What Is Cryptocurrency?

Cryptocurrency is a digital, or virtual, electronic currency system. It uses

encryption and cryptography techniques, similar to solving extremely complicated
math problems, to authenticate and secure transactions on a distributed ledger
such as a blockchain.

Cryptocurrencies can be exchanged for one another or for fiat currencies such as
the U.S. dollar, but they are usually not backed by governments and are not yet
considered legal tender.1

Learn how cryptocurrencies work, how they came about, and what to know
before investing in them.

Definition and Examples Cryptocurrency

Cryptocurrency is a digital currency system that lives on a blockchain, where
every transaction is verified and secured by computers or nodes using
cryptography.

 Alternate names: Digital currency, virtual currency

The idea of cryptocurrency was first introduced in 1998 by Wei Dai, who talked
about using cryptography to create and transact a new form of money, rather
than rely on a central authority to do that.

Bitcoin, the oldest and most well-known cryptocurrency, is the first practical
iteration of that concept. Bitcoin was first introduced in 2009 through a white
paper authored by Satoshi Nakamoto.2
 While the identity of Nakamoto remains a mystery, the concept of a decentralized peer-to-peer
electronic payment system that does not depend on banks and other financial institutions has caught
on.

Ethereum, XRP, and Litecoin are among other popular cryptocurrencies.

As of July 24, 2021, there were more than 11,000 cryptocurrencies with a global
market capitalization of over $1.3 trillion being traded on 390 exchanges,
according to CoinMarketCap..3
How Cryptocurrency Works
A simple cryptocurrency transaction is sending that cryptocurrency from one
person to another. Cryptocurrencies are stored in electronic “wallets,” and the
transfer occurs from one wallet to another.

Pros and Cons of Investing in Cryptocurrency

Pros

 Potential for high returns

 Offers diversification

Cons

 Enormous volatility

 May be hard to understand

 No known benchmark for valuation

 Potential for scams and fraud

The Future of Cryptocurrency

It appears that cryptocurrency is on track for more widespread adoption. While
there may be some changes and bumps in the road along the way,
cryptocurrencies and blockchain technology are likely to continue to grow in
popularity.

It has the attention and support of major investment banks like Goldman Sachs
and JP Morgan. It isn’t just some crazy meme for nerds on the internet. It’s a
risky investment opportunity that’s gathering interest and recognition across the
world.

Mathew McDermott, the London-based Goldman Sachs managing director of its

digital asset team, told Financial News that “we’ve crossed a line” into an era of
adoption in which cryptocurrencies are a widely accepted store of value and
hedge.

Pros and Cons of Investing in Cryptocurrency

Pros
  Potential for high returns

 Offers diversification

Cons

 Enormous volatility

 May be hard to understand

 No known benchmark for valuation

 Potential for scams and fraud

Pros Explained

 Potential for high returns: No investment return can be guaranteed, but

the value of Bitcoin, in particular, has seen remarkable growth—and
volatility—in recent years. In its 13-year history, Bitcoin has delivered
average annual returns of 180%, according to research from Bank of
America.9
 Offers diversification: Cryptocurrency can potentially enhance a portfolio
simply by being different from what you may already be invested in. The
returns on cryptocurrency appear to be relatively uncorrelated to other
asset classes, such as equities. Thus, using a modest amount as a
diversifier could add to overall returns or stave off bigger losses.

Cons Explained

 Enormous volatility: If you invest in cryptocurrency, settle in for a wild

ride. Its value has gone up and down dramatically in recent years. For
example, Bitcoin’s price surpassed $1,000 for the first time in 2017 and
reached a record high of more than $19,000 by the end of the year, before
plummeting to nearly $3,000 just a year later. In April 2021, the
cryptocurrency set new highs when its price went past $64,000.1 0
 It may be hard to understand: In general, it’s a good idea to invest in
things you are familiar with. If you are investing in a company, for example,
it is important to understand what it does and how it makes money.
Understanding the ins and outs of cryptocurrency, however, may be a
challenge since it’s a digital and virtual currency, unlike a physical product
or service. Investors may need (and want) to understand blockchain and
other terms associated with crypto before investing.
 There’s no benchmark for valuation: Unlike traditional assets like stocks
or real estate, there’s no uniform understanding of how to value
cryptocurrency properly. That makes it very difficult to know whether you’re
paying more than the investment is really worth.
 Potential for scams and fraud: Anonymity, complexity, and evolving
regulations make cryptocurrencies vulnerable to scams and fraud.
Regulatory bodies such as the CFTC, SEC, and Financial Industry
Regulatory Authority (FINRA) have all issued warnings to investors about
Ponzi schemes and other scams pertaining to cryptocurrencies.