocurrencies are not issued by public entities but are a form of money, and this has made it challenging to establish their legal status in different areas globally because, over time, cryptocurrencies have operated outside most of the financial infrastructure.
Cryptocurrency Regulations
In the U.S., the legal status of cryptocurrencies has implications for their trade and use. The Financial Action Task Force (FATF) recommended in June 2019 that cryptocurrency transfers be subject to the Travel Rule, requiring AML compliance. The IRS treats cryptocurrencies as property subject to capital gains taxes. In July 2023, the courts decided that any cryptocurrencies bought by institutional buyers, such as trading houses, are securities, while cryptocurrencies bought by retail investors on exchanges are not. However, crypto exchanges are regulated by the SEC.. So, the crypto industry is legal in the U.S., but regulatory agencies are gaining more control.
As of June 2024, El Salvador is the only country that accepts Bitcoin as legal tender. Elsewhere, cryptocurrency regulation varies.
- In Asia, Japan’s Payment Services Act defines Bitcoin as legal property. Exchanges in Japan must gather customer information. China has banned crypto exchanges, transactions, and mining but has its own CBDC.
- India is reportedly developing a framework, but crypto is not yet illegal, and exchanges are free to offer cryptocurrencies.
- Europe considers cryptocurrencies legal. Derivatives need to qualify as financial instruments. The European Commission’s Markets in Crypto-Assets (MiCA) regulation went into effect in June 2023, setting rules for companies providing financial services using crypto.
Cryptocurrency Safety: Is Cryptocurrency a Safe Investment?
Cryptocurrencies have a reputation for investment instability, with loss of investment due to scams, hacks, volatility, and bugs. While the underlying cryptography and blockchain are generally secure, the technical complexity of using and storing crypto represents significant risks to new users. In addition to market risks, investors should be aware of the following:
- User Risk: Crypro transactions cannot be reversed or canceled once sent. Roughly a fifth of all bitcoins are inaccessible due to lost passwords or incorrect addresses.
- Regulatory Risks: Cryptocurrency’s regulatory status is unclear in many areas. A regulatory crackdown could make it harder to sell cryptocurrencies.
- Counterparty Risks: Investors rely on exchanges or custodians which could lose an investor’s entire investment due to theft or loss.
- Management Risks: Due to a lack of regulations, there are limited protections against unethical management practices. Many investors have lost large sums to management teams that have failed to deliver a product.
- Programming Risks: Many trading platforms use automated smart contracts to control the user’s finances and movement. A bug or exploit in these could lead to loss.
- Market Manipulation: Market manipulation in cryptocurrency, with bad actors acting unethically, remains a problem.
Despite these risks, cryptocurrencies have seen market value increases. Some have made fortunes by investing in early-stage cryptos.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies were introduced with the intent to revolutionize financial infrastructure. Here are the advantages and disadvantages of cryptocurrency:
Advantages:
- Removes single points of failure
- Easier to transfer funds
- Removes third parties
- Can generate returns
- Streamlined remittances
Disadvantages:
- Pseudonymous transactions
- Pseudonymity allows for criminal uses
- Highly centralized
- Expensive to participate in a network
- Off-chain security issues
- Price Volatility
Advantages Explained
Cryptocurrencies represent a new decentralized financial model that eliminates the need for intermediaries like banks to enforce trust and police transactions. Removing intermediaries eliminates the possibility of a single point of failure, such as a large financial institution sparking a cascade of worldwide issues
Cryptocurrencies offer easier direct fund transfers between two parties without requiring a trusted third party like a bank. Decentralized transfers are secured by public and private keys, using incentive systems such as proof of work or proof of stake. Because they do not need third-party intermediaries, cryptocurrency transfers can be faster than standard money transfers. Flash loans in decentralized finance are an excellent example of this. The remittance economy is testing one of cryptocurrency’s most prominent uses. Cryptocurrencies, such as Bitcoin, can serve as intermediate currencies to streamline money transfers across borders.
Disadvantages Explained
Cryptocurrencies are pseudonymous, not anonymous, as they leave a digital trail that agencies like the FBI can follow. Cryptocurrencies have become a popular tool with criminals for nefarious activities such as money laundering and illicit purchases. Cryptocurrencies have also become a favorite of hackers who use them for ransomware activities. Cryptocurrency ownership is becoming more concentrated as companies buy and hold them for price appreciation. One of the concepts of cryptocurrencies is that anyone can mine them using a computer. However, mining requires intensive energy consumption, which has concentrated mining among large firms. Though cryptocurrency blockchains are highly secure, off-chain crypto-related key storage repositories, such as exchanges and wallets, can be hacked, and the theft can run into the millions of dollars. Cryptocurrencies traded in the public market suffer from price volatility.
Is Crypto Actually a Good Investment?
Crypto can be a good investment for someone who enjoys speculating and can financially tolerate losing everything invested. However, it is not a wise investment for someone seeking to grow their retirement portfolio or for placing savings into it for growth.
Is Crypto Real Money?
One definition of money is a commonly accepted medium of exchange, a measure or store of value, and a unit of account. By this definition, cryptocurrency can function as real money.
How Does Crypto Make You Money?
There are several ways cryptocurrency can make money for you. Decentralized finance applications let you loan your crypto with interest; you can stake a compatible one on a blockchain or at certain exchanges for rewards, or you can hold on to it and hope its market value increases. None of these methods are guaranteed to make money, but many people have benefitted from them.
The Bottom Line
Cryptocurrencies are digital assets secured by cryptography. Due to their newness, they’re considered highly speculative, and it is important to fully understand the risks involved before investing.
