Cryptocurrency: What It Is, Pros & Cons

Bitcoin cryptocurrency stock market exchange chart. Bank market and virtual crypto currency value 3D graph
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What Is Cryptocurrency?

Cryptocurrency is a digital currency designed to act as a medium of exchange and a store of value but, because it’s new, it’s more commonly held as a speculative investment asset.

Also known as “crypto,” cryptocurrency uses blockchain technology to record transactions in a ledger system. The most important aspect of this technology is that it can be viewed publicly but it can’t be changed or controlled by any single entity, making cryptocurrency secure for online transactions and nearly impossible to counterfeit.

Tip: A blockchain can be described as a digital ledger of transactions, which uses cryptography, a network of computers, and electricity to build blocks of data. This system of recording makes it difficult or impossible to change or manipulate the data.

How Many Cryptocurrencies Are There?

There are thousands of cryptocurrencies that are publicly traded today, as others continue to come on the market. Many of these cryptos are not well known and don’t have much trading volume. Examples of popular, more widely traded cryptocurrencies include Bitcoin (BTC-USD), Ethereum (ETH-USD), Litecoin (LTC-USD), and Bitcoin Cash (BCH-USD).

Is Cryptocurrency Legal?

Cryptocurrency is legal in the U.S., as well as most developed market countries, such as the U.K., Germany, and Japan. Some countries have either banned it or restricted its use. For example, China has heavily restricted Bitcoin use but has not made it illegal to hold bitcoins.

How Does a Cryptocurrency Gain Value?

As of July 2021, the value of all cryptocurrencies exceeded $1 trillion. Like other currencies, the value of cryptocurrency is primarily driven by the supply of the currency and its demand in the market. However, unlike traditional currencies, cryptocurrency is not issued by a central bank or backed by a government. For this reason, monetary policy, inflation, and economic growth do not influence the value of cryptocurrency.

Some other forces that may influence the value of a given cryptocurrency include the cost of production, or the mining process, the supply and demand of competing cryptocurrencies, the exchanges it trades on, and any governing regulations or restrictions upon it.

Pros and Cons of Cryptocurrency

There’s no shortage of financial media coverage on the rapid growth and popularity of cryptocurrency. But like other types of financial assets, there are some significant risks and disadvantages that come along with the growth potential and benefits.

Pros of Cryptocurrency

  • Anonymity: Cryptocurrency transactions are completely anonymous, which is a benefit for users wanting privacy.
  • Transparency: Although transactions are anonymous, the data is recorded on an open ledger using blockchain technology. This means that data is transparent and publicly available at any time.
  • Decentralization: Since cryptocurrency is not issued by a central bank or backed by a federal government, there is no interference from government or influence from monetary policy.
  • Potential for quick gain: The popular cryptocurrency, Bitcoin, has had many short periods of significant gains, such as the first four months of 2021, where it more than doubled in price before falling again. Some of the top daily gains in crypto have surpassed 200%.

Cons of Cryptocurrency

  • Price volatility: While quick gains are a big attraction to crypto for many interested investors, there is also potential for fast and extreme declines in value. A recent example is Bitcoin’s 50% price drop in just two months from April to June 2021.
  • Excessive cost to produce: Many cryptocurrency types require vast sums of electricity and other resources to mine. For example, the energy required to mine Bitcoin represents the majority of costs associated with it.
  • Regulatory restrictions: While cryptocurrencies are generally legal in many developed countries, the currency is not formally regulated by central governments. The risk of investing in cryptocurrency will be elevated until federal governments adopt and regulate it in the same way as fiat currencies, such as the U.S. dollar.
  • Risk of losing coins: Many cryptocurrencies like Bitcoin require a private key to access the currency tokens that are stored in a digital “wallet.” If you lose your key, or if your computer hardware fails, you lose your tokens, which are not recoverable in any other way.

Where to Buy and Trade Cryptocurrency

Although there are thousands of cryptocurrencies in existence today, there are only a handful of trading platforms that offer trading. Crypto trading platform examples include Robinhood and Sofi Active Investing. Most platforms offer investors the opportunity to buy Bitcoin and other popular cryptocurrencies. Another option for buying cryptocurrency is Coinbase (COIN), which is a popular exchange where users can buy, sell, transfer, and store digital currency.

Here are the basic steps to buy and trade cryptocurrency:

  1. Choose a trading platform or exchange.
  2. Create an exchange “wallet” to store your cryptocurrency.
  3. Add a payment method, such as a debit card, to fund your account.
  4. Buy your chosen cryptocurrency.

Frequently Asked Questions

How Is Cryptocurrency Taxed?

Cryptocurrency taxation will vary depending upon the country where you reside. For example, in the US, cryptocurrency is taxed in the same way as other assets that are considered to be property, such as real estate or stocks. This means that you’ll owe capital gains tax for profits that you realize.

The amount of capital gains taxes owe on the sale of cryptocurrency will depend upon the gains you realize, your federal income tax bracket, and the holding period of the asset.

  • Short-term capital gains, for assets held less than one year, will be taxed at the same rate as your income, which can range between 10% to 37% in 2021.
  • Long-term capital gains, for assets held for more than one year, can be 0%, 15%, or 20%, depending upon your income for the taxable year.

Important: For an example of taxation on crypto profits, let’s say you buy some cryptocurrency for $10,000 and it appreciates to $200,000, at which point you take profit. Assuming a long-term cap gain tax of 20%, you’d owe $38,000 in taxes ($190,000 gain x .20) for that year.

Is Cryptocurrency Safe?

Whether or not cryptocurrency is safe depends upon how you plan to use it. In terms of security and anonymity for use in digital transactions, cryptocurrency is considered to be relatively safe. But from an investment perspective, cryptocurrency is considered to be high in risk because of its speculative and volatile nature.

Important: Cryptocurrency exchanges offer secure storage of your coins through an exchange wallet, which provides access with a private key. While the storage of cryptocurrency is secure, your private key is still susceptible to hacking, if not secured safely. Also keep in mind that cryptocurrency is not FDIC-insured like bank savings accounts.

Is Cryptocurrency a Good Investment?

Individuals interested in cryptocurrency should be aware of its unique risks before buying. Determining whether or not cryptocurrency is a good investment will depend on its suitability for a given investor’s investment goals and risk tolerance. For example, cryptocurrency does have potential for outsized gain but there’s also the risk for significant decline or permanent loss in the principal amount invested.

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