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| understanding cryptocurrency |
Find out what you need to know before you invest in virtual currency.
What Is Cryptocurrency?
Cryptocurrency is a digital or virtual currency that is secured with cryptography, making it nearly impossible to counterfeit or double-spend. Most cryptocurrencies exist on decentralized networks using blockchain technology, which is a distributed ledger enforced by a disparate network of computers.
The defining characteristic of cryptocurrencies is that they are generally not issued by any central authority, making them theoretically immune to government interference or manipulation.
- Cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of central governments and authorities.
- Some experts believe that blockchain and related technologies will disrupt many industries, including finance and law.
- Advantages of cryptocurrencies include cheaper and faster money transfers and decentralized systems that do not collapse at a single point of failure.
- Disadvantages of cryptocurrencies include their price volatility, high energy consumption for mining activities, and their use in criminal activities.
Understanding Cryptocurrencies
Cryptocurrencies are digital or virtual currencies backed by cryptographic systems. It allows secure online payments without the use of external intermediaries. The term "cryptography" refers to the various encryption algorithms and encryption techniques that protect these entries, such as elliptic curve cryptography, public and private key pairs, and hash functions.
Central to the appeal and functionality of Bitcoin and other cryptocurrencies is blockchain technology. As its name indicates, a blockchain is essentially a collection of blocks of information connected in an online ledger. Each block contains a set of transactions that have been independently verified by every validator on the network.
Every new block created must be verified before it can be confirmed, making it nearly impossible to forge the transaction history. The contents of the online ledger must be approved by a network of individual nodes, or computers that maintain the ledger.
Experts say blockchain technology could serve many industries, supply chains and processes such as online voting and crowdfunding. Financial institutions such as JPMorgan Chase & Co. (JPM) Blockchain technology to reduce transaction costs by simplifying payment processing.
Types of Cryptocurrency
Many cryptocurrencies were created to facilitate work done on the blockchain on which they are built. For example, Ether Ethereum is designed to be used as a means of payment to validate transactions and open blocks. When blockchain technology moved to proof of stake in September 2022, ether (ETH) inherited an additional duty as the blockchain's staking mechanism. Ripple's XRP is designed to be used by banks to facilitate transfers between different geographies.
Since there are a lot of cryptocurrencies on the market, it is important to understand the types of cryptocurrencies. Knowing whether the coin you are looking at has a purpose can help you decide whether or not it is worth investing in, as a cryptocurrency with a purpose is likely to be less risky than one without a use.
Most of the time, when you hear about types of cryptocurrencies, you hear the name of the currency. However, currency names are different from currency types. Here are some of the types you'll find along with some of the featured icon names in this category:
- Utility: XRP and ETH are examples of utility tokens. They serve specific functions in their blockchain.
- Transactions: Tokens designed to be used as a means of payment. Bitcoin is the most famous of these.
- Governance: These tokens represent voting or other rights on the blockchain, such as Uniswap.
- Platform: These tokens support applications designed to use blockchain, such as Solana.
- Security Tokens: Tokens that represent ownership of an asset, such as a stock that has been tokenized (value transferred to the blockchain). MS Token is an example of a token. If you can find one of these for sale, you can take part ownership of the Millenium Sapphire.
If you find a cryptocurrency that doesn't fall into one of these categories, you've found a new category or something that needs to be investigated to ensure its legitimacy.
Are Cryptocurrencies Legal?
Paper currencies derive their authority from the government or monetary authorities. For example, every dollar bill is backed by the US government.
But cryptocurrencies are not backed by any public or private entities. Therefore, it has been difficult to prove their legal status in various financial jurisdictions around the world. It doesn't help that cryptocurrencies primarily operate outside of most existing financial infrastructure.
In the U.S.
The legal status of cryptocurrencies creates implications for their use in daily transactions and trading. In June 2019, the Financial Action Task Force (FATF) recommended that cryptocurrency wire transfers be subject to the requirements of its Travel Rule, which requires anti-money laundering compliance.
Although cryptocurrencies are considered a form of money, the Internal Revenue Service (IRS) treats them as financial assets or property for tax purposes. As with most other investments, if you make capital gains from selling or trading cryptocurrencies, the government wants a cut of the profits. How the IRS taxes digital assets — whether as capital gains or ordinary income — depends on how long taxpayers hold cryptocurrency and how they use it.
In the United States, in July 2023, courts ruled that cryptocurrencies are considered securities when purchased by institutional buyers but not by retail investors purchased on exchanges.
Enthusiasts described it as a victory for cryptocurrencies; However, cryptocurrency exchanges are regulated by the Securities and Exchange Commission (SEC), as are coin offerings or sales to institutional investors. So, cryptocurrencies are legal in the US, but regulatory bodies are slowly gaining more ground in the industry.
El Salvador is the only country that accepts Bitcoin as legal tender for cash transactions as of August 2023. In the rest of the world, cryptocurrency regulation varies by jurisdiction.
In Asia
The Japanese Payment Services Act defines Bitcoin as legal property. Cryptocurrency exchanges operating in the country are required to collect information about the customer and details related to the bank transfer.
China has banned cryptocurrency exchanges, transactions and mining within its borders, but has a central bank digital currency (CBDC).
India is reportedly drafting a framework for cryptocurrencies, but until it is enacted, cryptocurrencies are not yet illegal. Exchanges are free to offer cryptocurrencies.
In Europe
Cryptocurrencies are legal in the European Union. Derivatives and other products using cryptocurrencies must qualify as “financial instruments.” In June 2023, the European Commission's Markets for Cryptoassets (MiCA) Regulation came into force. This law establishes safeguards and sets rules for companies or vendors that provide financial services using cryptocurrencies.
Are Cryptocurrencies Safe Investments?
Cryptocurrencies have attracted a reputation as unstable investments due to significant investor losses due to scams, hacks, errors and volatility. Although underlying cryptography and blockchain technology are generally secure, the technical complexity of using and storing crypto assets can pose a significant risk to new users.
In addition to the market risks associated with speculative assets, cryptocurrency investors should be aware of the following risks:
- User Risk: Unlike traditional finance, there is no way to reverse or cancel a cryptocurrency transaction after it has already been sent. According to some estimates, about a fifth of bitcoins are now inaccessible due to lost passwords or incorrect sending addresses.
- Regulatory Risk: The regulatory status of some cryptocurrencies remains unclear, with many governments seeking to regulate them as securities, currencies, or both. A sudden regulatory crackdown could make selling cryptocurrencies difficult or cause prices to fall market-wide.
- Counterparty risk: Many investors and traders rely on exchanges or other custodians to store their cryptocurrencies. Theft or loss by one of these third parties could result in the loss of your entire investment.
- Management Risk: Because there are no coherent regulations, there are few protections against deceptive or unethical management practices. Many investors have lost large sums of money to management teams that failed to deliver the product.
- Programming Risks: Many investment and lending platforms use automated smart contracts to control the movement of users’ deposits. An investor using one of these platforms assumes the risk that a bug or exploit in this software will result in the loss of his investment.
- Market Manipulation: Market manipulation remains a major problem in the cryptocurrency space, with powerful people, organizations, and exchanges behaving unethically.
Despite these risks, cryptocurrencies have seen a significant jump in prices, with the total market capitalization rising to approximately $1.2 trillion. Despite the speculative nature of the asset, some have been able to create significant fortunes by taking on the risks of investing in cryptocurrencies at an early stage.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies were introduced with the aim of revolutionizing financial infrastructure. However, as with every revolution, there are trade-offs. At the current stage of cryptocurrency development, there are many differences between the theoretical ideal of a decentralized system with cryptocurrencies and its practical implementation.
Advantages
- Eliminates single points of failure
- Facilitating the transfer of funds between parties
- Removes third parties
- Can be used to generate revenue
- Conversions are simplified
Disadvantages
- Transactions are pseudonymous
- The pseudonym allows for criminal uses
- It has become too centralized
- Expensive to participate in the network and earn
- Off-chain security issues
- Prices are very volatile
Advantages Explained
Cryptocurrencies represent a new decentralized model of money. In this system, it is not necessary for central intermediaries, such as banks and monetary institutions, to enforce trust and monitor transactions between two parties. Thus, a system based on cryptocurrencies eliminates the possibility of a single point of failure - such as a large financial institution triggering a series of global crises, such as the one that erupted in 2008 due to the failure of large investment banks in the United States.
Cryptocurrencies promise to make it easier to transfer money directly between two parties without the need for a trusted third party such as a bank or credit card company. These decentralized transfers are secured using public keys, private keys, and various forms of incentive systems, such as proof of work or proof of stake.
Since they do not use external intermediaries, cryptocurrency transfers between two transacting parties can be faster than standard money transfers. Flash loans in DeFi are an excellent example of such decentralized transfers. These loans, which are processed without backing collateral, can be executed within seconds and used for trading.
Cryptocurrency investments can generate profits. The value of cryptocurrency markets has skyrocketed over the past decade, reaching nearly $2 trillion. Bitcoin was valued at over $680 billion on cryptocurrency markets as of November 2023.
The remittance economy is testing one of the most prominent use cases for cryptocurrencies. Cryptocurrencies such as Bitcoin act as intermediary currencies to simplify cross-border money transfers. Thus, the fiat currency is converted into Bitcoin (or other cryptocurrency), transported across borders, and then converted into the destination fiat currency without the intervention of a third party.
Disadvantages Explained
Although they claim to be an anonymous form of transaction, cryptocurrencies carry pseudonyms. They leave a digital trail that agencies like the FBI can follow. This opens the way for governments, authorities and others to track financial transactions.
Cryptocurrencies have become a popular tool for criminals to carry out nefarious activities such as money laundering and illicit purchases. The case of fearsome hacker Roberts, who ran a drug market on the dark web, is already well known. Cryptocurrencies have also become a favorite among hackers who use them for ransomware activities.
In theory, cryptocurrencies are supposed to be decentralized, with their wealth distributed among many parties on the blockchain. In fact, ownership is very concentrated. Just 100 addresses contain approximately 15% of Bitcoin in circulation and total value.
read more : 10 Rules of Investing in Crypto
One aspect of cryptocurrencies is that anyone can mine them using a computer connected to the Internet. However, mining popular cryptocurrencies requires a significant amount of energy, sometimes equivalent to the energy consumed by entire countries. High energy costs and the unpredictability of mining have led to mining being concentrated among large companies with billions of dollars in revenue.
Although cryptocurrency blockchains are highly secure, it is possible for major storage repositories associated with off-chain cryptocurrencies, such as exchanges and wallets, to be hacked. Many cryptocurrency exchanges and wallets have been hacked over the years, sometimes resulting in millions of dollars in coins being stolen.
Cryptocurrencies traded on public markets suffer from price fluctuations, so investments require careful price monitoring. Bitcoin, for example, has seen rapid rises and falls in its value, rising to nearly $65,000 in November 2021 before falling to just over $20,000 a year and a half later. As a result, many people consider cryptocurrencies to be a short-term fad or speculative bubble.
How Do You Buy Cryptocurrencies?
You can buy cryptocurrencies from popular cryptocurrency exchanges like Coinbase, apps like Cash App, or through brokers. Another popular way to invest in cryptocurrencies is through financial derivatives, such as Chicago Mercantile Exchange Bitcoin futures, or other instruments, such as Bitcoin trusts and ETFs.
What Is the Point of Cryptocurrency?
Cryptocurrencies are a new model of money. They promise to simplify the current financial infrastructure to make it faster and cheaper. Additionally, its technology and architecture decentralize existing monetary systems and enable transacting parties to exchange value and money independently of intermediary institutions such as banks.
What Are the Most Popular Cryptocurrencies?
Bitcoin is the most popular cryptocurrency, followed by other cryptocurrencies such as Ethereum, Binance Coin, Solana, and Cardano.
The Bottom Line
Cryptocurrencies are digital assets that are secured by cryptography. As a relatively new technology, it is highly speculative, and it is important to understand the risks involved before investing.
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