Cryptocurrency – meaning and definition
Cryptocurrency refers to any form of currency that exists digitally or virtually and uses cryptography to secure transactions. Cryptocurrencies do not have a central issuing or regulating authority. Instead, they use a decentralized system to record transactions and issue new units.
What is cryptocurrency?
Cryptocurrency is a digital payment system that does not rely on banks to verify and confirm transactions. It is a peer-to-peer system that allows anyone to send and receive payments from anywhere. Instead of physical cash being transported and exchanged in the real world, cryptocurrency payments exist solely as digital values in an online database that documents specific transactions.
When transferring cryptocurrency funds, transactions are recorded in a public ledger. Cryptocurrency is stored in digital wallets.
Cryptocurrency is so named because it uses cryptography to verify transactions. This means that advanced coding is involved in storing and transmitting cryptocurrency data between wallets and public ledgers. The purpose of cryptography is to provide security and protection.
The first cryptocurrency was Bitcoin, created in 2009 and still the best known today. Much of the interest in cryptocurrencies is in the market trading for profit, with speculators sometimes driving prices sky high.
How does cryptocurrency work?
Cryptocurrencies run on a distributed public ledger called a blockchain, a record of all transactions updated and maintained by the coin holders.
Cryptocurrency units are created through a process called mining, which involves using computing power to solve complicated mathematical problems that generate coins. Users can also purchase coins from exchanges, then store and spend them using crypto wallets.
If you own cryptocurrency, you don't own anything physical, but a key that allows you to move a record or unit of measurement from one person to another, without the need for a trusted third party.
Although Bitcoin has been around since 2009, cryptocurrencies and blockchain technology applications are still in their infancy in financial terms, but more uses are expected in the future. Transactions including bonds, stocks, and other financial assets could eventually be traded using this technology.
Cryptocurrency Examples
There are thousands of cryptocurrencies in the world. Some of the best known include:
Bitcoin:
Founded in 2009, Bitcoin was the first cryptocurrency and remains the most traded. The currency was developed by Satoshi Nakamoto, who is believed to be a pseudonym for an individual or group of people whose exact identity remains unknown.
Ethereum:
Developed in 2015, Ethereum is a blockchain platform with its own cryptocurrency, called Ether (ETH) or Ethereum. After Bitcoin, it is the most popular cryptocurrency.
Litecoin:
This currency is similar to bitcoin, but has evolved more quickly to develop innovations, including faster payments and processes to allow for more transactions.
Ripple:
Ripple is a distributed ledger system founded in 2012. Ripple can be used to track different types of transactions, not just cryptocurrencies. The company behind the currency has worked with several banks and financial institutions.
Non-bitcoin cryptocurrencies are collectively known as "altcoins" to distinguish them from the original.
How to acquire cryptocurrencies?
You may be wondering how you can safely buy cryptocurrencies. There are typically three steps to take, which are:
Step 1: Choose a platform
The first step is to decide which platform to use. Typically, you can choose between a traditional broker or a dedicated cryptocurrency exchange:
- Traditional brokers. These are online brokers that offer ways to buy and sell cryptocurrencies, as well as other financial assets like stocks, bonds, and ETFs. These platforms tend to offer lower trading costs but fewer crypto features.
- Cryptocurrency exchanges. There are many crypto exchanges to choose from, each offering different cryptocurrencies, wallet storage, interest-bearing account options, and more. Many exchanges charge fees based on the asset.
When comparing different platforms, consider what cryptocurrencies are on offer, what fees are charged, security features, storage and withdrawal options, and any educational resources.
Step 2: Transfer funds to your account
Once you’ve chosen your platform, the next step is to fund your account so you can start trading. Most cryptocurrency exchanges allow users to purchase cryptocurrencies using fiat (i.e. government-issued) currencies, such as the US Dollar, British Pound, or Euro, using debit or credit cards. The rules vary by platform.
Cryptocurrency purchases with credit cards are considered risky, and some exchanges do not accept this type of transaction. Some credit card companies also do not allow cryptocurrency transactions. This is due to the fact that cryptocurrencies are highly volatile.
It is not advisable to risk going into debt or potentially paying high credit card fees for certain assets.
Some platforms will also accept bank transfers. The payment methods accepted and the time it takes for deposits or withdrawals differ per platform. Likewise, the time it takes for deposits to be processed varies depending on the payment method.
An important factor to consider is fees. This involves potential deposit and withdrawal transaction fees, as well as trading fees. Fees vary depending on the payment method and platform, so you should research this at the outset.
Step 3: Place your order
You can place an order via the broker or exchange’s web or mobile platform. If you’re planning to buy cryptocurrencies, you can do so by selecting “buy,” choosing the order type, entering the desired amount of cryptocurrencies, and confirming the order. The same process applies to “sell” orders.
There are also other ways to invest in cryptocurrencies. These include payment services like PayPal, Cash App, and Venmo, which allow users to buy, sell, or hold cryptocurrencies. Additionally, there are the following investment vehicles:
- Bitcoin trusts: You can buy shares of bitcoin trusts through a regular brokerage account. These vehicles give retail investors access to cryptocurrencies through the stock market.
- Bitcoin Mutual Funds: There are bitcoin ETFs and bitcoin mutual funds available.
- Blockchain stocks or ETFs: You can also invest in cryptocurrencies indirectly through companies specializing in blockchain technology that execute cryptocurrency transactions. Alternatively, you can buy stocks or ETFs of companies that use blockchain technology.
The best option will depend on your investment goals and risk appetite.
How to store cryptocurrencies
Once you’ve purchased cryptocurrency, you need to store it securely to protect it from hackers or theft. Typically, cryptocurrency is stored in crypto wallets, which are physical devices or online software used to securely store cryptocurrency private keys.
Some exchanges provide wallet services, making it easy to store money directly on the platform. However, not all exchanges or brokers automatically provide wallet services.
There are different wallet providers available in the market. The terms “hot wallet” and “cold wallet” are used interchangeably:
- Hot wallet storage: "Hot wallets" refer to cryptocurrency storage that uses online software to protect private asset keys.
- Cold Wallet Storage: Unlike hot wallets, cold wallets (also known as hardware wallets) rely on offline electronic devices to securely store private keys.
Typically, cold wallets tend to charge fees, while hot wallets do not.
What can you buy with cryptocurrency?
When it was first launched, Bitcoin was intended to be a medium for everyday transactions, making it possible to buy everything from a coffee to a computer, or even high-value items like real estate.
This has not yet become a reality, and while the number of institutions accepting cryptocurrencies is growing, high-value transactions in this currency are still rare. However, it is possible to purchase a wide range of products from e-commerce sites using cryptocurrency.
Here are some examples:
Technology and e-commerce websites:
Several companies that sell technology products accept cryptocurrencies for purchases on their websites, including newegg.com, AT&T, and Microsoft. Overstock, an e-commerce platform, was one of the first sites to accept Bitcoin. Shopify, Rakuten, and Home Depot also accept it.
Luxury items:
Some luxury retailers accept cryptocurrency as a form of payment. For example, online luxury retailer Bitdials sells Rolex, Patek Philippe, and other high-end watches in exchange for Bitcoin.
Cars:
Some dealerships of popular brands and also luxury cars already accept cryptocurrency as payment.
Insurance:
In April 2021, Swiss insurer AXA announced that it had begun accepting Bitcoin as a form of payment for all of its insurance lines except life insurance (due to regulatory concerns). Premier Shield Insurance, which sells home and auto insurance policies in the US, also accepts Bitcoin for premium line payments.
If you want to use cryptocurrency at a retailer that doesn't accept it directly, you can use a cryptocurrency debit card, such as BitPay in the US.
Cryptocurrency scams and frauds
Unfortunately, cryptocurrency-related crime is on the rise. Cryptocurrency scams include:
- Fake websites: Scam websites that feature fake testimonials and jargon about cryptocurrency, promising massive and guaranteed returns as long as you continue investing.
- Virtual Ponzi Schemes: Cryptocurrency scammers promote fake digital currency investment opportunities and create the illusion of large returns by paying early investors with money from new investors. One fraudulent operation, BitClub Network, raised more than $700 million before its perpetrators were indicted in December 2019 .
- Endorsement by “celebrities”: Fraudsters pose online as billionaires or well-known individuals who promise to multiply your investment in virtual currency, but instead steal the money received. They may also use messaging apps or chat rooms to spread rumors that a famous businessman is endorsing a particular cryptocurrency. After engaging investors to buy and driving up the price, the fraudsters sell their stake and the currency loses value.
- Is cryptocurrency safe?
Cryptocurrencies are typically created using blockchain technology. Blockchain refers to the way transactions are recorded in “blocks” and identified with a timestamp. It’s a fairly technical and complex process, but the result is a digital ledger of cryptocurrency transactions that is difficult for hackers to tamper with.
Additionally, transactions require a two-factor authentication process. For example, you may be asked to enter a username and password to initiate a transaction. You may then be required to enter an authentication code sent via SMS to your personal mobile phone.
While there are security measures in place, that doesn’t mean cryptocurrencies can’t be hacked. Several high-value breaches have cost crypto startups dearly. Hackers managed to penetrate Coincheck and steal $534 million, and also BitGrail, from which they took $195 million, making these attacks two of the largest cryptocurrency breaches of 2018.
Unlike nation-state-managed currencies, the value of virtual currencies is driven entirely by supply and demand. This can create wild swings that produce astronomical gains or losses for investors. And cryptocurrency investments are subject to far fewer regulatory safeguards than traditional financial products like stocks, bonds and mutual funds.