What is Cryptocurrency? How does it work?

By Adam Jusko, ProudMoney.com, adam@proudmoney.com

Cryptocurrency is an umbrella term for any currency that uses blockchain database technology to keep historical track of transactions made with the currency in order to authenticate ownership. This technology can also provide anonymity to the holders of crypto. If we look at the generally accepted meaning of “crypto” and “currency”, you might think of the term as more literally meaning “encrypted money.”

Because cryptocurrencies were (and are) created with no intrinsic value, meaning they don’t have the backing of any government and therefore only have the value that other crypto holders give them, the prices of pretty much all cryptocurrencies have fluctuated wildly in terms of “cash out” value to the U.S. dollar. For example, the most well-known and widely-held crypto currency, Bitcoin, saw its value double from around $30,000 to $60,000 per Bitcoin from January to April of 2021, then slide back to $30,000 again by July, only to more than double again by November, then plummet back down under $38,000 by January of 2022. That’s a lot of volatility.

Why Is Cryptocurrency Valuable?

While cryptocurrencies fluctuate significantly in price, there are obviously a good number of people who believe that these alternative currencies have value. Why? Here are a few reasons:

  • They may be a “store of value” – Just as some people believe it is wise to purchase gold or other precious metals because they have a perceived intrinsic value, cryptocurrency advocates believe Bitcoin and other currencies may be a way to “hedge” against the possible devaluation of the U.S. Dollar (or currencies of other countries) when inflation is high.
  • They allow for faster money movement – Because cryptocurrencies don’t rely on a “trusted third party” (such as a bank) to facilitate financial transactions, currency can be exchanged much faster. No need to wait for the bank to “clear” a check or otherwise hold up availability of funds when currency changes hands.
  • Trackable transaction history that can’t be altered – Blockchain technology allows for a historical record of all movement of a cryptocurrency from one party to another. (Imagine if there was a way to know exactly where a U.S. $10 bill had been on every stop since it was issued and you’ll get the idea.) This can provide proof of payment and/or proof of ownership, potentially reducing legal disputes or stopping attempts at counterfeiting.
  • Some crypto is “limited edition” – Some cryptocurrencies have a maximum number of “coins” that will ever exist. Because no more will be “minted” beyond that maximum number, the ones that exist can’t lose value based on an increased supply in the future. While this adds a certain rarity to these cryptocurrencies, they need to be seen as valuable to begin with for it to actually matter.
  • Anonymous buying and selling – While all crypto transactions can be seen publicly on the blockchain, the people or organizations actually doing those transactions are kept anonymous by using an alias (a “public key”) that is simply a string of letters and numbers that you might think of as being similar to a bank account number. This anonymity is very attractive to some people and organizations.

How Do I Buy Cryptocurrency?

Cryptocurrencies can be purchased in a number of ways. Probably the most popular way for beginners to buy, sell, and store crypto is through exchanges like Coinbase, BlockFi, Crypto.com and others. You can also buy crypto through familiar apps and providers including PayPal, Robinhood, SoFi and more. All of these options provide you with a sort of user-friendly “on ramp” to acquiring crypto, but they do require you to deal with a sort of middleman between you and the crypto, which can be an advantage in terms of security but a disadvantage if you want anonymity. (You will be required to set up an account and give your personal information to buy from these exchanges.)

There are also decentralized exchanges (DEX) that provide true peer-to-peer crypto transactions, but they are not necessarily the place to start as a beginner. Decentralized exchanges include Uniswap, dYdX, PancakeSwap and more.

How Does Cryptocurrency Work? How Do I Spend It?

Cryptocurrency is a digital money without a physical counterpart, meaning you can’t hold it in your hand like you can with cash. However, much of our world rarely uses cash, so the lack of physical crypto is less of a disadvantage than it might seem.

However, that doesn’t mean it is easy to spend. There are very few retailers that will accept crypto as payment for goods. You can’t walk into the grocery store and pay with crypto, and you can’t pay your rent with crypto (unless your landlord is very unusual). In most cases, crypto changes hands on a peer-to-peer basis, meaning one individual pays another individual for a product or service (sort of like Venmo or PayPal).

At this point in crypto’s evolution, more people are buying crypto and simply holding on to it than actually using it to buy anything or pay anyone. They are either (a) speculating that it is an investment that will rise in value, or (b) they believe it is useful as a “store of value” similar to gold or other precious metals, meaning it could be a hedge against inflation of the U.S. dollar or the currencies of other countries. Some people are holding it for both of those reasons.

I Have FOMO! Should I Buy Some Cryptocurrency?

If you are seeing cryptocurrencies rise in price and you have a fear of missing out on your share of the profits, you might consider purchasing some cryptocurrency. But be careful: at this point the value of crypto comes mainly from the fact that other people think (or hope) that it has long-term usefulness. It hasn’t actually demonstrated that long-term value as of yet. So your investment is very speculative — you’re betting on success without a solid rationale as to why it will come. Don’t invest money into cryptocurrency unless you’re prepared to completely lose all of that money should cryptocurrency turn out to be a fad or simply smoke-and-mirrors.

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