What is Cryptocurrency?

Cryptocurrency is a digital currency that an individual company or government does not control. It is not backed by a central authority, such as the United States.

It is overseen online by a decentralized network of users. They are considered digital coins or tokens and are guarded by blockchain technology through encryption.

You can buy things with these "coins" as you would with government currency, but not all merchants accept them, so your options may be limited.

Definition and Explanation of Cryptocurrency

Cryptocurrency is a digital or virtual currency that uses cryptography to secure financial transactions. Unlike traditional currencies, it is decentralized, meaning it is not controlled by any government or financial institution. Cryptocurrencies are created through a process called mining, which involves solving complex mathematical problems. The most well-known cryptocurrency is Bitcoin, but there are over 2,000 other cryptocurrencies in existence, each with its unique features and uses.

Brief History of Cryptocurrency

The concept of cryptocurrency has been around for several decades, but it wasn’t until 2009 that the first decentralized cryptocurrency, Bitcoin, was created by an individual or group of individuals using the pseudonym Satoshi Nakamoto. Since then, the crypto market has grown exponentially, with new cryptocurrencies emerging and existing ones evolving. Today, cryptocurrencies are used for a variety of purposes, including financial transactions, investments, and even as a store of value.

How Does Cryptocurrency Work with Blockchain Technology

When a transaction is conducted, a group of computers called miners using blockchain software will check to see if the payment is valid. The transaction is authenticated after the miners certify that the token’s history is up to the blockchain's inception. This process is called/considered a ‘confirmation’. 

After a set number of these confirmations has occurred, then the transaction gets wrapped into a block. These individual blocks are then labeled and linked one after the other to form the chain. That’s where the name blockchain derives from.

 Once these blocks are minted/formed they are now permanent and cannot be edited or deleted.

The blockchain acts precisely like a digital public ledger.

Once the transaction is confirmed, the person receiving their money can access it using a secret code called a private key.

Understanding Blockchain Technology

Blockchain technology is the backbone of cryptocurrency, enabling secure, transparent, and decentralized transactions. It is a distributed ledger technology that produces a secure encrypted record of the value of each virtual coin and its associated transactions.

How Blockchain Works

A blockchain is a kind of database that records and timestamps every entry into it. The blockchain is a decentralized, distributed ledger that records transactions. Many crypto blockchain databases are run with decentralized computer networks. The networked computers check and recheck the transactions to ensure accuracy. If there’s a discrepancy, the networked computers have to resolve it.

Importance of Blockchain in Cryptocurrency

Blockchain technology is essential for the functioning of cryptocurrency. It allows for secure, transparent, and decentralized transactions, making it possible for cryptocurrencies to operate without the need for a central authority. Blockchain technology also enables the creation of a permanent and unalterable record of all transactions, ensuring the integrity of the cryptocurrency.

Benefits of Blockchain Technology

Blockchain technology has several benefits, including:

• Security: Blockchain technology ensures that transactions are secure and tamper-proof.

• Transparency: Blockchain technology provides a transparent record of all transactions, making it possible to track the movement of funds.

• Decentralization: Blockchain technology enables decentralized transactions, making it possible for cryptocurrencies to operate without the need for a central authority.

• Efficiency: Blockchain technology enables fast and efficient transactions, reducing the need for intermediaries and transaction costs.

Various Cryptocurrencies Available

Introduced in 2009, there are almost 10,000 cryptocurrencies with a collective market capitalization of more than two trillion dollars. But some cryptocurrencies are more trusted than others.

Cryptocurrencies are classified as financial assets by the Internal Revenue Service (IRS). This classification means that, while they function as a form of money, they are treated as property for tax purposes, leading to capital gains taxation upon sale or trade. This has significant implications for investors in terms of how digital assets are regulated and reported in financial transactions.

Bitcoin

Bitcoin (BTC) was introduced by Satoshi Nakamoto and operates on its own blockchain. It ensures its security and prevents fraudulent transactions by verifying them through a process called "proof of work." To do this, miners must solve difficult cryptographic puzzles.

Initially, Bitcoin cost less than $500, but as of August 10, 2024, its worth was $61,174.60. However, it has had some bumps along the way. In December 2022, it was valued at $17,168, so there is some risk.

Ethereum

Ethereum (ETH) is another crypto (or ‘altcoin’) with a large market capitalization.

The difference between Ethereum and Bitcoin is it’s more like a computer network that lets people run special decentralized applications (DApps) and sets up smart contracts within its system. While Bitcoin acts more as a currency.

As of August 10, 2024, Ethereum was valued at $2,611.53.

Tether

Tether stands out from other cryptocurrencies because it is categorized as a stablecoin.

A stablecoin’s value is usually pegged with another store of value or real-world asset. For example, Tether (USDT) is pegged to the U.S. dollar. But stablecoins can also be pegged to gold, silver or any other commodity.

The theory is that a stablecoin will or should maintain its value equivalent to its peg.

Stablecoins like Tether are considered more stable in their value than other cryptocurrencies. This is a choice for investors who are concerned about the volatility of digital assets.

Crypto Investment

Cryptocurrency can be purchased through a broker or crypto exchanges.

Brokers simplify the crypto buying process for a small fee. They might also restrict moving your crypto holdings. So be aware if you want to transfer your crypto off those platforms. However, some investors may prefer to hold their coins in an ‘online’ crypto wallet offered by platforms such as Robinhood or SoFi.

You can also purchase cryptocurrency through exchanges like:

• Coinbase
• Gemini
• Binance.US

They offer platforms for buying and selling digital currency. But these platforms have a high learning curve for some new investors.

Consider familiarizing yourself with an exchange before investing any of your hard-earned cash.

Set Up an Account on Crypto Exchanges

You'll need to set up an account, which requires you to provide personal information to prove who you are. This is often referred to as "know your customer" or KYC protocols.

This includes identification like a driver’s license or passport. Some may require a photo of yourself.

Add Funds You Want to Invest

You'll need to ensure funds are available in your account before investing. There are various methods to add money. These include:

• connecting with your bank
• initiating a wire transfer
• using a debit card
• using a credit card

Depending on the type of deposit method, broker, or exchange, it may take time for funds to be made available.

Keep in mind if you use a credit card, card companies often categorize crypto purchases as cash advances. This could subject you to high fees and interest from your credit card issuer.

With these credit card and exchange fees, you could lose up to ten percent of your crypto purchase.

Cryptocurrency Transaction

Because cryptocurrency exchanges are vulnerable to theft or hacking, you must have an access code to your account. Losing or forgetting it could mean losing your investment. Keep your cryptocurrencies in a safe storage place.

Cryptocurrencies are considered speculative assets due to their volatile nature. Investing in these assets carries high risks, and you should only invest what you can afford to lose, as significant financial losses are possible.

To protect your assets, you should add two-factor authentication. This will make it more difficult for an unauthorized user to access your funds.

If you buy cryptocurrency through a broker, your crypto will probably be in a wallet linked to the exchange. If you are dissatisfied with the service you can transfer your crypto to a separate hot or cold wallet

A hot wallet is operated on internet-connected devices like:

• tablets
• phones
• computers

Hot wallets pose a higher theft risk.

A cold wallet, such as a USB or hard drive, provides high-level security for storing crypto. That’s because these are offline and disconnected from the internet. But the risk is that if you lose the associated keycode or experience device failure, you will permanently lose access to your crypto.

They may assess a small fee if you choose to transfer your cryptocurrency off the exchange.

Pros and Cons of Cryptocurrency

The biggest pro of cryptocurrency investing is the potential for high returns. Since its introduction in 2009, crypto assets like Bitcoin and Ethereum have delivered some of the most substantial gains in investing history.

Other pros are:

• decentralization
• accessibility
• diversification

But it’s important to also note crypto investing risks.

Cryptocurrencies are susceptible to and experience dramatic price swings. As government regulations evolve, their volatility is probably going to continue. While many people have experienced significant gains others have had large losses.

Security is also a concern. Many investors have been the victims of scams or fraud.

The bottom line is it’s a risk, not a done deal, just like any other investment. The point is to evaluate your risk tolerance and proceed accordingly.

Do Your Due Diligence

There are several items you should consider before diving into crypto.

For example, each cryptocurrency has three items. They include:

• investment thesis
• consensus mechanism
• use cases

You must understand each crypto's details and unique investment proposition before investing.

Ensure you understand your risk tolerance. If you are investing in a volatile asset like crypto, you need to be able to weather any losses.

Consider your investment goals. How does crypto fit into your portfolio ?Ensure you're not relying too heavily on it. In other words, diversify your portfolio.

Conclusion

You can score big with cryptocurrency, but unfortunately, you can also lose everything. Crypto can be a great piece of your financial portfolio, but you might not want to put all the proverbial eggs in one basket.