What is cryptocurrency? What to know about this increasingly popular digital currency before investing (2024)

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• Cryptocurrencies are digital assets that are created and run on a blockchain.
• Bitcoin and ether are two popular cryptocurrencies, but there are many others.
• Investing in cryptocurrency can be extremely risky, and the underlying technology is very new.

Investors need to understand how cryptocurrencies work, who creates and controls them, and why you might want to buy cryptocurrencies.

While there may be opportunities to build wealth, there are a lot of risks involved with crypto investing, and you need to be mindful of scams.

What is cryptocurrency?

Cryptocurrency is a decentralized digital currency that investors can buy and sell along the blockchain. Unlike banknotes or minted coins with a tangible physical form, cryptocurrencies can only be accessed using computers and other electronic devices.

A decentralized currency is not issued by a government or financial institution. In fact, no single person, company, or government controls a cryptocurrency's blockchain. Instead, it's run by a decentralized network of computers worldwide. Anyone with advanced technology skills and coding experience can create a cryptocurrency.

The lack of a central authority can also make cryptocurrencies more secure. "It's hack-proof because there's no one central point of failure," explains David Donovan, executive vice president at Publicis Sapient.

How do cryptocurrencies work?

While there are thousands of cryptocurrencies, many with unique traits, they all work similarly. It's hard to avoid jargon when discussing cryptos, but the concepts can be relatively easy to understand.

Blockchain technology

A cryptocurrency's blockchain is a digital record of all crypto transactions. Copies of the blockchain are stored and maintained by computers around the world. They're often compared to general ledgers, part of traditional double-entry bookkeeping systems where each transaction leads to debit and credit in different sections of the books.

"It works like a general ledger — it's that simple," says Donovan. Perhaps you start with two coins and send one to someone. "On the blockchain, it would say I'm sending you one coin, and I now have one coin, and you have one coin."

Each grouping of transactions is turned into a block and chained to the existing ledger. Once a block is added, it can't be reversed or altered — which is why people describe blockchains as "immutable."

Some cryptos have their own blockchain. For example, there are Bitcoin and Ethereum blockchains. However, some cryptos are built on top of an existing blockchain rather than starting from zero.

Ether is the cryptocurrency native to the Ethereum blockchain, but is also available for trading on other exchanges like Coinbase, Binance.US, Ninjatrader and Robinhood.

Public transactions under pseudonymous

Cryptocurrencies have another defining feature. The blockchains are public ledgers, which means anyone can see and review the transactions that occurred. However, they can also provide a degree of anonymity.

"You have a private key, which is how you initiate transactions, and a public key, which is how someone identifies you in the market," says Donovan.

A blockchain's transactions are tied to a crypto wallet's public key, but nobody necessarily knows who controls that wallet. This is why cryptos are often described as pseudonymous — the public key is a person's pseudonym.

Coming to consensus

• Proof of work. This relies on people around the world, known as miners, competing to be the first to solve complex cryptographic puzzles and add the next block to the blockchain. The winners are paid after the other network members confirm that the required amount of computing power was used to find the solution. "The way you ensure all the participants are validating the transactions is the hard work, effort, and money they're spending solving the problem," says Donna Parisi, global head of financial services and FinTech at Shearman & Sterling. However, proof-of-work systems require a lot of energy to power.
• Proof of stake. This is a newer and less energy-intensive mechanism. "Proof of stake is they validate transactions on the blockchain by people putting value on the line," explains Parisi. "They stake some of the currency they own to make sure they only validate true transactions."

Types of cryptocurrencies

According to CoinMarketCap, there were more than 25,149 different cryptocurrencies with a global market value of about $1.16 trillion as of May 30, 2023. Some of the most popular cryptocurrencies include:

• Bitcoin
• Dogecoin
• Ether
• Litecoin
• Tether
• Binance coin
• Dai
• TRON
• Cronos
• USD coin
• Bitcoin cash

Bitcoin, the first cryptocurrency, was launched in 2009 as an alternative type of decentralized and digital money. Since then, people have also created cryptocurrencies that serve other functions or are designed for specific types of transactions. All non-Bitcoin cryptocurrencies are often referred to as altcoins.

"Cryptocurrencies can have many different uses," says Parisi. "Some are used in gaming environments to earn rewards in a game, while others facilitate payments. Some are designed for cross-border remittances … some are designed for micro payments."

For example, stablecoins are a type of cryptocurrency that try to maintain a steady and fixed exchange rate with another asset, such as the US dollar. Governance tokens are another example of a specialized cryptocurrency. They give token holders voting power in a corresponding crypto project.

What is digital currency?

Digital currency is a type of currency that can only be accessed in an electronic form, such as through a computer or mobile phone. This money has no physical equivalent, unlike tangible forms of currency like banknotes or minted coins.But just like physical money, digital currencies can be used to purchase goods and services.

However, you'll be limited to online platforms and communities, such as investing platforms, gaming sites, and gambling portals. Some of the most popular forms of digital currency include cryptocurrencies, central bank digital currencies (CBDC), and stablecoins.

"There's a strive toward decentralization," says Nisa Amoils, a managing partner at A100xx Ventures. "Digital currencies like cryptocurrencies continue to be a worthwhile investment for many investors."

Digital currencies come in two forms:

• Centralized currency: Currencies issued by governments or financial institutions as part of the commercial banking system that are available to the general public.
• Decentralized currency: Currencies not issued by governments or financial institutions. Instead, decentralized currencies operate through peer-to-peer financial networks to eliminate the middleman (aka banks) and allow lending, trading, and borrowing directly with merchants.

Digital currencies like crypto are often appealing to investors who are wary of government-issued funds and are that are seeking alternatives.

"Some people who had been excluded from the traditional financial system, or have had their currencies devalued, are seeking an opportunity to participate in the markets, and this is a retail-driven phenomenon first," says Amoils. "There's this crisis of trust, and people want wealth creation for themselves. And so that spurred this whole kind of trading speculative movement."

How to invest in cryptocurrency

You can start investing in cryptocurrencies through existing crypto exchanges and investing platforms. Some of the best cryptocurrency exchanges (such as Kraken and Coinbase) offer assets like staking rewards, goal-planning features, low fees, and more.

Some of the best investment apps that offer cryptocurrencies (such as Robinhood Investing) include a range of investment types, low fees, market access, and more.

If you want to get more advanced and start trading, note that you can strategies such as shorting crypto that are popular with day traders who don't buy and hold for the long term.

You can create your own crypto

Anyone with coding skills and/or advanced technical knowledge can create their own cryptocurrencies — although this is not always an easy feat and isn't recommended for beginners. The three ways to create crypto are:

• Building a new blockchain: The most advanced way to create crypto, but offers the most flexibility of nodes, architecture, tokenomics, and more.
• Modifying a blockchain: If you can't create your own blockchain, you can modify an existing blockchain's open-source code to your liking. Still, this method requires expansive technical knowledge.
• Building upon a blockchain: The simplest way to make your own coins or tokens is by expanding upon an already existing blockchain. But keep in mind that the success of your cryptocurrency will be reliant on the success of the original blockchain. Some blockchains that allow this are Binance and Ethereum.

Are cryptocurrencies secure?

The blockchain technology behind cryptocurrencies can help ensure that the coins and systems remain secure. "What's never been refuted is the value of blockchain," says Donovan. "The way the ledger system is set up and every transaction is recorded. And the fact that it's immutable."

However, that doesn't mean you don't need to worry about security. The crypto world is rife with scams. Of course, that's also true of traditional financial systems and currencies. Someone asking you to pay with a gift card or wire transfer is a red flag that you're dealing with a scammer. But several factors could make crypto scams especially worrisome.

For example, cryptocurrency transactions can't be reversed. There's also less regulation of cryptocurrencies and platforms than of traditional financial services in the US. Plus, some people may feel pressure to act quickly and send or invest their money because they're worried about missing out on an opportunity.

"One way to avoid a scam is to invest in more well-established cryptocurrencies," says Parisi. "You still may be subject to scams or fraud in terms of how you hold it, send it, or receive it." But you can have some certainty that the cryptocurrency itself isn't a scam.

Are cryptocurrencies a good investment?

Cryptocurrencies may present a good investment opportunity, and there are many ways to invest in the crypto world.

You could buy a coin (or coins) and hold onto them, hoping they'll increase in value. Or you could use your coins in a decentralized finance (DeFi) platform to earn interest through staking or lending. You also might take a more traditional route, such as an exchange-traded fund (ETF) that is tied to cryptocurrencies. There could even be opportunities to invest in projects or supporting industries rather than in the cryptocurrencies themselves.

"From an investment perspective, crypto is rapidly evolving," says Parisi. "You shouldn't put an amount of assets you're not willing to lose. It should be, relatively speaking, a small portion of your portfolio."

Before making any investment, consider the potential pros and cons:

Should you invest in crypto?

While cryptocurrency investing is a hotly debated topic, it's worth understanding what's going on so you can make an informed decision. If you decide to get started, you could fully jump in or just dip your toe.

"Learn about crypto by opening up wallets, accounts, trading currencies, and learning more about the use cases," says Parisi. "But do it in a reasonable way. We're still in the early days, and regulation of crypto is still evolving."

Donovan suggests opening an account with a regulated and publicly traded company like Coinbase. But, he says, "It's really about being smart and using the system to take baby steps."

Crypto FAQs