Cryptocurrency can be a confusing topic–even for financial experts. These digital currencies can be used to buy goods and services, but you can also invest and trade them for profit. Cryptocurrencies are also unregulated and have had volatile price swings, which has certainly kept people talking.
Bitcoin is definitely at the top of the list of the most popular cryptocurrencies, but it’s not the only one available. Bitcoin has also been especially volatile this year so far, thanks in part to China’s recent crackdown on “mining” the coins.
Right now, you might be wondering what cryptocurrency is, and how it works. Let’s go over the basics.
What Is Cryptocurrency?
Cryptocurrency, or crypto, is a digital form of payment that can be exchanged for goods and services. The catch is that this type of digital currency generally only exists electronically — in other words, there’s no physical paper bill or coin version. You usually exchange crypto with someone online using your phone or computer, without going through an intermediary like a bank.
You can use crypto for quick payments or avoid transaction fees that banks charge. Some prefer to use cryptocurrency because the transactions are hard to track, while others perfer to hold and trade crypto as an investment. Some companies have issued their own currencies that can be used for transactions. Their proprietary crypto is traded specifically for the good or service that the company provides.
In general, different cryptocurrencies have different purposes or best uses. However, all of them share one thing in common: anonymity.
Most cryptocurrencies work using a technology called blockchain. Blockchain is a system of recording information in a way that makes it difficult or impossible to change, cheat, or hack the system.
Every computer in the currency’s network has a full list of transactions. Each time a transaction occurs, the majority of computers in the network authenticate and authorize the transaction. Those transactions are added to the blockchain in groups, aka blocks, every few minutes. This creates a decentralized database managed by multiple participants, and all participants have a copy for complete transparency. All records are encrypted and validated records can’t be changed.
Because this specific type of database is run by the people who use it, there is no one person in charge who can change the entries. It prevents fraud, counterfeiting, and theft. Decentralization is often very important to crypto enthusiasts who prefer not to place their money in the hands of a bank or government.
Why Cryptocurrencies Are So Popular
There are many reasons why people are flocking to cryptocurrencies. Some supporters see cryptocurrency as the way of the future. They anticipate that these digital currencies will become the accepted way to exchange money, and these folks are buying Bitcoin and other cryptocurrencies now before they become more valuable.
Others have no interest in the long-term future of cryptocurrency. They are more interested because crypto is currently a hot investment. Many of these investors might be flocking to purchase Bitcoin, since the value is currently down, in the hopes that it will rebound soon. They’ll simply sell it again once they can turn a profit.
Many supporters see cryptocurrency as a better investment than cash. While cash is susceptible to inflation and losing value over time, cryptocurrency can gain value over time. This is because crypto removes central banks from managing the money supply. But, as we’ve seen, there’s a risk that crypto can go into freefall as well.
The Different Cryptocurrencies Available
Bitcoin and Ether (Ethereum) are two of the most well-known cryptocurrencies. However, there are many different cryptocurrencies out there, and new ones are continuously being created.
More than 10,000 different cryptocurrencies are currently being traded publicly. Among the thousands of cryptocurrencies available, though, most have very little value and unclear potential.
Many investors consider bitcoin to be the original cryptocurrency. As the first, it is also the most popular and highly valued. Bitcoin was initially created to be used as a digital peer-to-peer payment system, but it has undergone rapid growth to become a significant currency. Some businesses have even started accepting bitcoin in addition to traditional currencies. Even still, Bitcoin has seen high volatility over the course of its history.
Ethereum is the name of the broader blockchain network, an open-source blockchain upon which developers can build apps and other cryptocurrencies. Ether is the native cryptocurrency of the platform. It is the second-largest cryptocurrency by market capitalization, behind Bitcoin. Although Ether’s value has risen sharply since it was created in 2013, it is still much farther behind Bitcoin.
This is the cryptocurrency token of Ripple, a digital payment network for financial transactions. XRP is built for digital payments; fans claim it is a faster and more efficient way to exchange between two currencies or networks than traditional banking systems. Think of it as a bridge currency to other currencies. Ripple does not use blockchain mining like Bitcoin, Ethereum, and others. Instead, it uses a consensus mechanism to validate account balances and transactions.
Is Cryptocurrency a Good Investment?
Whether or not it’s smart to invest in cryptocurrencies is a hotly debated topic. Some investors swear it is going to change the world, while others say it is a terrible financial decision. In truth, no one knows what the future holds for crypto. But there are a few things to consider.
Cryptocurrency could revolutionize the banking and financial services industries around the globe. We’re already starting to see more merchants accepting certain cryptocurrencies as a form of payment. Investing in crypto now could be a way of getting in on the ground floor.
Cryptocurrency is a highly volatile investment. While traditional financial markets experience moderate volatility, the cryptocurrency markets are in a different league altogether. Prices will skyrocket and plummet at a much quicker and more extreme pace. These extreme price swings, along with less liquidity than traditional financial markets, make cryptocurrency immensely volatile and risky.
With that being said, the same price swings that make cryptocurrency investment volatile also make crypto assets potentially very profitable. Although no one knows how cryptocurrency will perform over time, some investors have been able to make big profits in the last several years.
Will It Hold Value?
For an interesting perspective on the value of crypto assets, Warren Buffett once compared Bitcoin to paper checks: “It’s a very effective way of transmitting money, and you can do it anonymously and all that. A check is a way of transmitting money, too. Are checks worth a lot of money just because they can transmit money?”
In other words, some savvy investors don’t see crypto as its own form of currency, but more as a means of transmitting other forms of currency.
As for cryptocurrencies actually becoming the currency of the future, they will need to stabilize first. Extreme volatility prevents merchants and consumers from determining fair pricing for goods and services. Can you imagine trying to earn and spend the U.S. dollar if the value fluctuated the way cryptocurrency does? Your grocery bill could swing as much as 30% from week to week for the same goods.
How to Buy Cryptocurrency
If you’re still curious about crypto, investing a small portion of your portfolio in cryptocurrency is a way to help diversify without too much risk. It’s important to make sure you only invest what you can afford to lose (like with any other investment, really) because of how volatile crypto can be.
To buy cryptocurrencies, you will need a crypto wallet. Unlike a regular wallet that you keep in your pocket or purse, your crypto wallet doesn’t actually hold anything physical. Instead, it is a device, program or app, physical medium, or a service that stores the keys for cryptocurrency transactions. The keys are like passwords that give you access to your cryptocurrencies. They prove your ownership of your digital currency, but your actual holdings live on the blockchain.
Some users prefer paper wallets; keys are written on a physical medium and stored in a safe place. While this can make it harder for malicious users to steal your keys, it makes using your crypto harder, too.
Hardware wallets are another way to make it harder for anyone to access your cryptocurrency. Keys are stored on a thumb drive that is kept in a safe place, and you only connect it to a computer when you want to use your crypto.
The most popular option by far are online wallets, which utilize apps or other software. It makes purchasing, using, and trading crypto easy — but your protection against hackers is only as good as your wallet’s security. Look for features like two-step encryption and two-factor verification.
Once you have a wallet and have created an account on an exchange, you can transfer money to buy cryptocurrencies. Some cryptocurrencies, like Bitcoin, allow you to purchase with U.S. dollars. Other crypto might require you to pay with Bitcoin or another cryptocurrency.
A growing number of online brokers, like Sofi Active Investing and Tradestation are also getting into the cryptocurrency game. With these apps, you can purchase cryptocurrency alongside the rest of your investments, like stocks and ETFs.
Before taking the plunge, it’s extremely important to choose your crypto assets carefully. Not all of them are created equal, so be sure to do your homework to make sure you’re buying the right one for you.