What Is Cryptocurrency and How Does It Work?
What You Should Be Aware Of
Cryptocurrencies allow you to buy and sell goods and services for a profit. Learn more about cryptocurrency, including what it is, how to buy it, and how to protect yourself.
Kevin Voigt and James Royal, Ph.D. 1st of October, 2021
A cryptocurrency (or "crypto") is a digital currency that can be used to purchase goods and services, but it is secured by an online ledger and strong cryptography. The majority of interest in these unregulated currencies is for profit trading, with speculators driving prices skyward at times.
Bitcoin, the most popular cryptocurrency, has seen its price fluctuate a lot this year, reaching nearly $65,000 in April before losing nearly half of its value in May. Bitcoin's price has been hovering around $45,000 in recent weeks (You can check the current price to buy Bitcoin here.)
Here are seven questions to ask about cryptocurrency, as well as some things to avoid.
1. What exactly is cryptocurrency?
Cryptocurrency is a type of digital currency that can be used to buy and sell goods and services over the internet. Many businesses have created their own currencies, known as tokens, that can be exchanged for the company's goods or services. Consider them to be the equivalent of arcade tokens or casino chips. To obtain the good or service, you will need to exchange real money for cryptocurrency.
Blockchain is the technology that underpins cryptocurrency. Blockchain is a distributed ledger that manages and records transactions across many computers. This technology's security is one of its main selling points.
2. What is the total number of cryptocurrency?
How much do they cost?
According to CoinMarketCap.com, a market research website, there are over 10,000 different cryptocurrencies publicly traded.
Initial coin offerings, or ICOs, are still a popular way for cryptocurrencies to raise money.
According to CoinMarketCap, the total value of all cryptocurrencies was over $1.9 trillion on Aug. 18, 2021, down from an April high of $2.2 trillion.
The value of all bitcoins, the most popular digital currency, was estimated to be around $849 billion, up from recent lows.
Despite this, bitcoin's market value has dropped from a high of $1.2 trillion in April.
3. What is the appeal of cryptocurrency?
Cryptocurrencies have a wide range of supporters. Some of the most well-known are as follows:
Supporters see cryptocurrencies like Bitcoin as the currency of the future, and they're rushing to get their hands on them now, presumably before they become more valuable.
Some supporters like that cryptocurrency frees central banks from controlling the money supply, because central banks tend to devalue money over time through inflation.
Others like the blockchain technology that underpins cryptocurrencies because it is a decentralized processing and recording system that is potentially more secure than traditional payment systems.
Some speculators are interested in cryptocurrencies because they are increasing in value, but they are uninterested in the currencies' long-term acceptance as a means of money transfer.
4. Is it wise to invest in cryptocurrencies?
Cryptocurrencies may appreciate in value, but many investors regard them as speculative investments rather than long-term investments. What is the reason for this? Cryptocurrencies, like real currencies, have no cash flow, so in order for you to profit, someone else must pay more for the currency than you did.
This is known as the “greater fool” investment theory. In contrast, a well-managed business grows in value over time by increasing profitability and cash flow.
“Those who believe that cryptocurrencies like bitcoin will be the currency of the future should keep in mind that a currency requires stability.”
Some prominent members of the investment community have advised potential investors to avoid them. Warren Buffett, the legendary investor, likened Bitcoin to paper checks, saying, "It's a very effective way of transmitting money and you can do it anonymously and all that." A check can also be used to send money. Is it true that checks are worth a lot of money? Just because they have the ability to send money?"
For those who believe that cryptocurrencies like Bitcoin will be the currency of the future, it's important to remember that a currency needs to be stable in order for merchants and consumers to know what a fair price for goods is. Throughout much of their history, Bitcoin and other cryptocurrencies have been anything but stable. For example, after trading near $20,000 in December 2017, Bitcoin's value plummeted to around $3,200 a year later. It was trading at record levels again by December 2020.
This price fluctuation poses a problem. People are less likely to spend and circulate bitcoins today if they may be worth a lot more in the future, making them less viable as a currency. Why spend a bitcoin that could be worth three times its current value next year?
5. What is the procedure for purchasing cryptocurrency?
While some cryptocurrencies, such as Bitcoin, can be purchased with US dollars, others require bitcoins or another cryptocurrency to be paid for.
To purchase cryptocurrencies, you'll need a "wallet," which is a web-based application that stores your funds. In general, you open an account on a cryptocurrency exchange and then use real money to buy cryptocurrencies like Bitcoin or Ethereum. Here's how to get started with Bitcoin investing.
Coinbase is a well-known cryptocurrency exchange where you can open a wallet and buy and sell Bitcoin and other cryptocurrencies. Cryptocurrencies are also available from a growing number of online brokers, including eToro, Tradestation, and Sofi Active Investing. Free cryptocurrency trades are available through Robinhood (Robinhood Crypto is available in most, but not all, U.S. states).
6. Is it legal to use cryptocurrencies?
They are without a doubt legal in the United States, though China has effectively banned their use, and whether they are legal in other countries is ultimately a matter of national sovereignty. Also, think about how to protect yourself from scammers who see cryptocurrencies as a way to defraud investors. Buyer beware, as always.
7. How do I safeguard myself?
If you're interested in purchasing a cryptocurrency through an ICO, read the fine print in the company's prospectus for the following details:
Who is the company's owner? A well-known and identifiable owner is a good sign.
Is it being pursued by any other major investors? If other well-known investors want a piece of the currency, it's a good sign.
Will you have a stake in the company or will you only have access to currency or tokens? This is an important distinction to make. Owning a stake entitles you to a share of the company's profits (you're an owner), whereas purchasing tokens entitles you to use them like chips in a casino.
Is the currency already developed, or is the company seeking funding to do so? The less risky a product is, the further along it is.
Examining a prospectus can be time-consuming; the more information it contains, the better your chances of finding something legitimate. However, even legitimacy does not guarantee that the currency will be successful. That's a completely different question that necessitates a great deal of market knowledge.
Beyond those concerns, simply owning cryptocurrency puts you at risk of theft as hackers attempt to break into the computer networks that keep your assets safe. In 2014, a well-known exchange went bankrupt after hackers stole hundreds of millions of dollars in bitcoins. Those aren't typical risks associated with stock and mutual fund investments on major U.S. exchanges.
Should you invest in cryptocurrencies?
Cryptocurrency is a highly speculative and volatile investment. Investing in established companies' stocks is generally safer than investing in cryptocurrencies like Bitcoin.
What cryptocurrencies are available through online brokers?
The following online brokerages and cryptocurrency exchanges that NerdWallet reviews currently have cryptocurrencies available.
Binance.US allows you to buy and sell over 50 different cryptocurrencies.
Coinbase allows you to buy and sell over 50 different cryptocurrencies.
eToro is a cryptocurrency trading platform that offers access to 18 different cryptocurrencies.
Gemini allows users to buy and sell 40 different cryptocurrencies.
Robinhood: Seven cryptocurrencies are supported, including Bitcoin, Bitcoin Cash, and Ethereum.
SoFi Active Investing: Allows you to trade 20 different cryptocurrencies, including Bitcoin, Ethereum, and Litecoin.
TradeStation: Trades Bitcoin, Bitcoin Cash, and Ethereum, among other cryptocurrencies.
Webull: Allows you to trade four different cryptocurrencies: Bitcoin, Bitcoin Cash, Ethereum, and Litecoin.