What is cryptocurrency?
Cryptocurrency is a digitized currency designed to be used online and bypass any traditional financial system. It is not backed by any gold standard or government, but is protected by a distributed ledger that verifies amounts and ownerships across multiple platforms using blockchain technology.
The “crypto” part of the name refers to the complex cryptography that facilitates the creation and processing of digital currency and the way cryptocurrency is distributed across decentralized platforms. Cryptocurrency is, in essence, code.
The digital currency is used for payments and traded by investors, although unlike traditional currency prices are subject to significant volatility.
While there are multiple types of cryptocurrencies, they all have the same common traits, such as:
- The ability to trade or transfer cryptocurrency online with having to use a traditional financial institution such as a bank or payment processor.
- Cryptocurrencies are typically not government-controlled or issued by any central authority.
- They are managed by peer-to-peer networks of computers, using blockchain technology and open-source software.
People are also reading…
You may hear people refer to the tokens when discussing cryptocurrency, although, in essence, that’s just another name for identifying digital currency. There are differences in the types of tokens that are utilized and what you can do with them, however.
Utility Tokens
Utility tokens let holders access a network of services, such as making payments, exchanging tokens between users, or purchasing goods and services in a closed network.
Intrinsic Tokens
Intrinsic tokens are similar to utility tokens. Bitcoins, Ethereum, Litecoin, and other altcoins, for example, allow access to the underlying service, but can be used beyond closed networks.
Equity Tokens
Equity tokens work like stock shares, providing ownership to an underlying asset. In this case, the asset would be cryptocurrency. Owners can profit from assets or dividends distributed to equity token holders.
Asset-Backed Tokens
Asset-based tokens are collateralized by physical or other digital assets.
For everything in the crypto ecosystem, blockchain technology is the key to making all this work together without a central authority using what’s called a distributed ledger. Below is a deeper dive into how crypto works and a look at the typical transaction process.
Cryptocurrency History
You can’t talk about the history of cryptocurrency and digital money without starting with Bitcoin (BTC). Bitcoin was the first digital currency and remains the most used form of cryptocurrency.
Bitcoin was unveiled in 2008 as the first cryptocurrency by an anonymous person or group going under the name Satoshi Nakamoto. While several people have claimed to be Nakamoto, the actual inventor has never been verified as remains somewhat of a mystery.
Cryptocurrency was initially designed as a way to circumvent the traditional institution of banking and financial products after the 2008 market collapse.
Cryptocurrencies, like Bitcoin, has been extremely volatile in pricing from a value of just nine cents in 2010 to an astounding high of over $73,000 in 2024. There have been multiple dramatic price spikes and drop-offs that left some investors shaken and made others millionaires.
Since the launch of Bitcoin, multiple other forms of digital currency have been launched. Different cryptocurrencies besides Bitcoin are often referred to as altcoins (alternative to Bitcoin) include these popular cryptocurrencies:
- Ethereum (ETH)
- Binance Coin (BNB)
- Tether (USDT)
- Solana (SOL)
- Cardano (ADA)
- USD Coin (USDC)
- XRP (XRP)
- Polkadot (DOT)
- Terra (LUNA)
- Dogecoin (DOGE)
- Avalanche (AVAX)
The total global cryptocurrency market exceeds $2 trillion and has spawned nearly one hundred other types of cryptocurrencies, although none have come close to the valuations of Bitcoin or Ethereum so far. With that said, there are a number of altcoins that continue to gain market share like Dogecoin, Solana and XRP. Solana for instance is the fifth largest cryptocurrency in terms of market share with a market cap of $62.44B at time of writing, according to Binance.
How Does Cryptocurrency Work?
When you keep money in a traditional bank, your bank account keeps track of how much money you have. With cryptocurrency, each digital currency has its own blockchain. This is a never-ending chain of records that stores cryptocurrency transactions made with every one of the digital assets.
Because the crypto blockchain is simultaneously stored and distributed across a diverse network, it is extremely difficult for hackers to infiltrate. While no central authority is in control, verification happens across thousands of data points which all must align to prove ownership.
Cryptocurrency units are created through a process called cryptocurrency mining, which involves vast computing power to solve highly complicated mathematical problems to generate coins. These become digital assets that can be bought, sold, or invested. With most cryptocurrencies, there are a limited number of units available at any one time. In some cases, there are finite amounts, which can impact the value of cryptocurrency.
With money, like the U.S. dollar, you have pieces of paper that represent a value. With cryptocurrency, there is no physical asset. What you own is a private key that lets you move the record and assign ownership to other parties using cryptocurrency exchanges without having to rely on a central bank, central authority, or intermediaries.
So, how do you get started with cryptocurrency?
Buying, Selling, Trading, or Investing in Cryptocurrency
To buy cryptocurrency, you need a digital wallet. A digital wallet is an online app that holds your currency. Most commonly, this occurs within crypto exchanges where you exchange money, and turn it into cryptocurrency to use in a digital ecosystem. These exchanges charge asset-based fees.
Funding a Cryptocurrency Account
Funding an account requires you to purchase crypto. Most exchanges allow users to buy using the U.S. Dollar, British Pound, or the Euro. You may be able to use debit or credit cards, although some credit card providers will not allow crypto purchases due to the extreme volatility of the marketplace. Some exchanges will accept ACH payments or wire transfers.
You can buy and sell cryptocurrency in exchanges at any time. There are also other ways to invest in cryptocurrency. For example, social payment platforms let customers buy, sell, or hold crypto. Traditional brokers have also gotten into the crypto game. You can trade digital assets like stocks or bonds and it’s spawned a whole range of investment options, including cryptocurrency mutual funds.
Storing Crypto
The private key to your cryptocurrency is stored in your digital wallet, which you can use when you need to sell or trade. There are different types of wallets:
- Hot wallets use online software or cryptocurrency apps that hold private keys to make it easy to buy, trade, or sell.
- Cold wallets, also known as hardware wallets, are offline devices that securely store private keys.
Using Crypto
Due to its decentralized finance model, users need to generate a public key to handle transactions between parties. A sophisticated algorithm generates this public key from the private key stored in a user’s digital wallet. When a transaction occurs, the private key is sent only to the parties involved in the transaction.
The public key is used to verify the digital signature to prove ownership of the private key, but masks the user’s identity.
Here’s an example of how a transaction would work between two individuals as a medium of exchange. Before a transaction is completed, several steps occur. First, the transaction is digitally signed using the private key. The public key is used to prove that the digital signature is valid and is tied to the private key.
The transaction is then broadcast to the cryptocurrency network. Distributed blockchain nodes verify the validity of the user and transaction which are then recorded in the blockchain as new blocks, which are then distributed through the network.
When two parties agree to a transaction, the public key (public address) is revealed to both parties. This act similar to the way a bank account number would work. The sender needs this number to send the funds. The recipient can then use their private key to withdraw the money from their account.
Each phase of the transaction is recorded in the distributed ledger, creating a ripple effect across the network. No new blocks can be created or recorded without assent from the owner of the private key.
The public key and address are generated from the private key, but because of the intense mathematical algorithms involved, it’s become nearly impossible to use the public key to trace the crypto assets back to their original owner. This is one of the reasons why cryptocurrency has become so popular with cybercriminals because it facilitates payments, but makes it nearly impossible to track where the digital currency has gone.
While the public key is viewable in the public ledger, the private key is really private. If it’s lost, it is not recoverable.
Taxing Cryptocurrency
Just because crypto doesn’t flow through a central bank or government authority doesn’t mean it’s exempt from taxes. Virtual currencies are treated as assets by the IRS, subject to gains or losses when exchanged.
Due to the nature of the way cryptocurrency works, this can be complex. When you purchase goods or services using crypto, you are actually exchanging them at the current rate. Any subsequent gain or loss in value from its initial purchase would technically need to be reported.
Why Are Cryptocurrencies Popular?
Supporters of cryptocurrency often cite the ability to buy, sell, and trade crypto without the involvement of traditional financial institutions. A central bank, for example, might issue more money as a mechanism to influence the economy and devalue the currency. Crypto, however, would remain unaffected. Others like the fact that crypto is simply not under government control.
Supporters also believe that the blockchain technology facilitating decentralized processing and recording is simply more secure than traditional payment systems.
Another reason for the popularity is from speculators. Some early adopters saw astounding results as the price rose and made their fortunes quickly. When prices can skyrocket overnight, the right timing can result in massive gains. Many investors also saw the opposite occur. For example, if you bought Bitcoin at its November peak and sold at its December low, you would have lost 30% of your investment in a matter of weeks.
Investing in cryptocurrency is highly speculative. The value is tied purely to what someone else will pay for it. When you invest in a stock, it’s an investment in a company that generates cash. The more profitable it is, the more valuable the stock becomes. With crypto, there’s no cash flow. To profit, you need to find a buyer willing to pay you more than what you paid for it based on supply and demand.
Trends in Cryptocurrency
The future of cryptocurrency is yet to be written. While trillions of dollars have been invested, there are also concerns about regulation.
Increased Adoption by Retailers
Beyond investing, cryptocurrency is increasingly being accepted online by retailers and other merchants for payments. Many of the country’s largest retailers do not currently accept cryptocurrency, but there are constant rumors about adoption plans. Others currently accept payment using virtual currency.
More than 8,000 merchants worldwide accept crypto through many of the exchanges. In September 2021, the country of El Salvador officially recognized Bitcoin as a legal tender. This allows anyone to use Bitcoin to pay for purchases or even pay taxes to the government.
Potential Regulations
Crypto users favor the lack of intermediaries and traditional financial institutional involvement in the currency exchange, but lawmakers are increasingly scrutinizing digital currencies.
China, for example, has made all crypto transactions illegal in its country.
In the U.S., the Biden administration has floated plans for regulation, including defining cryptocurrency exchanges as brokerages. This would place crypto exchanges under the same regulatory authority as investment firms. This would require more transparency and increased tax reporting, which the government says would help to track tax evaders. For example, this would likely mean reporting buy and sell prices to determine capital gains or losses, and require exchanges to issue 1099-B tax forms with the cost basis to investors.
The Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) have also reportedly been watching cryptocurrency closely. In the European Union, the Anti-Money Laundering Directive requires cryptocurrency to comply with certain guidelines in certain regions.
Another area where increased compliance requirements are being considered involved a type of cryptocurrency called stablecoins.
Stablecoins
Unlike Bitcoin or Ethereum where values fluctuate hourly, stablecoins are a form of cryptocurrency that stays relatively steady in relation to tangible assets, such as the U.S. dollar, Euro, or physical assets.
While US dollars or Euros are considered fiat currencies, backed by the government, cryptocurrency is not.
Stablecoins come in three different forms:
- Fiat-collateralized, which are pegged to fiat currency reserves, such as the U.S. dollar or Euro. They may hold collateral of precious metals or commodities and maintain reserves. Examples are Tether (TUSD) and True USD (TUSDUSD) that maintain unit pricing equivalent to a single U.S. dollar which is backed by deposits.
- Crypto-collateralized, which are backed by other cryptocurrencies. Because of the extreme price volatility in the crypto markets, stablecoins in this category are typically over-collateralized to provide stability. For example, 2X the amount of crypto may be held as digital assets to account for market fluctuation as much as 50%.
- Non-collateralized, which do not use a reserve to maintain stable pricing. Basecoin, for example, uses an algorithmic consensus mechanism to increase or decrease the supply of token as needed to retain stability. This is similar to the way a central authority might print notes to retain the valuation of fiat currency. This process used what’s called a smart contract to run autonomously on the decentralized platform.
Crypto ETFs
Another emerging trend is crypto exchange-traded funds (ETFs). The SEC approved the first U.S. Bitcoin futures product in October. Crypto ETFs had already launched in Europe and Canada, but the SEC has yet to approve a spot crypto ETF.
While not available yet in the U.S, crypto ETFs may offer a way for investors to take advantage of the crypto market without having to buy directly. It may also offer a way to diversify investments across different types of digital currencies, much the same way an index fund mirrors company performance.
Nonfungible Tokens (NFTs)
Nonfungible tokens (NFTs) have garnered a lot of media attention in the past year. A cryptocurrency such as Bitcoin or Ethereum is fungible, meaning you can exchange it for a like item. NFTs are one-of-a-kind items that cannot be duplicated. You could trade NFTs, but you would not be able to get an identical item.
NFT ownership is also verified through blockchain technology, which maintains ownership records. It’s become big business especially in the art world, where one-of-a-kind digital art is bought and sold. Sotheby’s, which has been in the art auction business since the 1700s, recently announced an NFT marketplace. Christie’s NFT auctions have been in place for some time now.
More than $10 billion in NFT transactions occurred in the third quarter of 2021 alone and individual sales can result in tens of millions of dollars. What’s unique about NFTs is that anyone may be able to view the artwork, but ownership is limited to the purchaser.
This content is for educational purposes only. Your situation is unique, and the products and services discussed here may or may not be right for your individual situation. This is not an offer of financial advice, or financial services. Performance information may change. Past performance is not indicative of future results. All investing includes the risk of loss. The opinions expressed here are that of the contributor alone.
‘);
var s = document.createElement(‘script’);
s.setAttribute(‘src’, ‘https://assets.revcontent.com/master/delivery.js’);
document.body.appendChild(s);
window.removeEventListener(‘scroll’, throttledRevContent);
__tnt.log(‘Load Rev Content’);
}
}
}, 100);
window.addEventListener(‘scroll’, throttledRevContent);
}