- Cryptocurrency is a completely digital currency that operates on blockchain technology.
- Cryptocurrency fans praise its transparency, security and lack of third-party intermediaries like banks and regulators.
- While cryptocurrency is still somewhat challenging to use as payment, it’s becoming more mainstream and easier to transact with.
- The value of a cryptocurrency is driven by supply and demand as well as its popularity and utility.
Cryptocurrency is a hot topic and has been since the birth of Bitcoin in 2009—but if you still don’t know exactly what it is or why everyone is always talking about it, you’re not alone. It’s a complex and somewhat abstract idea that requires a significant bit of explanation.
But cryptocurrency is unlikely to just fade out. Even with its volatility, cryptocurrency has staying power because its fans like the security, transparency and lack of third-party intermediaries.
So if you still have questions, here’s an overview of what cryptocurrency is, why people love it, how it works and more.
Inside this article
What is cryptocurrency?
According to the North American Securities Administrators Association, a group representing securities regulators, cryptocurrencies are digital assets created by companies or individuals that take the form of a virtual coin or token. Cryptocurrency transactions don’t go through a bank or a regulatory body like normal transactions of dollars or stock holdings. Instead, they happen on a blockchain.
Blockchain is the underlying technology that allows cryptocurrencies to operate. According to the Financial Industry Regulatory Authority, a government-authorized nonprofit that oversees the financial markets, blockchain is a distributed ledger that acts as a shared database for all cryptocurrency transactions. Anyone can see the blockchain but no one can edit or delete past transactions, only add new ones.
Cryptocurrency—or crypto, it means the same thing—can be used just like normal money. You can buy things with it, get paid for your work with it or invest in and trade it like stocks. It’s just completely digital—you’ll never hold it in your hand—and only exists within the blockchain.
|Common cryptocurrency terms|
|Blockchain||Blockchain is a shared digital ledger of transactions and is the underlying technology that cryptocurrencies operate on.|
|Block||A block is a store of transaction data within the blockchain.|
|Cryptocurrency||A cryptocurrency is a completely digital asset that exists on the blockchain.|
|Token||A token is to cryptocurrency as the dollar is to fiat currency (a term for normal money that's backed by a government, like the dollar or the Euro). It's a denomination of that cryptocurrency.|
|Keys||The "crypto" in cryptocurrency stands for the fact that all transactions on the blockchain are coded and have to be deciphered. A public key works as the "address" of the cryptocurrency. You will use that in a similar way that you would a bank account number. On the other hand, your private key is your password and proof of ownership of your cryptocurrency. If you lose your private key, you can kiss your crypto stash goodbye.|
|On-ramp||On-ramp is the term for when you exchange U.S. dollars or another currency for cryptocurrency.|
|Wallet||A wallet is an app or program that stores your keys and controls your access to your cryptocurrency. Just like a normal wallet holds your cards that control your access to your bank account or credit line, this is a place to keep all the access info for your cryptocurrency holdings in one place.|
|Mining||Mining is the term used for creating new tokens within a cryptocurrency.|
|Gas||Gas is a term specific to the Ethereum cryptocurrency. If you buy or sell Ether, you have to pay a small fee to the Ethereum blockchain for every transactions. That fee is called "gas," as in gas money, and it goes toward to cost of powering the blockchain.|
|Airdrop||A giveaway where tokens are "dropped" into your wallet, usually to thank you for investing in a cryptocurrency or to promote a new one.|
What is the point of cryptocurrency?
You might be asking yourself, if it’s pretty much the same as normal money, why does it exist? And why are people so excited about it?
“I think more than anything else, it generates interest because it’s a unique and novel concept,” says Curt Mastio, CPA, founder of Founder’s CPA, a firm that works with blockchain and cryptocurrency startups. “A lot of the buzz around it is that it could have similar impacts to what the internet had back in the early 90s in terms of transforming how we move value relative to how we have historically in the traditional financial system.”
If some fans are drawn in by the excitement of revolutionary technology, others are more entranced by the power to make transactions without a bank or government entity overseeing them. Mastio cites the “crypto-punk, libertarian” influence of early crypto fanatics who saw themselves as taking back the ownership of the internet and the finance world from big corporations.
And then there are the crypto fans who enjoy the transparency and security of transacting in the blockchain, where all transactions are public record and confirmed by the consensus of the community. Since no one can rewrite or delete blocks on the blockchain, some crypto stalwarts see it as more secure than traditional financial networks.
On the other side, critics note that crypto also comes with a lot of risks. The Federal Trade Commission warns that cryptocurrencies aren’t backed by a government or central bank, don’t have the same insurance as a bank account, are extremely volatile and unpredictable and have been used to scam investors before. Make sure you understand the risks before diving in.
How does cryptocurrency work?
Are you ready to take the leap and own crypto yourself? Here’s how to do it in three easy steps.
Step 1: Get a wallet. There are many options for apps and programs that will act as your crypto wallet. Do your research and choose a reputable one. You can also self-host your wallet—but if you lose your key or something else goes wrong, you’ll be on your own.
Step 2: Buy crypto. Mastio says to think of this process like buying a share of Apple stock. “If you want to purchase stock in Apple, you have to find a willing seller for that stock. Typically you’ll go to a brokerage. In the crypto world, we call those like exchanges, with Coinbase being a big example,” he explains. “So you create an account with one of those exchanges and then you can take U.S. dollars from your bank account, deposit them in that exchange—which is known as creating an on-ramp—and then purchase whatever digital asset that you want.”
That’s the most common route. But you can also receive crypto as payment for work, via an airdrop or by mining it yourself.
Step 3: Save your keys. According to 2018 research from Chainalysis, a blockchain data platform, 20% of all Bitcoin has been lost, probably permanently. That’s up to 3.7 million Bitcoin. To prevent losing your crypto, make sure you store your public and private keys somewhere safe. You can save your keys in cold wallets (offline) or hot wallets (online) or simply by writing them down and storing them somewhere safe. Each method has its pros and cons but do your research and determine the safest way for you.
Tip: Don’t store your keys by taking a picture of them with your phone—hackers can find those.
So what’s next? It’s up to you! You can hold on to your crypto and see if it grows in value. Or you can use it as payment. Some websites and companies will accept Bitcoin or Ether for goods or services, Mastio notes, including some of his clients. However, that’s still not very common—you’re more likely to cash out your crypto for dollars and then spend it.
You can also purchase digital asset-backed debit cards to spend your crypto at places that wouldn’t accept actual crypto, like Target or Nordstrom. “Say you have $5,000 worth of Bitcoin—some exchanges will allow you to put that on a debit card,” Mastio says. “Then you can spend up to $5,000 at normal retailers and utilize that crypto.”
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What determines the value of cryptocurrency?
So what makes crypto valuable? How do we determine that one Bitcoin is equivalent to X dollars?
Mastio says two main things drive the value of a cryptocurrency: speculation and utility.
Speculation: This boils down to the supply and demand of crypto. If a crypto is rare and a lot of people want it, the price will climb. If there’s a lot of it to be had and no one is interested, the price will drop.
Utility: This is essentially the popularity and use of the token or its blockchain. Mastio says this is best understood by looking at Ether: “Ether is the native asset of the Ethereum blockchain, and in order to transact on the Ethereum blockchain, you have to pay gas fees in the form of Ether. So as the use of the Ethereum blockchain increases over time, people need more Ether, which drives up demand for Ether.” So when the supply of Ether holds or decreases because so many people are buying it, transacting with it or holding onto it as an investment, it can drive up the value further.
Cryptocurrency is relatively new and still evolving, and it’s likely we’ll see a lot of changes over the next few years as government and financial regulators possibly start to get involved. But by understanding the basics of how crypto works and why people are so enthusiastic about it, you can determine if you want to get into the crypto game yourself—or just stay informed so you know what people are talking about when the next big crypto story breaks.
What is cryptocurrency mining?
Mining is the process of creating new tokens for a specific cryptocurrency. Initially people were able to do this themselves with their home computer, but it now takes so much operating power that an ordinary computer won’t make much headway.
Is cryptocurrency real money?
No. Crypto is an asset that holds a value. It’s more comparable to a stock than a dollar bill—its value can fluctuate wildly and there are many steps before you can access its cash value.
Do I have to pay taxes on cryptocurrency?
Yes! The IRS says crypto is taxable just like any other property. Taxes can kick in when you sell or exchange crypto, use it to pay for goods and services or hold it as an investment.