INVESTING

CRYPTOCURRENCY

Cryptocurrency
By
JAKE FRANKENFIELD
Updated January 11, 2022

Reviewed by
ETHAN VERA

Fact checked by
VIKKI VELASQUEZ

What Is Cryptocurrency?
A cryptocurrency is a digital or virtual currency that is 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.

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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.
Experts believe that blockchain and related technology 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.
Watch Now: What Is Cryptocurrency?

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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 or purchased from cryptocurrency exchanges. Not all
ecommerce sites allow purchases using cryptocurrencies. In fact, cryptocurrencies, even
popular ones like Bitcoin, are hardly used for retail transactions. However, the skyrocketing
value of cryptocurrencies has made them popular as trading instruments. To a limited
extent, they are also used for cross-border transfers.

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Blockchain
Central to the appeal and functionality of Bitcoin and other cryptocurrencies is blockchain
technology. As its name indicates, blockchain is essentially a set of connected blocks or an
online ledger. Each block contains a set of transactions that have been independently
verified by each member of the 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 the entire network of
an individual node, or computer maintaining a copy of the ledger.
Experts say that blockchain technology can serve multiple industries, such as supply chain,
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. [2]

Types of Cryptocurrency
Bitcoin is the most popular and valuable cryptocurrency. An anonymous person called
Satoshi Nakamoto invented it and introduced it to the world via a white paper in 2008.
There are thousands of cryptocurrencies present in the market today.

Each cryptocurrency claims to have a different function and specification. For example,
Ethereum's ether markets itself as gas for the underlying smart contract platform. Ripple's
XRP is used by banks to facilitate transfers between different geographies.

Bitcoin, which was made available to the public in 2009, remains the most widely traded
and covered cryptocurrency. As of November 2021, there were over 18.8 million bitcoins in
circulation with a total market cap of around $1.2 trillion. Only 21 million bitcoins will ever
exist. [3]

In the wake of Bitcoin's success, many other cryptocurrencies, known as "altcoins," have
been launched. Some of these are clones or forks of Bitcoin, while others are new
currencies that were built from scratch. They include Solana, Litecoin, Ethereum, Cardano,
and EOS. By November 2021, the aggregate value of all the cryptocurrencies in existence
had reached over $2.1 trillion—Bitcoin represented approximately 41% of that total value.
[4]

Are Cryptocurrencies Legal?

Fiat currencies derive their authority as mediums of transaction 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. [5]

As of December 2021, El Salvador was the only country in the world to allow 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. [6] 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 in December. [7]

Cryptocurrencies are legal in the European Union. Derivatives and other products that use
cryptocurrencies will need to 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. [8] 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. The Securities and Exchange Commission
(SEC) has said that Bitcoin and Ethereum are not securities.

Important: Although cryptocurrencies are considered a form of money, the
Internal Revenue Service (IRS) treats them as a financial asset or property. And,
 as with most other investments, if you reap capital gains in selling or trading
cryptocurrencies, the government wants a piece of the profits. On May 20, 2021,
the U.S. Department of the Treasury announced a proposal that would require
taxpayers to report any cryptocurrency transaction of and above $10,000 to the
IRS. [9] How exactly the IRS would tax proceeds—as capital gains or ordinary
income—depends on how long the taxpayer held the cryptocurrency. [10]

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
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 that was
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 the need for 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. [11]
Because they do not use third-party intermediaries, cryptocurrency transfers between
two transacting parties are faster as compared to standard money transfers. Flash loans
in decentralized finance are a good example of such decentralized transfers. These
loans, which are processed without backing collateral, can be executed within seconds
and are used in trading. [12]
Cryptocurrency investments can generate profits. Cryptocurrency markets have
skyrocketed in value over the past decade, at one point reaching almost $2 trillion. As of
Dec. 20, 2021, Bitcoin was valued at more than $862 billion in crypto markets. [13]
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
Though they claim to be an anonymous form of transaction, cryptocurrencies are
actually pseudonymous. They leave a digital trail that agencies such as the Federal
Bureau of Investigation (FBI) can decipher. This opens up possibilities of governments
[14]
or federal authorities tracking the financial transactions of ordinary citizens.
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. [15]
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, an MIT study found that just 11,000 investors held roughly 45% of Bitcoin's
surging value. [16]
One of the conceits of cryptocurrencies is that anyone can mine them using a computer
with an Internet connection. However, mining popular cryptocurrencies requires
considerable energy, sometimes as much energy as entire countries consume. The
expensive energy costs coupled with the unpredictability of mining have concentrated
mining among large firms whose revenues running into the billions of dollars. According
to an MIT study, 10% of miners account for 90% of its mining capacity. [16]
Though cryptocurrency blockchains are highly secure, other crypto 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. [17]
Cryptocurrencies traded in public markets suffer from price volatility. Bitcoin has
experienced rapid surges and crashes in its value, climbing to as high as $17,738 in
December 2017 before dropping to $7,575 in the following months. [3] Some economists
thus consider cryptocurrencies to be a short-lived fad or speculative bubble.

$862.1 billion
Total market cap of Bitcoin, as of Dec. 20, 2021.
Frequently Asked Questions
What Is Cryptocurrency in Plain Words?
Cryptocurrencies are digital assets and decentralized systems that allow for secure online
payments.

How Do You Get Cryptocurrency?

Any investor 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 through
other instruments, such as Bitcoin trusts and Bitcoin ETFs.

What Is the Point of Cryptocurrency?

Cryptocurrencies are a new paradigm for money. Their promise is to streamline existing
financial architecture to make it faster and cheaper. 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.

Can You Generate Cryptocurrency?

Cryptocurrencies are generated by mining. For example, Bitcoin is generated using Bitcoin
mining. The process involves downloading software that contains a partial or full history of
transactions that have occurred in its network. Though anyone with a computer and an
Internet connection can mine cryptocurrency, the energy- and resource-intensive nature of
mining means that large firms dominate the industry.

What Are the Most Popular Cryptocurrencies?

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

Are Cryptocurrencies Securities?

The SEC has said that Bitcoin and Ethereum, the top two cryptocurrencies by market cap,
are not securities. It has not commented on the status of other cryptocurrencies.

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.

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ARTICLE SOURCES

Related Terms
Bitcoin Definition: How Does Bitcoin Work?
Bitcoin is a digital or virtual currency created in 2009 that uses peer-to-peer technology to facilitate
instant payments.
more

Blockchain Explained
A blockchain is a digitally distributed, decentralized, public ledger that exists across a network. It is
most noteworthy in its use with cryptocurrencies and NFTs.
more

What Is Ethereum?
Ethereum is a blockchain-based software platform with the native coin ether. Ethereum smart
contracts support a variety of distributed apps across the crypto ecosystem.
more

Digital Money Definition

Digital money or digital currency is any type of payment that exists purely in electronic form and is
accounted for and transferred using computers.
more

Convertible Virtual Currency Definition

Convertible virtual currency is an unregulated digital currency that can be used as a substitute for real
and legally recognized currency.
more

Virtual Currency
Virtual currency is a digital representation of value in purely electronic form. It can be open or closed
and centralized or decentralized.
more
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