Cryptocurrency 101

If you read the headlines, then you will find cryptocurrencies being praised as the wave of the future and simultaneously decried as a dangerous fad or a financial bubble due to burst.

However, what everyone appears to agree on is that cryptocurrencies are proving to be a powerful and disruptive new way of looking at and managing personal and business finances.

The types of cryptocurrencies available continue to multiply and new cryptocurrencies offer investors ever more specialized features, applications and opportunities. Each new innovation increases the number of investors buying into the cryptocurrency market, expands digital currencies’ social acceptance and adds to their impact on traditional financial markets.

It is never been more important to get a handle on what cryptocurrencies are and how they are influencing the generation, movement and management of money on a global scale.

What is cryptocurrency and how does it work?

Cryptocurrencies are entirely digital currencies that operate as independent units of value. Units are typically called either “coins” or “tokens,” depending on the type of cryptocurrency. Using blockchain technology, investors share a massive, decentralized digital accounting system that tracks and controls digital currency coins or tokens. Coins do not have any physical form and are not linked to any physical assets such as gold or silver, as most non-digital currencies have traditionally been. Their value lies solely in investor’s shared agreement of their worth.

Unlike fiat (government-issued) currencies such as the U.S. dollar, the euro or the yen, cryptocurrencies are not authorized, printed and issued by a national government. In fact, there is no central authorizing agency overseeing the distribution or management of cryptocurrencies. However, digital currencies can be stored, exchanged or traded for other goods or services of value just like paper money, precious metals and other exchangeable assets. Popular examples of cryptocurrencies include Bitcoin, Litecoin, Ethereum and Monero.

Cryptocurrencies cannot typically be directly exchanged for fiat currencies using mainstream methods or institutions such as banks. However, innovations such as digital currency debit cards do, in some cases, allow users to get around this hurdle and an increasing number of individuals and businesses are choosing to do business directly in cryptocurrencies. It is becoming increasingly common for self-employed adults especially to seek out jobs they can get paid for in Bitcoin or other digital currencies.

What makes cryptocurrencies attractive to so many investors?

Cryptocurrencies are steadily gaining popularity for a lot of reasons. Although investors can use cryptocurrencies in many of the same ways they use fiat currencies, a handful of critical differences between digital currencies and their mainstream counterparts are particularly attractive to investors.

  • Privacy. Cryptocurrencies are bought, sold and exchanged using only identifying numbers similar to bank account numbers. Since there is no other identifying information involved, parties can remain entirely anonymous while transacting using a digital currency. Because there are no third parties (like banks) involved that might be required to comply with state or federal reporting requirements, cryptocurrencies thus allow individuals can move, manage and hold their money in complete confidence and privacy. Unless users intentionally select a cryptocurrency designed to support full transparency, cryptocoin transactions are untraceable.
  • Convenience. With a cryptocurrency wallet, which is quick and easy for anyone to set up, investors can manage all of their digital finances without the help or control of a bank or other financial institution. Users can access their accounts and process transactions from their computers or mobile devices almost instantly any time of day or night, 24 hours a day, seven days a week.
  • Low transfer and transaction costs. Standard banking and finance actions and transactions can quickly become expensive, especially for individuals or businesses moving large sums of money or transferring assets across borders and/or between nationally issued currencies. Banking of that nature can also be frustratingly time-consuming, subject to the use of an intermediary third party, business hours restrictions and processing or lag times. Cryptocurrencies allow private parties to transfer money between themselves almost instantly and without any of the interference or overhead costs associated with banks and other traditional exchanges.
  • Lack of regulation. Although the laws on cryptocurrencies are subject to change, right now there is relatively little regulation within the cryptocurrency market. This allows investors opportunities to invest and manage their digital funds with much more latitude and freedom than they might have in more traditional markets.
  • Lack of federal manipulation. Government-issued currencies are subject to manual manipulation by authorized agencies. For example, the U.S. dollar can be intentionally subject to inflationary or deflationary forces by the printing of additional money, the raising or lowering of interest rates and other policy decisions. Digital currencies such as Bitcoin, which are inherently hard limited at a certain total number of coins, are free from these outside adjustments. This factor makes them extremely attractive to many investors looking to use cryptocurrency for investment strategies.

Are there risks associated with cryptocurrencies?

While many people feel cryptocurrencies are safer than fiat currencies, they are not entirely without risk. Many of the same features that make digital currencies so attractive are also directly related to their perceived weaknesses.

  • Cryptocurrencies are not insured by governments or financial institutions. Because fiat currencies are issued and managed by national governments, they are also typically subject to some governmental protections. For example, the Federal Deposit Insurance Corporation (FDIC) insures most American bank accounts against theft and other crimes up to $250,000. Most banks also offer some form of protection to their clients in the event of theft or fraud. Cryptocurrencies are not subject to those same controls or protections. Cryptocurrency assets that are hacked and stolen are often impossible to recover and there are no centralized authorities to whom investors can appeal for assistance or reimbursement.
  • Not all cryptocurrencies can be directly exchanged for fiat currencies. Banks and other authorized financial institutions can readily exchange almost any government-issued currency, like the U.S. dollar, for any other government-issued currency such as euros. Most products and services can be paid for using credit or debit cards that automatically convert the sale price to the designated currency for the card. (e.g. you can buy something priced in euros using your American credit card and it will translate the cost from euros to U.S. dollars on your bill). Although most cryptocurrencies can be easily exchanged for other cryptocurrencies, trading them for fiat currencies is not always as simple. New innovations continue to tackle this challenge, but some difficulties and inefficiencies remain.
  • Cryptocurrencies can gain or lose value more quickly than other forms of currency. Because there is no central or governmental managing agency controlling cryptocurrencies, their value can be inconsistent and volatile. This creates both risk and unique opportunities for investors. Learn more about evaluating your assets here.
  • Different types of cryptocurrency work differently. Different cryptocurrencies are intentionally designed to meet different digital banking needs. Some forms primarily serve as an easily exchangeable form of payment for goods and services. Others more closely resemble securities and other financial investment tools. This creates many opportunities but does require that investors do a little research to ensure they are using the type of cryptocurrency best suited to their needs.

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