Cryptocurrency

Cryptocurrrency
Erik MartinApr 27, 2022
Key Takeaways:
  • A cryptocurrency is an encrypted data string that denotes a unit of currency.
  • Cryptocurrency is here to stay.
  • Cryptocurrency investment is risky.

By now, you’ve probably heard of Bitcoin. It’s a form ofcryptocurrency – a digital type of money protected by cryptography. Many people are interested in getting, using, and investing in Bitcoin and other forms of cryptocurrency.

But it’s important to answer several questions first. What is cryptocurrency? How does it work? What are cryptocurrency‘s pros and cons? What factors impact its value? And is it safe and legal? Read on for answers and more information about cryptocurrency.

What is cryptocurrency?

Put simply; cryptocurrency is a form of digital or virtual currency that can be used to purchase and sell products and services. Cryptocurrency is secured by cryptography, which uses codes to safeguard data by converting it into a form that only intended recipients can process and read.

“Cryptocurrency works similarly to PayPal or a bank card, except that instead of US dollars, users trade digital assets for goods and services,”Jonathan Merry, director at Bankless Times, explains. “Cryptocurrency transactions are protected via encryption and stored in a public ledger utilizing blockchain technology” (more on this next).

Unlike regular currency held by a central bank and managed by regulating financial organizations, cryptocurrency is decentralized.

“This means that, unlike the dollar or the yen, there’s no government backing their use and saying ‘these are legal tender.’ Instead, cryptocurrency uses a series of cryptography calculations to verify transactions,” says financial expertShawn Plummer.

Keegan Francis, the founder of GoFullCrypto, says all cryptocurrencies work on the principle of keeping owners of cryptocurrency honest.

“Instead of trusting that entities within a system are truthful, by decentralizing this currency everyone can verify whether or not a cryptocurrency possessor is truthful,” he says.

Understanding blockchain

Cryptocurrency transactions are recorded in an online ledger called a blockchain – a series of connected blocks. Every block includes a set of transactions that have been verified independently by each member involved in the cryptocurrency network. Each block has a particular storage limit. When the limit is reached, the block is closed and connected to the last block filled. This creates a data chain, or “blockchain.”

“Think of a blockchain as an Excel spreadsheet that records every transaction on the Internet and cannot be altered,” notesMark Fidelman, CMO and founder of SmartBlocks in Miami.

Having a blockchain in place prevents transaction fraud/forgery because each new block created has to be authenticated by every node in that network.

“For example, if a computer running the Bitcoin codebase downloads the blockchain and processes every transaction in sequential order, they should end up with the same database of accounts as every other computer in the network that would do the same thing,” Francis continues.

Popular forms of cryptocurrency

The most widespread cryptocurrency in use today remains Bitcoin. Other popular and emerging cryptocurrencies in circulation include Ethereum, Solana, Tether, XRP, USD Coin, Terra, Binance Coin, and Paxos Gold. The total crypto market is expected to be worth more than$2.3 trillion by 2028. Bitcoin’s worth comprises a large percentage of the entire cryptocurrency market.

Fidelman points out that every cryptocurrency works a little differently.

“Bitcoin is considered the equivalent of digital gold. Ethereum is itself a type of currency and a platform for other cryptocurrencies. On the other hand, Paxos Gold is a cryptocurrency backed by real gold and which closely follows the price of gold.”

How is cryptocurrency’s value determined?

Like stocks, the value of cryptocurrency is based on supply and demand from cryptocurrency users and investors. In other words, they are worth what people are willing to pay for them and what the market will bear.

“If no one is using a certain type of cryptocurrency, then it is ultimately valueless, regardless of how revolutionary or innovative the cryptocurrency technology is perceived to be,” Francis says.

However, unlike stocks, most cryptocurrency value is also determined by the utility it offers to its holders.

“For instance, some cryptocurrencies allow for lending and borrowing, which generates fees for the lender,” says Fidelman.

Additionally, cryptocurrency is given value by the energy it takes to produce a form of cryptocurrency.

“Making new Bitcoins, for example, is fairly complex. But the more computational power you have to take part in the Bitcoin-mining process, the more Bitcoins you stand to earn,” notes Plummer. “Because it takes a lot of electricity to mine Bitcoins, their value, in one sense, is dictated to some extent by the amount of energy people are using to make them.”

Advantages and disadvantages of cryptocurrency

There are several perks and pitfalls to using cryptocurrency. According to Francis, the pros include:

  • Censorship resistance. Because no government or central authority controls cryptocurrency, “no one can stop a cryptocurrency transaction from taking place,” he says. “Also, cryptocurrencies don’t ask questions about who you are, where you are from, how much money you have, or your race, ethnicity, gender, or social class. Cryptocurrencies are the most egalitarian form of money ever created.”
  • Instant transactions. Neither the sender nor receiver of cryptocurrency has to wait for the transaction to be settled.
  • Acceptance across borders. cryptocurrency doesn’t need to be converted when you exchange it in another country. “Money can be sent across borders without the permission of financial authorities,” Francis says.
  • No worries about inflation. “Bitcoin, for example, has a finite supply of 21 million coins that no one can change. This means that central banks cannot arbitrarily inflate the money supply,” he adds.
  • They are decentralized. With cryptocurrency, there is no fear of a single catalyst of failure, like a major lender going under and snowballing a financial crisis that builds around the globe.
  • The potential to earn profit. Crypto markets have increased in value in recent years and can generate healthy returns for investors.
  • Less risk of fraud. Again, abiding by a blockchain in place safeguards against bad actors, as every new block created has to be authenticated by every node in that network.

But cryptocurrency is volatile, and its value can change rapidly. Your cryptocurrency, such as a Bitcoin, can be worth significantly less tomorrow than it is today.

“Because they are relatively new, the future values of cryptocurrencies are difficult to predict compared to other kinds of investing,” cautions Plummer. “If you want to buy a stock, you can look at the company fundamentals, its leadership, the products or services it provides, and other data. But with crypto, you’re often trusting what other believers and non-believers in the form of cryptocurrency say – and they don’t know much, either.”

Although blockchain technology is designed to prevent fraud, cryptocurrencies are often targeted by criminals who want to make purchases of illegal goods and services or intend to commit money laundering. Consider that many crypto wallets and exchanges have been infiltrated by hackers, too.

“Without any non-regulated technology, the chance for illegal activity with cryptocurrency is high,” continues Fidelman. “Also, because cryptocurrency is still young, it can be complicated for newbies. Thus, the risk of losing your crypto to hackers or mistakes is higher than for traditional currencies.”

Lastly, some forms of crypto, such as Bitcoin, require vast amounts of electricity and computing power to mine/create the digital currency. This can result in exorbitant technology and utility costs for miners. And it can have an adverse ecological effect on the planet.

How to acquire and use cryptocurrency

Usually, to make a cryptocurrency transaction, you must interchange currency with a peer using a cryptocurrency digital wallet.

“A digital wallet is software that enables you to move funds from one place to another. You’ll need a password, also known as a private key, to execute a transaction,” explains Merry. “The private key functions similarly to a bank account. You can control several keys and all monies supplied to them. The transaction is recorded on a public ledger that displays transaction totals without revealing the people’s identities.”

You can also earn cryptocurrency by providing goods or services for someone willing to pay you in cryptocurrency.

Or, crypto can be purchased directly on a website that sells cryptocurrency. It is also be purchased or traded via brokers, using special apps, or on platforms called cryptocurrency exchanges, such as Coinbase.

“These platforms facilitate trading one form of currency for another, such as Ethereum for Bitcoin,” says Francis.

Investors can further put money into cryptocurrency using financial derivatives or other financial instruments.

Is cryptocurrency safe?

Many experts have faith that some forms of cryptocurrency are safe to use and invest in. Others are skeptical about relying on crypto, which can fluctuate widely in value.

“Bitcoin is safe and has a future as a viable form of currency. Other cryptocurrencies may not be safe,” Francis says. “Many are investing in Bitcoin as a hedge against inflation, which is currently rising. Other cryptocurrencies do not present the same value.”

As a future form of currency, crypto has a ways to go, believes Plummer.

“You really can’t rely on something this volatile as a means of exchange. By the time you send or receive Bitcoin, it’s likely going to be worth more or less than it was in the previous hour. If this volatility is reduced, we may see wider use,” he says. “It’s easy to fall into the hype and assume you found the next big thing only to watch the price fall considerably without understanding why.”

In other words, be careful before relying on or investing in cryptocurrency. Do your homework and learn as much as you can about what’s involved, including possible risks.

Frequently Asked Questions

How does cryptocurrency work?

arrow-right

Cryptocurrency is a form of digital currency that can be used to buy and sell goods and services. Cryptocurrency is secured by cryptography, which uses codes to protect data by transforming it into something that only intended recipients can process and read. Cryptocurrency transactions are stored in a public ledger utilizing blockchain technology. Cryptocurrency is also decentralized, unlike regular currency held by a central bank and managed by regulating financial organizations.

Is cryptocurrency legal?

arrow-right

In the United States, mining, acquiring, using, trading, and investing in many forms of cryptocurrency is legal, for the most part. But in other countries, including China, it is not legal or allowed. Currently, El Salvador is the only nation across the globe that permits Bitcoin as legal tender for monetary transactions.

What types of cryptocurrency exist?

arrow-right

The most widespread cryptocurrencies in use today are Bitcoin, Etherium, Solana, Tether, XRP, USD Coin, Terra, and Binance Coin, among others.