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.

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.

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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 e-commerce 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.

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.¹The 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 be used in multiple industries, such as supply chain, and processes like 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. It was invented by an anonymous person called Satoshi Nakamoto and was introduced 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 the total value.⁴

Are Cryptocurrencies Legal?

Fiat currencies derive their authority as a medium 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 of 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 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 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 like Bitcoin Futures are available at the Chicago Mercantile Exchange. The Securities and Exchange Commission (SEC) has said that Bitcoin and Ethereum are not securities.

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 proceeds would be taxed—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.

Here are 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 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, like 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. An example of such decentralized transfers are flash loans in decentralized finance. These loans, which are processed without backing collateral, can be executed within seconds and are used in trading.¹²
• Cryptocurrency investments can be used to generate profits. Cryptocurrency markets have skyrocketed in value, reaching almost $2 trillion at one point of time, in the past decade. As of Dec. 20, 2021, Bitcoin was valued at more than $862 billion in crypto markets.¹³
• One of the most prominent use cases of cryptocurrencies is being tested in the remittance economy. Currently, cryptocurrencies like Bitcoin are used as intermediate currencies to streamline money transfers across borders. Thus, a fiat currency is converted to bitcoin (or other cryptocurrency) and transferred across borders and, subsequently, converted to the destination fiat currency. This method streamlines the money transfer process and makes it cheaper.

Disadvantages

• While they claim to be an anonymous form of transaction, cryptocurrencies are actually pseudonymous. They leave a digital trail that can be deciphered by agencies like the Federal Bureau of Investigation (FBI). This opens up possibilities of governments or federal authorities tracking the financial transactions of ordinary citizens. ¹⁴
• 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 with 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 roughly 45% of Bitcoin, a cryptocurrency whose value has surged in recent times, is held by just 11,000 investors.¹⁶
• One of the conceits of cryptocurrencies is that they can be mined by anyone using a computer with an internet connection. However, mining popular cryptocurrencies requires considerable energy, sometimes as much as that consumed by entire countries. The expensive energy costs, coupled with the unpredictability of mining, has concentrated mining among large firms whose revenues running into billions of dollars. According to an MIT study, 10% of miners account for 90% of its mining capacity.¹⁶
• While 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 with 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 Cryptocurrencies are thus considered by some economists 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 Simple Words?

Cryptocurrencies are digitals assets and decentralized systems that allow for secure online payments.

How Do You Get Cryptocurrency?

Any investor can purchase cryptocurrency from popular crypto exchanges like Coinbase, apps like 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 makes it possible for transacting parties to exchange value and money without the use of intermediary institutions like 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. While anyone with a computer and an internet connection can mine cryptocurrency, the energy- and resource-intensive nature of mining means that the industry is dominated by large firms.

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 saikd 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. Since 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.

Source: https://pmarketweb.wordpress.com/2021/12/23/all-about-cryptomarket loaded 06.02.2022