Cryptocurrencies (or crypto) are a type of digital asset. If a merchant accepts cryptocurrency as a form of payment, someone can use it in the same way as cash to buy a pair of shoes or order takeout. People can also trade, invest and speculate in cryptocurrency, which is its most popular use.
In addition to enabling payments and investment opportunities, new uses for cryptos and blockchain technology are continually being explored—such as non-fungible tokens (NFTs) and decentralized finance (DeFi) projects. But understanding the fundamentals can be important for people who want to keep up with the ever-changing crypto landscape.
The history of cryptocurrency
Although precursors to crypto date back to the mid-1980s, it wasn’t until 2008, when an unidentified person, or perhaps a group of people, using the alias Satoshi Nakamoto, published a white paper laying the foundation for Bitcoin. Nakamoto’s white paper introduced the idea of a peer-to-peer electronic cash system outside the banking system. In January 2009, Nakamoto “mined,” or created, the first Bitcoin.
How cryptocurrency works
Most cryptocurrencies rely on decentralized, distributed networks that use blockchain technology, an online ledger spread among a worldwide network of computers.
With a traditional ledger, a person or organization, like a bank, records transactions. On the blockchain, no individual or entity has that responsibility.
Once someone makes a crypto transaction using a digital wallet, it's sent to a peer-to-peer network of independently run computers. These validate a user's status and verify the transaction.
Transactions on the blockchain are duplicated and spread out, and each block of data in the chain holds a set number of transactions. When a new user appears on the blockchain, a record of that transaction goes on the ledger. It’s nearly impossible to alter these transactions once they become part of the blockchain.
Each user gets a copy of every transaction to boost security. So if someone wants to corrupt the blockchain, they have to alter every single block on the chain, not just one. Every transaction is time-stamped and all records are encrypted.
Cryptocurrency mining also involves computers solving complex math equations and recording data on the blockchain. By solving these puzzles, called proof of work, the computers make the blockchain more secure.
Whoever finds a solution shares their proof across the blockchain, and other miners confirm its accuracy. Once a consensus is reached, transactions are clustered into digital blocks and added to the blockchain.
Miners earn cryptocurrency in the form of tokens and a share of transaction fees.
Types of cryptocurrency
There are many different cryptocurrencies, and among the most widely used based on market value are:
The first cryptocurrency—decentralized, peer-to-peer crypto—launched in 2009. Although it’s the oldest crypto, bitcoin’s price remains highly volatile. In 2020 alone, the price dropped below $5,000 and jumped to over $63,000 per coin.
Ethereum is similar to Bitcoin in that it runs on a blockchain, but there's a key difference: Users can program it and use it to build apps. Etheruem has persistently had the second-highest market cap of any crypto, behind Bitcoin.
Ethereum also uses smart contracts, which are essentially collections of code and data that live at a specific address (or location) on the Ethereum blockchain. These smart contracts are designed to self-execute without human intervention when certain conditions are met. They can be used for decentralized financial services, apps, and games.
A crypto developed by Ethereum co-founder Charles Hoskinson, Cardano was built on a “scientific philosophy” and dozens of peer-reviewed research papers. Cardano uses its own internal crypto, called ADA, to let users send and receive funds. It’s also a different type of blockchain technology, with the goal of being “greener” and more scalable than other platforms. As Cardano evolves, its researchers use evidence-based approaches and continue to solicit peer insights before implementing each new phase of development—including a recent update to allow smart contracts, like Ethereum. It’s currently the third-largest crypto.
According to CoinMarketCap, there are over 6,000 different types of cryptocurrencies, and more are always being created. In addition to cryptocurrencies, which rely on their own blockchain, there are also crypto tokens that are built on top of an existing blockchain. Ethereum is a popular platform, in part, because it lets users create tokens that can be used and traded like a cryptocurrency.
What is cryptocurrency used for?
You could in theory use crypto to buy goods and services, but most retailers don't accept cryptocurrency as a form of payment. And since its value fluctuates greatly, unlike dollars, its use as a medium for exchange is limited.
However, cryptocurrency is a popular investment; it's relatively easy to buy and the value of some cryptocurrencies, such as Bitcoin, have skyrocketed. That, in turn, has produced huge returns for some investors, though gyrations in the prices cost others.
Beyond its role in the financial industry, there's also buzz around the potential for cryptocurrency's other uses, and its new technology could disrupt everything from the auto industry to cargo shipping to voting.
Benefits of cryptocurrency
Those who are bullish on cryptocurrency believe that they are the future of money—where power is in the hands of users rather than intermediaries or governments, and transactions are completely transparent. Others merely view crypto simply as an asset that they can buy and sell to try to make money.
- Decentralized. There’s no go-between, or intermediary, with cryptocurrency. In turn, users communicate and exchange directly with other users.
- No bank fees. Although there may be fees when you make a transaction over a crypto exchange platform, like Coinbase or Kraken, there aren't overdraft fees or monthly maintenance account charges. You'll want to know which fees come with using a crypto platform to make transactions.
- Anonymity. Users have a good deal of anonymity, although they can be tracked. But unlike traditional transactions made with debit or credit cards, which are linked to a person's name, transactions made with cryptocurrency are linked to a wallet address.
- Greater accessibility. You only need a smartphone or computer to use cryptocurrencies. This could make it easier for those traditionally underserved by the financial industry to participate in this digital network of exchange.
Downsides of cryptocurrency
Crypto is, in many ways, the wild west of finance. It’s difficult to regulate, which leaves investors exposed to various types of risk.
- Murky regulations. Governments are working to regulate cryptocurrencies and crypto platforms. However, their decentralized nature and the ability to use the systems without identifying yourself makes this difficult.
- No legal protections. Wondering if cryptocurrency is safe? If you get scammed or lose your money, there's no bank or credit-card company to call for help. Further, because cryptocurrency can be difficult to understand and regulate, people may need to be extra cautious about scams.
- Inability to stop payment. Should you use cryptocurrency to pay for something, and never receive the item you paid for or it's defective, there's no way to halt or reverse a payment. The only way to get any money back is if the receiver returns it to you. Hackers can also steal the key to your digital wallet and clean out your account. In turn, scams abound when it comes to cryptocurrency. If someone asks for payment in cryptocurrency, be cautious. Always research sellers and retailers.
- Info could be publicized. Because blockchain is a public ledger, every cryptocurrency transaction is listed for all to see. Details could include the amount exchanged and each party's public addresses. You might remain pseudonymous. But if someone connects your identity with your public address, they could figure out all the transactions associated with that address.
- Inconsistent transaction speeds and cost. Cryptocurrency transactions can be fast and low cost. However, depending on the cryptocurrency and its current network congestion, speeds can drop and prices may rise to much higher than what someone would experience with a traditional transaction.
- Energy consumption. Cryptocurrency mining can consume a lot of energy and leave a large carbon footprint. According to Cambridge University's Bitcoin Electricity Consumption Index estimates that Bitcoin mining uses over 100 terawatt hours of electricity a year as of October 2021. This is more than the Philippines’s energy consumption in 2019, and about a third as much electricity as the UK used that year.
Why is cryptocurrency popular?
Cryptocurrencies are popular for different reasons. Some people see them as the future of finance, while others see them as a potential investment opportunity. In some areas, a decentralized currency may be more appealing than the national currency, particularly for people who don’t trust the government or the stability of the region. The ability to transact with near anonymity also makes cryptocurrencies an appealing option for criminals.
How do you buy cryptocurrency?
You can buy and sell cryptocurrency through an exchange on your computer or smartphone. Through these platforms, you can usually convert cryptocurrency from one type to another, and send and receive cryptocurrency.
If you want to make a purchase with cryptocurrency, you can do so through the digital wallet on your computer or phone. Similar to other platforms that use traditional money, you can exchange currency by noting a user’s wallet address and payment amount, then hitting send.
Is cryptocurrency a good investment?
Cryptocurrencies are highly volatile assets. Its appeal as an investment is partly a speculative bet—the value of a crypto can soar overnight. Some also see crypto as a way to revolutionize the financial industry.
Is cryptocurrency legal?
Legal standards vary from country to country. Cryptocurrencies are permitted in a handful of countries, including the US, Canada, UK, and Japan. El Salvador was the first country to adopt Bitcoin as legal tender. But in China, crypto transactions are illegal.
The bottom line
Since its inception in 2009, cryptocurrencies have become widely traded, based on their appeal as a decentralized digital currency that works outside centralized third-party platforms. But its extreme volatility and the ease of perpetrating scams, in part due to lack of government regulation and irreversible transactions, make it an investment that needs to be approached with caution.