WHAT IS CRYPTOCURRENCY AND HOW DOES IT WORK?

A cryptocurrency is a digital or virtual currency secured by cryptography, which makes it

nearly impossible to counterfeit or double-spend. Many cryptocurrencies are
decentralized networks based on blockchain technology—a distributed ledger enforced
by a disparate network of computers.
A defining feature of cryptocurrencies is that they are generally not issued by any
central authority, rendering them theoretically immune to government interference or
manipulation.

KEY TAKEAWAYS
 A cryptocurrency is a form of digital asset based on a network that is distributed
across a large number of computers. This decentralized structure allows them to
exist outside the control of governments and central authorities.
 Some experts believe blockchain and related technologies will disrupt many
industries, including finance and law.
 The advantages of cryptocurrencies include cheaper and faster money transfers
and decentralized systems that do not collapse at a single point of failure.
 The disadvantages of cryptocurrencies include their price volatility, high energy
consumption for mining activities, and use in criminal activities.
Understanding Cryptocurrencies
Cryptocurrencies are digital or virtual currencies underpinned by cryptographic systems.
They enable secure online payments without the use of third-party intermediaries.
"Crypto" refers to the various encryption algorithms and cryptographic techniques that
safeguard these entries, such as elliptical curve encryption, public-private key pairs, and
hashing functions.
Cryptocurrencies can be mined, purchased from cryptocurrency exchanges, or
rewarded for work done on a blockchain. Not all e-commerce sites allow purchases
using cryptocurrencies. In fact, cryptocurrencies, even popular ones like Bitcoin, are
hardly used for retail transactions. However, cryptocurrency values have made them
popular as trading and investing instruments. To a limited extent, they are also used for
cross-border transfers.

Blockchain
Central to the appeal and functionality of Bitcoin and other cryptocurrencies is
blockchain technology. As its name indicates, a blockchain is essentially a set of
connected blocks of information on an online ledger. Each block contains a set of
transactions that have been independently verified by each validator on a network.
Every new block generated must be verified by each node before being confirmed,
making it almost impossible to forge transaction histories.1 The contents of the online
ledger must be agreed upon by a network of individual nodes, or computers that
maintain the ledger.
Experts say that blockchain technology can serve multiple industries, supply chains,
and processes such as online voting and crowdfunding. Financial institutions such as
JPMorgan Chase & Co. (JPM) are testing the use of blockchain technology to lower
transaction costs by streamlining payment processing.

Types of Cryptocurrency
Many cryptocurrencies were created to facilitate work done on the blockchain they are
built on. For example, Ethereum's ether was designed to be used as payment for
validation work done on the blockchain. When the blockchain transitioned to proof-of-
stake in September 2022, ether (ETH) inherited an additional duty as the blockchain's
staking mechanism. Ripple's XRP is designed to be used by banks to facilitate
transfers between different geographies.
Because there are so many cryptocurrencies on the market, it's important to
understand the types of cryptocurrencies. Understanding if the coin you're looking at
has a purpose can help you decide whether it is worth investing in—a cryptocurrency
without a purpose is likely to be riskier than one with utility.
Most of the time, when you hear about cryptocurrency types, you hear the coin's name.
However, coin names differ from coin types. Here are some of the types you'll find with
some of the names of tokens in that category:
 Utility: XRP and ETH are two examples of utility tokens. They serve specific
functions on their respective blockchains.
 Transactional: Tokens designed to be used as a payment method. Bitcoin is the
most well-known of these.
 Governance: These tokens represent voting or other rights on a blockchain,
such as Uniswap.
 Platform: These tokens support applications built to use a blockchain, such as
Solana.
 Security tokens: Tokens representing ownership of an asset, such as a stock
that has been tokenized (value transferred to the blockchain). MS Token is an
example of a securitized token. If you can find one of these for sale, you can gain
partial ownership of the Millenium Sapphire.
If you find a cryptocurrency that doesn't fall into one of these categories, you've found a
new category or something that needs to be investigated to be sure it's legitimate.

Are Cryptocurrencies Legal?

Fiat currencies derive their authority from the government or monetary authorities. For
example, each dollar bill is backstopped by the Federal Reserve.
But cryptocurrencies are not backed by any public or private entities. Therefore, it has
been difficult to make a case for their legal status in different financial jurisdictions
throughout the world. It doesn't help matters that cryptocurrencies have largely
functioned outside most existing financial infrastructure. The legal status of
cryptocurrencies has implications for their use in daily transactions and trading. In June
2019, the Financial Action Task Force (FATF) recommended that wire transfers of
cryptocurrencies should be subject to the requirements of its Travel Rule, which
requires AML compliance.
FAST FACT
As of January 2023, El Salvador and the Central African Republic were the only
countries to accept Bitcoin as legal tender for monetary transactions. In the rest of the
world, cryptocurrency regulation varies by jurisdiction.

Japan's Payment Services Act defines Bitcoin as legal property. Cryptocurrency

exchanges operating in the country are subject to collect information about the
customer and details relating to the wire transfer. China has banned cryptocurrency
exchanges and mining within its borders. India was reported to be formulating a
framework for cryptocurrencies.
Cryptocurrencies are legal in the European Union. Derivatives and other products that
use cryptocurrencies must qualify as "financial instruments." In June 2021, the
European Commission released the Markets in Crypto-Assets (MiCA) regulation that
sets safeguards for regulation and establishes rules for companies or vendors providing
financial services using cryptocurrencies.
Within the United States, the biggest and most sophisticated financial market in the
world, crypto derivatives such as Bitcoin futures are available on the Chicago
Mercantile Exchange. In the past, the Securities and Exchange Commission (SEC)
took the stance that Bitcoin and Ethereum were not securities; however, in September
2022, SEC Chair Gary Gensler stated he believes cryptocurrencies are securities. This
stance implies that cryptocurrency's legal status may become subject to regulation.

 IMPORTANT
Although cryptocurrencies are considered a form of money, the Internal Revenue
Service (IRS) treats them as financial assets or property for tax purposes. And, as with
most other investments, if you reap capital gains selling or trading cryptocurrencies, the
government wants a piece of the profits. How exactly the IRS taxes digital assets—
either as capital gains or ordinary income—depends on how long the taxpayer held the
cryptocurrency and how they used it.

Are Cryptocurrencies Safe Investments?

Cryptocurrencies have attracted a reputation as unstable investments due to high
investor losses as a result of scams, hacks, and bugs. Although the underlying
cryptography is generally secure, the technical complexity of using and storing crypto
assets can be a significant hazard to new users.
In addition to the market risks associated with speculative assets, cryptocurrency
investors should be aware of the following risks:
 User risk: Unlike traditional finance, there is no way to reverse or cancel a
cryptocurrency transaction after it has already been sent. By some estimates,
about one-fifth of all bitcoins are now inaccessible due to lost passwords or
incorrect sending addresses.
 Regulatory risks: The regulatory status of some cryptocurrencies is still unclear,
with many governments seeking to regulate them as securities, currencies, or
both. A sudden regulatory crackdown could make it difficult to sell
cryptocurrencies or cause a market-wide price drop.
 Counterparty risks: Many investors and merchants rely on exchanges or other
custodians to store their cryptocurrency. Theft or loss by one of these third
parties could result in losing one's entire investment.
 Management risks: Due to the lack of coherent regulations, there are few
protections against deceptive or unethical management practices. Many
investors have lost large sums to management teams that failed to deliver a
product.
 Programming risks: Many investment and lending platforms use automated
smart contracts to control the movement of user deposits. An investor using one
of these platforms assumes the risk that a bug or exploit in these programs could
cause them to lose their investment.
 Market Manipulation: Market manipulation remains a substantial problem in
cryptocurrency, with influential people, organizations, and exchanges acting
unethically.
Despite these risks, cryptocurrencies have seen a major leap in prices, with the total
market capitalization rising to over $1 trillion. Despite the speculative nature of the
asset, some have been able to create substantial fortunes by taking on the risk of
investing in early-stage cryptocurrencies.

Advantages and Disadvantages of Cryptocurrency

Cryptocurrencies were introduced with the intent to revolutionize financial infrastructure.
As with every revolution, however, there are tradeoffs involved. At the current stage of
development for cryptocurrencies, there are many differences between the theoretical
ideal of a decentralized system with cryptocurrencies and its practical implementation.
Some advantages and disadvantages of cryptocurrencies are as follows.
Advantages
 Removes single points of failure
 Easier to transfer funds between parties
 Removes third parties
 Can be used to generate returns
 Remittances are streamlined

Disadvantages
 Transactions are pseudonymous
 Pseudonymity allows for criminal uses
 Have become highly centralized
 Expensive to participate in a network and earn
 Off-chain security issues
 Prices are very volatile

Advantages Explained
 Cryptocurrencies represent a new, decentralized paradigm for money. In this
system, centralized intermediaries, such as banks and monetary institutions, are
not necessary to enforce trust and police transactions between two parties. Thus,
a system with cryptocurrencies eliminates the possibility of a single point of
failure, such as a large bank, setting off a cascade of crises around the world,
such as the one triggered in 2008 by the failure of institutions in the United
States.
 Cryptocurrencies promise to make it easier to transfer funds directly between two
parties without needing a trusted third party like a bank or a credit card company.
Such decentralized transfers are secured by the use of public keys and private
keys and different forms of incentive systems, such as proof of work or proof
of stake.
 Because they do not use third-party intermediaries, cryptocurrency transfers
between two transacting parties can be faster than standard money transfers.
Flash loans in decentralized finance are an excellent example of such
 decentralized transfers. These loans, which are processed without backing
collateral, can be executed within seconds and are used in trading.
 Cryptocurrency investments can generate profits. Cryptocurrency markets have
skyrocketed in value over the past decade, at one point reaching almost $2
trillion. As of April 2023, Bitcoin was valued at more than $540 billion in crypto
markets.
 The remittance economy is testing one of cryptocurrency's most prominent use
cases. Currently, cryptocurrencies such as Bitcoin serve as intermediate
currencies to streamline money transfers across borders. Thus, a fiat currency
is converted to Bitcoin (or another cryptocurrency), transferred across borders,
and subsequently converted to the destination fiat currency. This method
streamlines the money transfer process and makes it cheaper.
Disadvantages Explained
 Though they claim to be an anonymous form of transaction, cryptocurrencies are
pseudonymous. They leave a digital trail that agencies like the Federal Bureau of
Investigation (FBI) can investigate. This opens up the possibility that
governments and authorities (and others) can track financial transactions.
 Cryptocurrencies have become a popular tool with criminals for nefarious
activities such as money laundering and illicit purchases. The case of Dread
Pirate Roberts, who ran a marketplace to sell drugs on the dark web, is already
well known. Cryptocurrencies have also become a favorite of hackers who use
them for ransomware activities.
 In theory, cryptocurrencies are meant to be decentralized, their wealth distributed
between many parties on a blockchain. In reality, ownership is highly
concentrated. For example, just 100 addresses hold roughly 12% of circulating
bitcoin and total value.
 One of the conceits of cryptocurrencies is that anyone can mine them using a
computer with an Internet connection. However, mining popular cryptocurrencies
require considerable energy, sometimes as much energy as entire countries
consume. The expensive energy costs and the unpredictability of mining have
concentrated mining among large firms whose revenues run into billions of
dollars. For example, only 98 (2%) of the 4,882 Bitcoin blocks opened from Dec.
29, 2022, to Jan. 29, 2023, were opened by unknown addresses—the other 98%
were opened by mining pools.
 Though cryptocurrency blockchains are highly secure, off-chain crypto-related
key storage repositories, such as exchanges and wallets, can be hacked. Many
 cryptocurrency exchanges and wallets have been hacked over the years,
sometimes resulting in millions of dollars worth of "coins" stolen.
 Cryptocurrencies traded in public markets suffer from price volatility. For
example, Bitcoin has experienced rapid surges and crashes in its value, climbing
to nearly $65,000 in November 2021 before dropping to just over $20,000 a year
and a half later. As a result, many people consider cryptocurrencies to be a
short-lived fad or speculative bubble.

How Do You Buy Cryptocurrencies?

You can purchase cryptocurrency from popular crypto exchanges such as Coinbase,
apps such as Cash App, or through brokers. Another popular way to invest in
cryptocurrencies is through financial derivatives, such as CME's Bitcoin futures, or
other instruments, such as Bitcoin trusts and ETFs.

What Is the Point of Cryptocurrency?

Cryptocurrencies are a new paradigm for money. They promise to streamline existing
financial architecture to make it faster and cheaper. In addition, their technology and
architecture decentralize existing monetary systems and make it possible for transacting
parties to exchange value and money independently of intermediary institutions such as
banks.

What Are the Most Popular Cryptocurrencies?

Bitcoin is the most popular cryptocurrency, followed by other cryptocurrencies such
as Ethereum, Binance Coin, Solana, and Cardano.

Bitcoin (BTC)
Market cap: $372.3 billion
Bitcoin is the first thought that comes to most people’s minds when talking about
cryptocurrency. Satoshi Nakamoto’s digital currency has become almost synonymous
with the concept of cryptocurrency itself. Bitcoin exists on its own blockchain, with
miners creating new blocks and receiving rewards. The reward is halved until BTC
reaches its cap of 21 million coins. Bitcoin supporters value it over others for many
reasons, including its decentralization and security. Experts predict that BTC will reach
this limit in 2140.
Ethereum (ETH)
Market cap: $128.9 billion
Ethereum is a blockchain platform on which ether, its coin, exists. Ether is used to buy
blockspace on the Ethereum blockchain, with the price of blockspace fluctuating based
on demand. It’s the second-largest cryptocurrency by market capitalization and a
programmable asset that allows buyers to create, launch, and monetize "dApps." ETH
currently uses a proof-of-work (PoW) protocol to ensure mining security, although the
platform plans to transition to a proof-of-stake (PoS) over the next year.
Unlike Bitcoin, ETH has a fixed emission schedule, although recent protocol upgrades
may lead to lower inflation than Bitcoin. In periods of high volume, transaction fees have
been high leading many cost-conscious users to venture into other chains. However,
recent scaling solutions called layer 2s promise to give users the ability to transact at a
lower cost while still having the strong security guarantees of the Ethereum network.

Tether (USDT)
Market cap: $66.1 billion
Tether’s value is linked to the US dollar, making it a stablecoin. Each coin is worth $1,
and the tokens themselves are supposedly backed 1 to 1 with actual dollars in the
Tether Foundation’s reserves, meaning if the price were to drop, the foundation would
be able to restore the peg. Tether was the first stablecoin and is presently the most
widely used. Traders often use USDT as an intermediary when moving between
cryptocurrencies instead of reverting to dollars, as it not only levies low transaction
charges but also is compatible with other cryptocurrencies.

USD Coin (USDC)

Market cap: $55.8 billion
USDC is a stablecoin natively built on Ethereum’s blockchain network, which, much like
Tether, is pegged to the USD. USDC offers stability, transparency, and convenience,
allowing users to transfer USDC 24/7. USDC can is issued by Circle, which like the
Tether Foundation is responsible for maintaining the 1-to-1 backing and price stability.

Binance Coin (BNB)

Market cap: $36 billion
BNB is a form of cryptocurrency used on Binance, one of the world’s largest crypto
exchanges. Initially run on the Ethereum network, BNB has since moved to its own
blockchain and is locked in constant competition with Ethereum. BNB offers some of the
best utility tokens on the cryptocurrency market, with fast transactions at low fees and a
relatively large ecosystem of applications. BNB employs a burning system where vast
amounts of BNB are destroyed during fixed periods to reduce supply, potentially
increasing price.

Binance USD (BUSD)

Market cap: $17.5 billion
Launched in 2019, BUSD is another cryptocurrency on the Ethereum blockchain. It’s a
stablecoin from Binance and Paxos that ties to the US dollar. The New York State
Department of Financial Services (NYDFS) approves using BUSD tokens.

Cardano (ADA)
Market cap: $15.4 billion
Cardano was launched by Charles Hoskinson, a co-founder of Ethereum, in 2017.
Cardano markets itself as a third-generation blockchain and smart contract platform,
which is potentially more scalable and decentralized than competitors. Cardano is
known for taking a slow and steady approach with peer-reviewed papers, meaning
although it may have superior designs and security, the pace of new feature
development has been slower than its competitors.

XRP (XRP)
Market cap: $15.4 billion
Formerly known as Ripple, XRP allows users to pay in various real-world fiat currencies
through a global network used by many financial institutions. XRP was built to be useful
for cross-border transactions by financial institutions. It has a large supply of 100 billion
coins.

Solana (SOL)
Market cap: $11.3 billion
Solana is a relatively new blockchain platform that creates the cryptocurrency SOL. It’s
a big player in decentralized finance (DeFi) and smart contracts. SOL is
an environment-friendly cryptocurrency whose supply is limited to 489 million
tokens. Solana gained huge popularity as a cheaper and faster alternative to ether
when Ethereum transaction fees spiked.

Are Cryptocurrencies Securities?

In the past, the SEC has said that Bitcoin and Ethereum, the top two cryptocurrencies
by market cap, were not securities. In September 2022, SEC Chair Gary Gensler stated
he believes cryptocurrencies are securities and has asked SEC staff to begin working
with crypto developers to register their crypto. However, he also clarified that he did not
speak on behalf of the SEC; he was only speaking for himself. He encouraged those
starting in the crypto space to register their crypto in the spirit of getting ahead because
"It's far less costly to do so from the outset.
The Bottom Line
Cryptocurrencies are digital assets that are secured by cryptography. As a relatively
new technology, they are highly speculative, and it is important to understand the risks
involved before making an investment.
Investing in cryptocurrencies and other initial coin offerings (“ICOs”) is highly risky and
speculative, and this article is not a recommendation by Investopedia or the writer to
invest in cryptocurrencies or other ICOs. Because each individual's situation is unique,
a qualified professional should always be consulted before making any financial
decisions. Investopedia makes no representations or warranties as to the accuracy or
timeliness of the information contained herein.
HOW TO INVEST IN CRYPTOCURRENCY

How Do You Invest in Cryptocurrency?

Are you considering investing in cryptocurrency? Though Bitcoin is likely the best-
known digital money, thousands of cryptocurrencies already exist. Cryptocurrency
investing can take many forms, ranging from buying cryptocurrency directly to investing
in crypto funds and companies. For direct investing in crypto coins, you can buy
cryptocurrency using a crypto exchange or through certain broker-dealers. Find out
more about how you can invest in one of the newest and most inventive  asset
classes available.

KEY TAKEAWAYS
 Cryptocurrency is digital money that is secured by blockchain technology.
 Cryptocurrency investing can take many forms, ranging from buying
cryptocurrency directly to investing in crypto funds and companies.
 You can buy cryptocurrency using a crypto exchange or through certain broker-
dealers.
 Pay attention to transaction fees when making crypto purchases because these
fees can vary widely among currencies.
 Investing in cryptocurrency is risky, so it's important not to invest more money
than you can afford to lose.

Different Types of Cryptocurrency Investing

When you think of investing in cryptocurrency, you might think about buying and holding
one or more crypto coins. Buying cryptocurrency directly is probably the most common
way to add crypto exposure to your portfolio, but when it comes to investing in
cryptocurrency, you have a few different options:
 Buy cryptocurrency directly: You can choose to directly purchase and store one
or more cryptocurrencies. Your options range from the most established digital
 currencies like Ethereum and Bitcoin to virtually unknown coins that are newly
released in an initial coin offering (ICO).
 Invest in cryptocurrency companies: You can invest in companies with a partial
or total focus on cryptocurrency. Your options include cryptocurrency mining
companies, mining hardware makers, companies like Robinhood Markets Inc.
(HOOD) and PayPal Holdings Inc. (PYPL) that support cryptocurrency, and many
others with varying levels of crypto exposure. You also can invest in companies
like MicroStrategy Inc. (MSTR), which hold large amounts of cryptocurrency on
their balance sheets.
 Invest in cryptocurrency-focused funds: If you don't want to choose among
individual cryptocurrency companies, then you can decide to invest in a
cryptocurrency-focused fund instead. You have a choice of exchange-traded
funds (ETFs), such as index funds and futures funds, in addition to a range of
cryptocurrency investment trusts.

FAST FACT
Some crypto-focused funds invest in cryptocurrency directly, while others invest in
crypto-focused companies or derivative securities such as futures contracts.
 Invest in a cryptocurrency Roth IRA: If you want to invest in cryptocurrency
and also garner the tax advantages afforded by an individual retirement account
(IRA), then you can consider investing in a cryptocurrency Roth IRA. Using the
services of a crypto IRA provider can also facilitate more secure storage for your
cryptocurrency holdings.
 Become a crypto miner or validator: Perhaps the most direct way to invest in
cryptocurrency is to mine it or act as a validator in a crypto
network. Cryptocurrency miners and validators earn rewards in crypto, which
they can either hold as investments or exchange for another currency.

How to Buy Cryptocurrency from an Exchange

If you want to invest in cryptocurrency directly, then you can use a cryptocurrency
exchange. Here's how to buy cryptocurrency through an exchange:
1. Choose which cryptocurrency exchange you want to use. Your best bet is
a reputable, well-known exchange with a large selection of currencies.
 2. Establish an account with the cryptocurrency exchange. You will need to
provide your personal information and verify your identity to complete the
registration process.
3. Fund your account with fiat money. Before you can buy any crypto, you need
to fund your exchange account with another currency, such as U.S. dollars.
4. Decide which cryptocurrency you want to buy. You can choose to invest in
one or many cryptocurrencies. Research your options to help you decide.
5. Place a buy order for your chosen cryptocurrency. Follow the steps required
by the exchange to submit and complete a buy order for one or more
cryptocurrencies.
6. Store your cryptocurrency in a digital wallet. After your purchase is complete,
the information you need to access your cryptocurrency is held in a digital
wallet. That crypto wallet can be hosted either by the cryptocurrency exchange
or an independent wallet provider.

IMPORTANT: As an investor in cryptocurrency, you need to decide how much of your

portfolio to allocate to digital assets.

A best practice among investors is to periodically review your entire portfolio to assess
the need to rebalance your holdings. That might mean increasing or scaling back your
crypto exposure, depending on your investment goals and other financial needs.

What to Know Before Investing in Cryptocurrency

Investing in cryptocurrency is considered risky. The prices of cryptocurrencies, even
the most established ones, are much more volatile than the prices of other assets like
stocks. The prices of cryptocurrencies in the future could also be affected by regulatory
changes, with the worst-case possibility that cryptocurrency becomes illegal and
therefore worthless.
Many investors are nonetheless attracted to the potential upside of investing in crypto. If
you decide to invest, it's important to carefully research any digital coin before buying it.
Pay attention to transaction fees when making crypto purchases because these fees
can vary widely among currencies.
The cryptocurrency space is evolving rapidly, so it's also important to pay attention to
new developments that may affect your crypto holdings. Cryptocurrency investors need
to understand the tax consequences of using crypto, especially if they purchase
something or sell their crypto investments.
Given the riskiness of cryptocurrency as an asset class, it's especially important not to
invest more money in crypto than you can afford to lose.

Is Cryptocurrency a Good Investment?

Investing in cryptocurrency is not for everyone. The prices of cryptocurrencies can be
volatile, which makes this type of investing likely a poor choice for conservative
investors. If you are willing to assume greater risk as an investor, then investing in one
or more cryptocurrencies may be right for you.
How Can I Invest in Bitcoin?
You can invest in Bitcoin directly by using one of the major cryptocurrency exchanges,
such as Coinbase or Binance. Another way to gain investment exposure to Bitcoin is to
buy shares in a company with significant Bitcoin exposure, such as a Bitcoin mining
company. A third option is to invest in a Bitcoin-focused fund such as an exchange-
traded fund (ETF).

How Much Money Do I Need to Buy Cryptocurrency?

You can invest in Bitcoin or another cryptocurrency without spending much money.
Using the Coinbase platform, for example, you can buy cryptocurrency with as little as
two units of your local currency.