What Is Cryptocurrency?

Elizabeth Macauley

Cryptocurrency is a term that encompasses all digital, encrypted, and decentralized currencies. If you haven’t heard of them yet—or don’t know much about them—just know that millions of people are already using them online as we speak. In fact, a recent study found that there are between 5.8 million and 11.5 million active cryptocurrency wallets.

While making financial decisions is something you’ve likely mastered as a small business owner—using traditional money, that is—in recent times, money markets have branched off into a whole new digital world filled with cryptocurrencies. To get up to speed on this new type of currency, keep reading.

Cryptocurrency Basics

Like most people, you’ve probably seen a lot of things get digitized in your lifetime. Now, you can say the same for currency.

Cryptocurrencies are digital currencies that are a part of a decentralized cash system. Satoshi Nakamoto created Bitcoin—the first cryptocurrency—in 2009. To this day, the identity behind Nakamoto isn’t known. However, their digital currency invention has taken the internet by storm with over a thousand cryptocurrencies existing to date.

Key features of cryptocurrencies include:

1. They only exist in a digital environment.

Cryptocurrencies only exist in a digital environment online. This means you can only access your currency through the internet from a computer or mobile device. Your cryptocurrency will not have a physical form like traditional currency at any point in time. In other words, you’ll never be able to physically hold your cryptocurrency as you would your regular cash.

That being said, cryptocurrencies are still kept in wallets, digital ones to be exact. Cryptocurrency wallets use a software program that helps you spend and receive the currency online.

2. They operate with a decentralized network.

There is no central server for most cryptocurrencies. They exist across a network of thousands of computers and devices. Cryptocurrencies are not controlled by one central authority like:

  • The government
  • Any one person
  • Any group
  • A bank

3. They’re part of a peer-to-peer network.

Cryptocurrency networks rely entirely on a peer-to-peer network. These peer-to-peer networks regulate transactions and ensure everything checks out. For users of cryptocurrencies, the decentralized network helps prevent fraud and government interference. It also helps create efficient transactions.

These networks operate through users passing cryptocurrencies directly to other users. As each exchange takes place, it gets regulated by others in the network. As mentioned above, it is never regulated by a central bank, government, or authority. After each transaction takes place, it gets recorded in the network’s public ledger. This ledger is visible to every user of the network and is referred to as the blockchain.

4. They use encryption.

Encrypted systems translate data into a code that is secure and can only be read by certain people who have the key that decodes it.

The process of converting this information into a secret code is known as cryptography. This method gets applied in each cryptocurrency exchange and is essential for making sure that the transactions are:

  • Secure
  • Anonymous
  • Never controlled by one central authority

5. Transactions are permanent.

Cryptocurrency transactions get recorded on the network’s ledger. This makes them irreversible, unchangeable, and permanent.

6. They guarantee anonymous transactions.

Most cryptocurrencies allow you to stay anonymous during transactions. Encrypted codes and other security measures conceal users’ identities on the network.

How Does Cryptocurrency Work?

To understand how cryptocurrencies work, a good place to start is with Bitcoin—the most widely used cryptocurrency.

As mentioned earlier, cryptocurrencies like Bitcoin get transferred from one user’s wallet to another user’s wallet. There is no third-party authority like a bank that monitors, assists, or manages the exchange.

Once you install your digital wallet from a site like Coinbase, you can generate an address. You can then give this address to those with whom you’re planning to make a transaction.

After a transaction, other users—known as miners—verify it on the public ledger. Miners verify each transaction by solving a mathematical problem associated with the exchange. When the problem is solved, the transaction is verified. Verified transactions are recorded in blocks on the blockchain, which makes up the public ledger. Blocks consist of multiple transactions, similar to a page of records.

Miners involved in verifying the transaction receive Bitcoin rewards for their efforts. In addition to these rewards, miners also get to keep the transaction fees paid in the exchange.

Keep in mind that the public ledger is also an essential component for preventing double spending. For instance, say you want to make a copy of your currency and pay a friend, and then use the other copy to pay for items online. In the Bitcoin network, you would not be able to do this because every transaction is documented in the public ledger. Miners would pick up on the fact that the same currency was exchanged twice.

Should You Use Cryptoccurency?

Every form of investment has potential benefits and drawbacks. Cryptocurrency is no different. Learn more about both the risks and the rewards:

Benefits of Cryptocurrency

Buying cryptocurrency like Bitcoin has proven to be profitable for many early investors. In fact, these currencies are worth thousands of dollars each. However, their benefits don’t stop there. Other benefits of investing in cryptocurrencies include:

1. You manage your transactions.

You, as the cryptocurrency owner, can manage where you send and receive currency on your own. There are no other parties involved in your transaction. This means there’s less opportunity for funds to get diverted elsewhere without your knowing. As a result, this will help reduce and eliminate fraud risk.

2. You can track your payments at any time.

You can track your cryptocurrency payments by the second. In contrast, bank transactions get tracked over the course of a few days. Having the ability to track transactions by the second can help you narrow down when your payment got delivered. Pinpointing this moment increases security for both the sender and receiver of the transaction.

3. Your transactions are private.

Different cryptocurrencies have different levels of privacy associated with them. Some cryptocurrencies allow you to stay anonymous through an entire transaction. Cryptocurrencies that do this include:

  • Monero. With this cryptocurrency, you can’t see the amount that gets exchanged between different users. This can be compared to Bitcoin, where other users can see how many Bitcoins were exchanged in each transaction. The sender and receiver’s identities also remain hidden during each transaction with Monero. Essentially all information is kept private during a transaction. The only parties that can see information are the sender of the cryptocurrency and the receiver.
  • Verge. This cryptocurrency not only keeps every transaction anonymous but also keeps them untraceable. Its peer-to-peer network structure ensures untraceable transactions through:
    • Encrypting messages multiple times
    • Changing computer IP addresses
    • Ensuring messages are not sent through the same channel as responses
  • Dash. All transactions are anonymous with this cryptocurrency. It creates anonymity by mixing up details of different transactions. It then documents multiple transactions as one transaction on the blockchain. These combined transactions provide more security to users. There is also no way to tell who transferred certain amounts to other parties.

4. Each transaction processes quickly.

Although cryptocurrency transaction speeds can vary, they’re usually quick. To get a better feel for this, you can compare cryptocurrency transactions to credit cards. Credit card transactions can take a few days to be processed. Cryptocurrency transactions occur instantly.

This means you can pay for items instantly. It also means you’ll have access to funds fast if you’re selling something. You won’t have to wait a day or two for the funds to get transferred to you.

5. You can make international transactions efficiently.

You can send and receive cryptocurrencies no matter where you’re located on the globe. For example, you can make an exchange from your living room in California to someone in South America immediately. You also won’t have to pay foreign transaction fees when using cryptocurrencies as you probably would with traditional currency.

6. Transaction costs are affordable.

Cryptocurrencies like Bitcoin usually have low transaction fees compared to other currencies. For instance, your bank probably charges a higher transaction fee than you would encounter with Bitcoin. This is because there is no central authority governing these currencies. Some cryptocurrencies with low transaction fees include:

  • Bitcoin
  • Ethereum
  • Cardano
  • Litecoin

Drawbacks of Cryptocurrency

Now that you’ve gotten a feel for the benefits, take a look at some drawbacks of using cryptocurrency, including:

1. Prices can change frequently.

The prices associated with cryptocurrencies are affected by supply and demand. This means that a cryptocurrency’s rate may fluctuate a lot. For cryptocurrencies with a limited supply like Bitcoin, you’ll likely encounter big price changes in future years.

Also, keep in mind that the Internal Revenue Service (IRS) considers cryptocurrency to be property. This means you’ll likely need to pay taxes on your earnings. With fluctuating prices, it can be hard to determine just how much you’ll have to pay in taxes.

2. Cryptocurrency is vulnerable to hacking.

Hackers have stolen cryptocurrency in the past and they will continue to do so in the future. In fact, according to a recent report, $927 million was stolen in the first three quarters of 2018. Hackers can get to your cryptocurrency in a variety of ways. These include:

  • Gaining access to your digital wallet. If you use an exchanging platform like Coinbase, you’ll have a user name and password. Hackers will attempt to steal your password by hacking into your email accounts. From there, they will reset your password. You can prevent this type of hacking with “two-factor authentication.” This security measure detects all new devices that attempt to log in to your account. When a new device is detected, it asks for a temporary key that is sent to your cell phone. This helps prevent hackers from getting into your email, even if they have your password.
  • Phishing scams. Hackers often set up fake websites that resemble ones you normally use. These websites will look and feel exactly the same as your regular site. However, when you fill out personal information on them, it goes straight to the hackers. These hackers can then get into your actual accounts and steal your currency. Hackers may also send out emails that seem like they’re from a recent cryptocurrency exchange. These emails will ask for your private information, such as passwords. They also may include links to fake websites. One way to identify these fake websites is by looking at the domain address. They’ll often be off by one letter that is difficult to notice.
  • Phone porting schemes. This involves scammers calling your mobile phone carrier and asking to switch your phone number to another account. They may use information like your name and date of birth. Once they get it switched, they reset your account passwords where your phone number is used as a security backup.
  • Malware programs. Malware can infect your computer through spam emails that trick you into downloading files. You also can get malware through infected USB flash drives or other drives that are inserted into your computer. In some cases, malware can spread through holes or gaps in your software. The malware detects these gaps and infects your computer or device. This makes it important to update your software regularly. Many of these malware programs can actually replace your digital wallet address with their own wallet address. This allows them to transfer your cryptocurrencies into their wallet.

3. Cryptocurrencies run the risk of becoming obsolete.

For cryptocurrencies with a set amount like Bitcoin, the possibility of becoming obsolete is very real. For instance, once the 21 million Bitcoins in the network are mined, there isn’t any way to create more. This will not only change the network but also give it the potential to come crashing down.

This crash may occur because miners won’t be getting Bitcoin rewards from mining. Instead, miners will only receive transaction fees. This lack of funding may cause miners to drop out of the Bitcoin network all together.

4. They’re not regulated.

Cryptocurrencies are not regulated by the federal government. This makes them a risky choice for investors. Without investor support, cryptocurrencies may have trouble growing in the future. Users also may not trust cryptocurrencies when they lack federal regulations.

5. Criminals use them.

Unfortunately, both criminals and terrorists use cryptocurrency. Some reasons they use it include:

  • Cryptocurrency wallets don’t have a location attached to them. This makes transactions hard to trace and finding who’s behind the transactions even harder.
  • Transactions are quick, easy, and anonymous. This encourages drug dealers to use them.
  • It’s easy to send large amounts of money out of the country. Cryptocurrencies are not bound by any country territories or borders. This makes it easy to transfer money across borders.
  • They can be used in scams. Some scams that surround cryptocurrencies include:
    • Fake opportunities to invest
    • Setting up fake exchanges between people

6. There’s a security backup in the event of a loss.

If you fall for a fake cryptocurrency scam or lose your currency in another way, you won’t get your money back.

What Is a Crypto Market Cap?

The cryptocurrency market cap is a measure of security in the market. Basically, it can tell you how valuable the cryptocurrency is.

To determine your cryptocurrency market cap, you need to multiply the circulating supply of cryptocurrencies by their current price. For example, say there are three million coins in circulation. Each coin is worth $2. This makes the market cap $6 million.

Larger caps can represent less risk to investors compared to smaller caps. For example, Bitcoin has a market capitalization that is approximately five times that of its nearest competitor. These fluctuating values tell investors which currency is less risky. In this case, that would be Bitcoin.

How to Buy Cryptocurrency

Although cryptocurrencies may seem elusive and hard to track down, buying cryptocurrency actually can be very simple. Methods for getting your first cryptocurrency like Bitcoin include:

  • Using Coinbase and Coinmama. Through platforms like Coinbase and Coinmama, you can buy Bitcoins with your credit card.
  • Using Bitcoin ATMs. In some cities and towns, you can use an ATM to buy Bitcoins. To find a Bitcoin ATM near you, you can use an online map like Coin ATM Radar.
  • Transferring currency directly to others. Bitcoins and other cryptocurrencies can be passed from one person to another as soon as you join the network.

The most difficult method for getting cryptocurrencies like Bitcoin is by actually mining them yourself. To do this, you first have to join the network. From there, you have to invest in expensive computer equipment. This equipment is essential for solving the complex math problems presented by the network. The more problems you solve, the more currency you gain as payment.

Are Cryptocurrencies Legal Everywhere?

Before you invest in cryptocurrency, it’s only natural to want to check that it’s legal—especially since it’s not regulated by the government.

Cryptocurrency is legal in the U.S., as well as other countries, such as:

  • Canada
  • Australia

The European Union has not made an official decision on cryptocurrencies.

However, some countries have forbidden it all together. These include:

  • Iceland, which doesn’t consider Bitcoin a currency by law
  • China, which has banned Bitcoin exchanges
  • Russia, which considers Bitcoin payments to be illegal

Not everyone is in agreement on what the future holds for cryptocurrency. That being said, it’s always good to stay up to date on how financial markets are changing. You never know—your small business may be accepting Bitcoins some day in the future.

2 Responses to "What Is Cryptocurrency?"

    • jeremiah scannell | August 9, 2019 at 1:14 pm

      Your information on Cryptocurrency; Very Informative. Thank you.

      • Chloe Silverman | August 9, 2019 at 1:56 pm

        Thank you for your feedback, Jeremiah! We are glad you found this article helpful.

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