You can use the many types of cryptocurrencies to buy and sell goods and services in the place of traditional currencies, or you can try your luck at trading them for profit. But what are the different cryptocurrencies, how do they function as a form of digital money and are they safe?
What is Cryptocurrency?
Cryptocurrency is a digital currency that represents a store of value and is used as a medium of exchange. Transactions are secured by sophisticated cryptography, making the currency virtually impossible to counterfeit. Cryptocurrencies are digital assets and do not exist in any physical form.
A cryptocurrency works on a worldwide, decentralized network of computers based on blockchain technology. Cryptocurrencies are not issued by any country's central authority of banking and finance. This makes them immune to government regulatory provisions, interference or manipulation.
Cryptocurrencies are denominated as tokens or coins, which you can use to make payments online. Mobile payment apps, such as PayPal and Venmo, will allow you to purchase, make payments and sell cryptocurrencies through their peer network platforms.
Read More: How Does PayPal Work?
What is Blockchain Technology?
The rapid growth in the market of cryptocurrencies created a need for ways and procedures to handle peer-to-peer transactions. This demand led to the development of blockchain technology.
Blockchain technology is something like a ledger on a global spreadsheet. It is not located on a central database, but instead runs on a worldwide network of volunteers’ computers. Anyone can view this ledger at any time since it resides on an open-access network not controlled by a single central bank. You can think of this distributed ledger as a Google Doc stored in the cloud that the entire public has access to.
Encryption and private keys maintain a degree of virtual security for a blockchain. This technology enables people to send money anonymously to other people without passing through a bank or any other financial institution.
Read More: 6 Best Mobile Payment Apps
What is Cryptocurrency Mining?
Mining is the process that validates and records new transactions on a cryptocurrency’s blockchain ledger. Since the market for cryptocurrencies is decentralized, no bank or other financial institution is available to verify the transactions with the virtual currency. This is achieved through cryptocurrency mining.
Individuals, known as miners, solve mathematical algorithms to match and verify the transactions before they are added to the ledger. These algorithms, called hashes, are complicated puzzles that miners must solve to validate a transaction. This process of mining virtually ensures that transactions cannot be falsified or altered.
Miners are compensated for their efforts by receiving a small amount of the cryptocurrency being mined. However, the mining process requires an extensive amount of high-powered computer hardware with computing power that consumes considerable electricity. The profitability of a mining operation depends on the cost of electricity and the scale of operations, with the ability to mine more based on the miner's proof-of stake - the more you have, the more you can mine.
What Are the Most Popular Cryptocurrencies?
Bitcoin (BTC) was the first cryptocurrency. It has been around the longest and is the most well-known and largest of the cryptocurrencies. According to the latest data from Yahoo Finance, Bitcoin has a market capitalization in excess of $1 trillion. Ethereum (ETH) comes in next with a market cap of a little over $300 billion. Other popular cryptocurrencies include Tether, Litecoin, Dogecoin and Cardano.
There are currently more than 10,000 publicly traded cryptocurrencies. In addition, new cryptocurrencies continue to pop up through initial coin offerings (ICOs).
Read more: Is Bitcoin Still a Player?
Advantages of Cryptocurrency
Cryptocurrencies are an easy way to transfer funds directly between individuals without going through another party's financial system, such as a bank or credit card company. Funds transferred with cryptocurrencies have minimal processing fees that are much cheaper than fees charged by banks and other financial services institutions.
Funds are stored in a user’s cryptocurrency wallet, which is only accessible with a private key created by the owner. Transactions in cryptocurrencies are anonymous and have privacy protection from governments and other prying parties.
Disadvantages of Cryptocurrency
Criminals like to take advantage of the anonymity of cryptocurrency transactions for illegal activities such as tax evasion and money laundering. Recent publicity has highlighted cyberattacks where private companies have made ransom payments with cryptocurrencies.
Exchange rates are based on supply and demand, which makes prices highly volatile. If you're trying to complete a trade transaction with another party, exchange rates between cryptocurrencies can change daily and even hour-by-hour.
If you lose access to your digital wallet, your money is gone. Unless your trading platform stores your username and password for your digital wallet, there is no way to retrieve your codes if you lose them.
As this form of virtual payment gains notice, scams are also on the rise.
How Do You Buy and Sell Cryptocurrencies?
Anyone can buy and sell a cryptocurrency through cryptocurrency exchanges. These exchanges act as intermediaries between buyers and sellers and earn money by charging commissions and transaction fees.
Most cryptocurrency transactions pass through centralized cryptocurrency exchanges. These exchanges are user-friendly and are preferred by beginning investors. Some customers prefer exchanges based on decentralized applications because they do not require anyone to complete forms revealing private information, which is required by centralized exchanges.
Several of the most popular centralized cryptocurrency exchanges are Coinbase, Binance, Kraken, Gemini and Cash App. Beginning users of cryptocurrencies prefer Cash App because its platform also includes a conventional peer-to-peer money transfer system, as is now the case with Venmo.
For those looking for a decentralized cryptocurrency exchange, Bisq is a good choice. Bisq has downloadable software and is accessible to anyone with a computer or smartphone. It does not have a registration process or a Know Your Customer (KYC) rule, as required by centralized exchanges.
Can You Invest in Cryptocurrencies?
Some people think of putting money in cryptocurrencies as investments. However, cryptocurrencies do not have any intrinsic value and are not backed by any assets such as gold or the U.S. dollar. Cryptocurrencies do not generate any cash flow or profits, like stocks of companies. Prices are determined by supply and demand and even by publicity in the media. The ripple effect of this publicity makes their prices highly volatile, and the wisdom of investing long-term is questionable.
To make a profit by investing in cryptocurrencies, you have to find someone who is willing to pay a higher price than you paid. This is known as “the greater fool” investment theory, leading to the question, "Who will buy when you're ready to sell?"
Trading in cryptocurrencies is done without any government regulation or regulators. This raises the question of what taxes are paid on gains and losses from trading.
What Can You Do With Cryptocurrencies?
Besides speculating on the rise and fall in the price of a cryptocurrency, you can now use cryptocurrencies, especially Bitcoin, to pay for purchases at more and more retailers. Here are a few:
- Whole Foods
- Home Depot
- Restaurant Brands International
The number of cryptocurrencies available and the demand for their applications will continue to grow. In addition to paying for goods and services, you can also speculate on the volatility in their prices.
- Federal Trade Commission: What To Know About Cryptocurrency and Scams
- Library of Congress: What is Cryptocourrency?
- Internal Revenue Service: Virtual Currencies
- Library of Congress: Cryptocurrency & Blockchain Technology
- Forbes: What is Cryptocurrency?
- Business Insider: Cryptocurrency Basics
- Yahoo Finance: 10 Best Cryptocurrencies To Invest in for 2021
- U.S. Commodity Futures Trading Commission: BitCoin Basics
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.