What is Cryptocurrency? Pros and Cons for Investment

Learn what you need to know before you invest in a virtual currency

What Is Cryptocurrency?

A cryptocurrency is a digital or virtual cash that is protected by cryptography. This makes it very hard to fake or spend twice. Most cryptocurrencies run on decentralised networks that use blockchain technology. Blockchain is a spread ledger that is kept track of by a network of computers.

One thing that makes cryptocurrencies unique is that they aren’t usually released by a central authority. This means that the government shouldn’t be able to interfere with or change them.

KEY TAKEAWAYS

  • A cryptocurrency is a type of digital object that is based on a network that is spread out over a lot of computers. This structure keeps them from being controlled by governments and other central powers.
  • Some experts think that blockchain and other similar technologies will change many fields, such as finance and law.
  • The benefits of cryptocurrencies include cheaper and faster money exchanges and decentralised systems that don’t fall apart when a single point of failure happens.
  • Some of the problems with cryptocurrencies are that their prices change often, mining them uses a lot of energy, and criminals use them.

Understanding Cryptocurrencies

Cryptocurrencies are digital or virtual currencies that are backed by cryptographic methods. They make it possible to pay online without going through a third party. “Crypto” refers to the different encryption algorithms and cryptographic techniques that protect these records, such as elliptical curve encryption, public-private key pairs, and hashing functions.

Blockchain technology is at the heart of why Bitcoin and other coins are popular and how they work. As its name suggests, a blockchain is made up of blocks of information that are linked together on an online record. Each block is made up of a group of transactions that have been checked by each verifier on a network.

Every new block that is made has to be checked before it can be approved. This makes it nearly impossible to make fake transaction histories. A network of computers that keep the online ledger up-to-date must all agree on what is in the online ledger.

Experts say that blockchain technology can be used in many different businesses, supply chains, and processes, such as online voting and crowdfunding. Financial companies like JPMorgan Chase & Co. (JPM) are using blockchain technology to streamline payment handling and cut down on transaction costs.

Types of Cryptocurrency

A lot of cryptocurrencies were made to make it easier to do work on the blockchain they are based on. For example, Ethereum’s ether was made to be used as payment for confirming transactions and opening blocks. In September 2022, when the blockchain switched from proof-of-work to proof-of-stake, ether (ETH) took on an extra job as the staking system for the blockchain.

Ripple’s XRP is made so that banks can use it to move money between different places.

Because there are so many different types of cryptocurrencies, it’s important to know what they are. Whether or not a coin has a use can help you decide whether or not to invest in it. A cryptocurrency that has a use is likely to be less risky than one that doesn’t.

When you hear about different types of cryptocurrency, you usually hear the name of the coin. But coin names and coin types are not the same. Here are some of the types and some of the names of the tokens that fall into that category:

  • Utility: Two examples of utility coins are XRP and ETH. They do different things on their own blockchains.
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  • Transactional: Tokens that are made to be used as a way to pay. The most well-known of these is Bitcoin.
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  • Governance: On a blockchain, like Uniswap, these tokens are used to vote or use other rights.
  • Platform: These tokens help apps like Solana that are built to use a blockchain.
  • Security tokens: Tokens that show who owns an object, like a stock that has been tokenized (its value moved to the blockchain). A securitized ticket is something like the MS ticket. If you can find one of these for sale, you can get a piece of the Millenium Sapphire.

If you find a coin that doesn’t fit into one of these categories, you’ve either found a new category or something that needs to be looked into to make sure it’s real.

Are Cryptocurrencies Legal?

The government or monetary powers are in charge of fiat currencies. For example, the U. S. government backs up each dollar bill.

But cryptocurrencies are not backed by either the government or a private company. Because of this, it has been hard to argue for their legal standing in different financial systems around the world. Cryptocurrencies have mostly worked outside of most established financial infrastructure, which doesn’t help.

In the US

How cryptocurrencies are treated by the law affects how they can be used in everyday deals and trading. In June 2019, the Financial Action Task Force (FATF) said that cryptocurrency wire payments should have to follow its Travel Rule, which requires AML compliance.

Important: Even though cryptocurrencies are a form of money, the Internal Revenue Service (IRS) treats them as financial assets or property for tax reasons. As with most other investments, if you make money by selling or buying cryptocurrencies and making a capital gain, the government wants a cut of the money. How the IRS taxes digital assets, either as capital gains or as regular income, relies on how long the taxpayer held the cryptocurrency and how they used it.

In the United States, courts decided in July 2023 that cryptocurrencies are securities when bought by institutions, but not when bought by individual investors on exchanges.

Crypto enthusiasts saw it as a win, but the SEC regulates crypto exchanges and coin offerings or sales to institutional buyers. So, crypto is legal in the U.S., but government agencies are slowly gaining ground in the business.

Fast Fact: As of January 2023, only El Salvador and the Central African Republic accepted Bitcoin as legal currency for buying and selling things. U.S. Office of International Trade. “El Salvador makes bitcoins a legal form of currency.” In the rest of the world, each country has its own rules about how to regulate bitcoin.

In Japan

In the European Union, it is okay to use cryptocurrencies. Derivatives and other goods that use cryptocurrencies must be considered “financial instruments.” In June 2022, the European Commission released the Markets in Crypto-Assets (MiCA) regulation, which sets rules for businesses or vendors that use cryptocurrencies to offer financial services.

Are Cryptocurrencies Safe Investments?

Cryptocurrencies have gotten a bad name as risky investments because scams, hacks, bugs, and instability have caused investors to lose a lot of money. Even though the cryptography and blockchain that crypto assets are based on are usually safe, the technical complexity of using and storing them can be a big risk for new users.

Investors in cryptocurrencies should be aware of the following risks, in addition to the market risks that come with risky assets:

  • User risk: Unlike traditional banking, once a cryptocurrency transaction has been sent, it can’t be undone or cancelled. Some people think that about 20% of all bitcoins are now unavailable because people have forgotten their passwords or sent them to the wrong address.16
  • Regulatory risks: The legal status of some cryptocurrencies is still unclear, and many governments want to control them as securities, currencies, or both. A quick crackdown by the government could make it hard to sell cryptocurrencies or cause the prices of all cryptocurrencies to drop.
  • Counterparty risks: Many traders and buyers store their cryptocurrency on exchanges or with other custodians. If one of these third parties stole or lost the investment, the whole thing could be lost.
  • Management risks: Since there aren’t many rules that make sense, there aren’t many ways to stop dishonest or illegal management practises. Many investors have lost a lot of money because the people in charge of the business didn’t offer a product.
  • Programming risks: Many sites for investing and lending use automated smart contracts to keep track of how user deposits move. When an investor uses one of these platforms, they take on the chance that a bug or security hole could cause them to lose their money.
  • Market Manipulation: Market manipulation is still a big problem in cryptocurrency, with powerful people, organisations, and exchanges acting in an unethical way.

Even with these risks, the prices of cryptocurrencies have gone up a lot, and the overall value of the market has grown to about $1.2 trillion.
Even though the asset is risky, some people have made a lot of money by taking the chance to invest in early-stage cryptocurrencies.

Advantages and Disadvantages of Cryptocurrency

The idea behind introducing cryptocurrencies was to change the way money works. But, as with every change, there are pros and cons. At the point where cryptocurrencies are now in their growth, there are many differences between the ideal of a decentralised system with cryptocurrencies and how it works in practise.

Advantages

  • Getting rid of single failure points
  • It is easier to move money between parties.
  • Gets rid of third parties
  • Can be used to bring in money
  • Payments are made easier.

Disadvantages

  • Transactions are done without a name.
  • Criminals can use pseudonyms to do bad things.
  • Have become very focused
  • It’s expensive to join a network and make money from it.
  • Off-chain problems with security
  • Prices change a lot.

Advantages Explained

Cryptocurrencies are a new kind of money that doesn’t have a governing bank. In this system, there is no need for centralised middlemen like banks and money institutions to ensure trust and keep track of transactions between two parties. So, a system with cryptocurrencies removes the chance of a single point of failure, like a large financial institution failing and causing a chain reaction of global crises like what happened in 2008 when big investment banks in the United States failed.

Cryptocurrencies claim to make it easier for two people to send money to each other without a third party like a bank or credit card company. These kinds of decentralised exchanges are kept safe with the help of public keys, private keys, and different incentive systems, like proof of work and proof of stake.

Transfers of cryptocurrency between two parties can be faster than normal money transfers because they don’t go through a third party. Flash loans are a great example of this kind of decentralised movement in the world of decentralised finance. These loans can be made without any collateral backing them up. They can be done in seconds and are used in trade.

You can make money by investing in cryptocurrencies. In the past 10 years, the value of cryptocurrency markets has gone through the roof, hitting almost $2 trillion. As of July 2023, the value of Bitcoin on crypto markets was more than $565 billion.

The remittance economy is trying one of the most common ways to use cryptocurrency. Cryptocurrencies like Bitcoin are used as intermediary currencies to make it easier to move money between countries. So, a fiat currency is changed into Bitcoin or another cryptocurrency, moved across countries, and then changed back into the fiat currency at the destination without the help of a third party.

Disadvantages Explained

Even though cryptocurrencies claim to be a way to send money without being tracked, they are not private. They leave a digital footprint that law enforcement agents like the FBI can follow. This gives governments, officials, and other people the chance to keep track of financial transactions.

Criminals are using cryptocurrencies more and more to do bad things like hide money and buy things they shouldn’t. People already know about Dread Pirate Roberts, who ran a store on the dark web where drugs were sold.

Hackers like to use malware, which is a type of cryptocurrency, as a way to get money from people.

The public radio network. “How Bitcoin has made ransomware attacks more likely.”

In theory, cryptocurrencies are supposed to be decentralised, with their wealth spread among many people on a ledger called a blockchain. In fact, there aren’t that many owners. For example, about 12% of all bitcoins and the overall value are held by just 100 addresses.

One of the ideas behind cryptocurrencies is that anyone with a computer and an Internet link can mine them. But mining for popular cryptocurrency takes a lot of energy, sometimes as much as a whole country uses. Due to the high cost of energy and the fact that mine is hard to plan for, it is mostly done by big companies whose profits are in the billions of dollars. For example, from December 29, 2022, to January 29, 2023, only 2% of the 4,882 Bitcoin blocks that were opened were opened by unknown addresses. The other 98% were opened by mining pools.

Even though cryptocurrency blockchains are very safe, platforms and wallets that store cryptocurrency keys outside of the blockchain can be hacked. Over the years, hackers have broken into many cryptocurrency platforms and wallets and stolen millions of dollars worth of coins.

Cryptocurrencies sold on public markets have volatile prices, so investors need to keep a close eye on them. For example, the price of Bitcoin has gone up and down quickly. In November 2021, it was worth almost $65,000, but a year and a half later, it was worth just over $20,000. Because of this, a lot of people think that cryptocurrencies are just a short-term trend or a speculative bubble.

How Do You Buy Cryptocurrencies?

You can buy cryptocurrency from brokers, apps like Cash App, or major cryptocurrency exchanges like Coinbase. Financial derivatives like CME’s Bitcoin futures or other tools like Bitcoin trusts and ETFs are another popular way to invest in cryptocurrencies.

What Is the Point of Cryptocurrency?

Cryptocurrencies change the way money works. They say that they will streamline the banking system so that it works faster and costs less. Also, their technology and design decentralize existing monetary systems and make it possible for parties to exchange value and money without banks or other middlemen.

Also Read: What Is Forex Trading? 

What Are the Most Popular Cryptocurrencies?

Bitcoin is the most popular cryptocurrency, but others like Ethereum, Binance Coin, Solana, and Cardano are also very popular.

The Bottom Line

Cryptocurrencies are digital assets that use cryptography to keep them safe. Since they are a relatively new technology, they are very risky, and you need to know what those risks are before you buy.

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