What Is Cryptocurrency?
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.
- A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of governments and central authorities.
- The word “cryptocurrency” is derived from the encryption techniques which are used to secure the network.
- Blockchains, which are organizational methods for ensuring the integrity of transactional data, are an essential component of many cryptocurrencies.
- Many experts believe that blockchain and related technology will disrupt many industries, including finance and law.
- Cryptocurrencies face criticism for a number of reasons, including their use for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them. However, they also have been praised for their portability, divisibility, inflation resistance, and transparency.
Watch Now: What Is Cryptocurrency?
Cryptocurrencies are systems that allow for secure payments online which are denominated in terms of virtual "tokens," which are represented by ledger entries internal to the system. "Crypto" refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions.
Types of Cryptocurrency
The first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most valuable. Today, there are thousands of alternate cryptocurrencies with various functions and specifications. Some of these are clones or forks of Bitcoin, while others are new currencies that were built from scratch.
Bitcoin was launched in 2009 by an individual or group known by the pseudonym "Satoshi Nakamoto." As of November 2021, there were over 18.8 million bitcoins in circulation with a total market cap of around $1.2 trillion, with the figure updating frequently. Only 21 million bitcoins will ever exist, preventing both inflation and manipulation.
Some of the competing cryptocurrencies spawned by Bitcoin’s success, known as "altcoins," include Solana, Litecoin, Ethereum, Cardano, and EOS. By November 2021, the aggregate value of all the cryptocurrencies in existence is over $2.4 trillion—Bitcoin currently represents approximately 42% of the total value.
Although cryptocurrency bills itself as a form of money, the Internal Review Service (IRS) considers it a financial asset or property. And, as with most other investments, if you reap capital gains in selling or trading it, the government wants a piece of the profits. On May 20, 2021, the U.S. Department of the Treasury announced a proposal that would require taxpayers to report any cryptocurrency transaction of $10,000 to the IRS. How exactly proceeds would be taxed—as capital gains or ordinary income—depends on how long the taxpayer held the cryptocurrency.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies hold the promise of making it easier to transfer funds directly between two parties, without the need for a trusted third party like a bank or credit card company. These transfers are instead secured by the use of public keys and private keys and different forms of incentive systems, like Proof of Work or Proof of Stake.
In modern cryptocurrency systems, a user's "wallet," or account address, has a public key, while the private key is known only to the owner and is used to sign transactions. Fund transfers are completed with minimal processing fees, allowing users to avoid the steep fees charged by banks and financial institutions for wire transfers.
The semi-anonymous nature of cryptocurrency transactions makes them well-suited for a host of illegal activities, such as money laundering and tax evasion. However, cryptocurrency advocates often highly value their anonymity, citing benefits of privacy like protection for whistleblowers or activists living under repressive governments. Some cryptocurrencies are more private than others.
Bitcoin, for instance, is a relatively poor choice for conducting illegal business online, since the forensic analysis of the Bitcoin blockchain has helped authorities arrest and prosecute criminals. More privacy-oriented coins do exist, however, such as Dash, Monero, or ZCash, which are far more difficult to trace.
Central to the appeal and functionality of Bitcoin and other cryptocurrencies is blockchain technology, which is used to keep an online ledger of all the transactions that have ever been conducted, thus providing a data structure for this ledger that is quite secure and is shared and agreed upon by the entire network of an individual node, or computer maintaining a copy of the ledger. Every new block generated must be verified by each node before being confirmed, making it almost impossible to forge transaction histories.
Many experts see blockchain technology as having serious potential for uses like online voting and crowdfunding, and major financial institutions such as JPMorgan Chase (JPM) see the potential to lower transaction costs by streamlining payment processing. However, because cryptocurrencies are virtual and are not stored on a central database, a digital cryptocurrency balance can be wiped out by the loss or destruction of a hard drive if a backup copy of the private key does not exist. At the same time, there is no central authority, government, or corporation that has access to your funds or your personal information.
Total market cap of Bitcoin, as of Aug. 2021.
Criticism of Cryptocurrency
Since market prices for cryptocurrencies are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely, since the design of many cryptocurrencies ensures a high degree of scarcity.
Bitcoin has experienced some rapid surges and collapses in value, climbing as high as $17,738 per Bitcoin in Dec. 2017 before dropping to $7,575 in the following months. Cryptocurrencies are thus considered by some economists to be a short-lived fad or speculative bubble.
There is concern that cryptocurrencies like Bitcoin are not rooted in any material goods. Some research, however, has identified that the cost of producing a Bitcoin, which requires an increasingly large amount of energy, is directly related to its market price.
Cryptocurrency blockchains can be highly secure, but other aspects of a cryptocurrency ecosystem, including exchanges and wallets, are not immune to the threat of hacking. In Bitcoin's 10-year history, several online exchanges have been the subject of hacking and theft, sometimes with millions of dollars worth of "coins" stolen.
Nonetheless, many observers see potential advantages in cryptocurrencies, like the possibility of preserving value against inflation and facilitating exchange while being easier to transport and divide than precious metals and existing outside the influence of central banks and governments.
What Is Cryptocurrency in Simple Words?
Cryptocurrencies are systems that allow for secure payments online which are denominated in terms of virtual "tokens."
How Do You Get Cryptocurrency?
Any investor can purchase cryptocurrency through crypto exchanges like Coinbase, Cash app, and more.
What Is the Point of Cryptocurrency?
Many experts see blockchain technology as having serious potential for uses like online voting and crowdfunding, and major financial institutions such as JPMorgan Chase (JPM) see the potential to lower transaction costs by streamlining payment processing.
How Does Cryptocurrency Make Money?
Cryptocurrencies allow for secure payments online which are denominated in terms of virtual "tokens," which are represented by ledger entries internal to the system. Investors can make money with cryptocurrency by mining Bitcoin, or simply selling their Bitcoin at a profit.
What Are the Most Popular Cryptocurrencies?
Bitcoin is by far the most popular cryptocurrency, followed by other cryptocurrencies such as Ethereum, Binance Coin, Solana, and Cardano.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.