It’s hard to find a person who hasn’t at least heard of cryptocurrency these days. But actually understanding how cryptocurrency works is a different story. If you’re considering putting money in crypto, there are many assumptions to question and risks to consider. In this article, we’ll elaborate on the following cryptocurrency basics:
Cryptocurrency is a digital currency. The root “crypto,” meaning code, offers a hint as to how it works: each “coin” or unit of currency is actually a line of code used to track transactions.
Though cryptocurrency is totally digital, it works a lot like the real currency. Just like you would exchange dollars for pesos before visiting Mexico, you also exchange money for cryptocurrency, which you can then use to purchase goods or services, or trade for profit.
Some experts also liken cryptocurrency to arcade tokens or poker chips, because – like foreign currency – their use is confined to particular contexts. You can’t use Bitcoin to buy a hamburger at McDonald’s, yet. You can only use it for goods and services for which the provider has agreed to accept Bitcoin.
So if cryptocurrency is just another form of currency, what’s the big deal? Why is there so much hype around “crypto”?
The first cryptocurrency, Bitcoin, was released in 2009. Though it remains the most well-known and reliable, since then thousands of cryptocurrencies have come and gone – and the total number changes as quickly as currency prices do. This volatility further underscores the uncertainty inherent in the crypto market.
Here’s a quick glance at some crypto market stats from Coin Market Cap:
As with any form of currency, the value of a given cryptocurrency is arbitrary. Bitcoin has no inherent value; it is evaluated based on what someone is willing to pay for it. This is why investor Warren Buffett blasted cryptocurrency as about as valuable as a paper check back in 2014, claiming that – like a paper check – crypto is nothing more than a way of transmitting money. It has no value on its own, just like a paper check is only worth the amount of money written on it.
Whether you believe in the power of crypto or not, the analogy is worth noting. Buffett’s point was that cryptocurrency is unreliable as an investment or wealth-generator because your money disappears as soon as the value of the currency does.
Cryptocurrency exchanges
To buy cryptocurrency, you can’t go to a traditional broker like you would for stocks or mutual funds. Instead, you have to buy it from cryptocurrency exchange – like brokerage firms designated specifically for cryptocurrency. These include:
Robinhood is one of few – if not the only – traditional brokerage firms that also offer cryptocurrency, with the bonus of requiring no commissions or fees.
Peer-to-peer
You can also buy cryptocurrency directly from individuals, but this comes with more risks.
As a refresher, cryptocurrency is still mostly used by individuals to purchase goods or services in an anonymous, decentralized marketplace. Here’s a breakdown of what that looks like:
Storing cryptocurrency
Cryptocurrency is stored in cryptocurrency wallets, most often software programs. These are sometimes called digital wallets, but not all crypto wallets are digital – some live on hardware, like USB drives, or locally on personal desktop computers. The other common forms are:
The blockchain
One of the most crucial elements of the crypto market is the blockchain. This is a decentralized (meaning stored on many computers), completely public ledger of every transaction that’s ever happened in a given cryptocurrency. Some experts compare it to a very long public receipt.
Accessing and using your currency
Currency holders use both a public key (or passcode) and a private key to access the blockchain as well as their individual assets. Their own transactions are recorded on the blockchain through what is known as a “cryptocurrency address.”
One important thing to recognize about cryptocurrency is that it’s completely unregulated by the government or financial institutions. Though this decentralization and lack of financial “middlemen” creates freedom and flexibility (particularly the omission of transaction fees and commissions), it also creates space for uncertainty and volatility, not to mention fraud and criminal activity.
To recap, champions of cryptocurrency point to the following advantages:
Many people believe that the anonymous, decentralized, cloud-based nature of the crypto market makes it the future of commerce (at least for online transactions).
Cryptocurrency remains one of the most high-profile and controversial trends in the finance world, and though individual currencies come and go, crypto, in general, seems to be sticking around for the near future. Investors should carefully consider the risks – as well as their own financial profiles, including their savings and how much they can afford to lose – before making any big moves.
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