What Are Bitcoins and Cryptocurrency?

Before delving into Bitcoin and cryptocurrency, make sure you understand the potential benefits and risks.

The spasmodic fluctuations in Bitcoin's exchange rate during the past two years has caused cryptocurrencies to emerge from relative obscurity to regularly populating the headlines of our most well-known trade and finance media outlets.

For those who are unversed in Bitcoin and other cryptocurrencies (like Litecoin, Ripple, or Ethereum), here is a bit of context. At the start of 2017, a single Bitcoin was valued at approximately $1,000. By the end of 2017, the value of one Bitcoin was at an all-time high of approximately $20,000. This means that if you had invested $100 in a Bitcoin in January 2017, you could have cashed out at approximately $2,000 in December 2017—a 20x return on investment. Following its peak valuation in 2017, Bitcoin (and other cryptocurrencies) suffered a dramatic crash, plummeting to values as low as $3,179 per coin in December 2018.

What is Cryptocurrency?

So what does the term cryptocurrency actually mean? In short, cryptocurrency is virtual/electronic currency that exists on a decentralized, global computer network. Its infrastructure relies on recently developed blockchain technology—an electronic ledger that instantaneously, automatically, and publicly records these virtual currency transactions. Generally speaking, the ledger maintained by each blockchain is an evolving record of all the transactions maintained, simultaneously and in common, by every computer in that blockchain's network. Each time one computer adds a line to its own copy of the shared ledger, the addition appears in an identical ledger held by every other computer in the blockchain. Once a transaction is confirmed, it will (theoretically) remain in the ledger in perpetuity, inerasable, and unalterable.

Due to the emergence of the blockchain, users are able to send and receive funds via the Internet on a peer-to-peer basis, without the need for an intermediary like PayPal, Mastercard, or a traditional banking institution. Also it's important to note that despite all of the media hype surrounding Bitcoin in particular, it is only one of over 1,000 types of cryptocurrencies available to customers.

You can purchase cryptocurrency using the cash deposited in your traditional, brick-and-mortar bank account. You can then use your crypto to consummate business transactions with other users who accept this form of payment. Naturally, the system also works in reverse, which means that you can always convert your crypto back into traditional paper bills deposited in your bank account.

Potential Benefits of Using Cryptocurrency

Both theoretically and practically, using cryptocurrency as a payment method can offer certain benefits. Users can make cryptocurrency transfers 24 hours a day, 7 days a week, rather than being subject to their bank's hours of operation.

A blockchain is designed to promote full transparency. While financial records have historically been stored in one place (whether it be a server, a courthouse, or a temple) or been governed by a central authority, blockchain ledgers (under some form of cryptographic seal) are distributed to all and belong to no one. Because the ledger is shared and monitored by every computer on the blockchain, no one can alter the ledger—in fact, the underlying software will reject it if you try. Each new block in the chain is essentially an amalgamation of the sequence of all prior transactions, including all the information contained in the previous one, all the way back to the first one—the so-called genesis block—which is a true representation of full transparency.

Because the currency ledgers are shared by each participating node in the global computer network, cryptocurrency transfers require low (or no) transaction fees and are less vulnerable to identity theft and fraud. In addition, because of the decentralized nature of the currency exchange, users can easily transmit funds internationally, and it is currently impossible for any entity or government to unilaterally seize or freeze any of these funds.

As cryptocurrency has continued to infiltrate the financial landscape, the number of individuals and entities willing to accept this medium as payment for products or services is growing at a rapid clip. The use of cryptocurrency can be an attractive option for businesses because customers cannot reverse payments. Rather, in the event of a dispute, clients are dependent on the business owner to reverse a payment via a direct refund. Also, cryptocurrency transfers don't require the disclosure of personal information, which further secures computer databases and sensitive data from system hackers. Lastly, from a pure investment perspective, Bitcoin enthusiasts like David Johnson, the founder and CEO of Latium, have argued that because Bitcoin technology is structured to cap the number of Bitcoins in circulation at 21 million, their value can only increase (due to limited supply).

Potential Risks of Using Cryptocurrency

While many view the use of cryptocurrency as a more secure and efficient way to conduct commercial transactions, several financial experts have also identified and underscored its risks. As with any investment, the value of cryptocurrency is prone to certain fluctuations based on global economic performance, current events, user optimism and demand, and other intangible market factors. In 2017, some economic gurus viewed the dramatic rise in Bitcoin's value as a bubble generated by existing media hype and swelling vendor zeal. These experts proved to be entirely justified in their financial clairvoyance; cryptocurrencies have been volatile historically, particularly during the Bitcoin crash of 2018. Their valuations are subject to wild swings on any given day—or in any given hour—making it challenging for even the most stalwart, experienced, and risk-loving investors to stay cool and hold their positions. As with any investment, timing is everything, and financial advisors remind us every day that any boom in the exchange rate of Bitcoin and other cryptocurrencies could end on any given day.

While it is theoretically true that a blockchain's ledger can't be erased or modified, this does not mean that one's online cryptocurrency wallet cannot be hacked or pilfered—this happens all the time. Furthermore, because cryptocurrency has often been used to effectuate nefarious, dark web transactions, the blockchain has gained a reputation for being entirely private. However, this would be a naïve characterization. Every transaction is there in the ledger for all to see. Each blockchain transaction is, fundamentally, either anonymous or pseudonymous, but there are many ways for that anonymity to be compromised.

Other common risks associated with cryptocurrency investing include the following:

  • Cryptocurrencies (with Tether being one possible, yet highly controversial, exception) are entirely virtual and not backed by any real-world assets, like gold bars, for example. As such, Bitcoins are completely unsecured, and you cannot carry them around in your pocket.
  • Credit cards can offer more substantial buyer protections than Bitcoins because cardholders can file claims and chargebacks.
  • If you lose some or all of your cryptocurrency due to hacking or some online malfunction, you'll likely have no recourse which leaves your funds somewhat vulnerable at all times.
  • Scammers and hackers are notorious for using phishing tactics to lure Bitcoin holders into visiting malicious websites. Any cryptocurrency investor should be exceedingly conscientious about not interacting with, or disclosing any personal or confidential information to, any persons or websites that set off red flags.
  • The future costs and benefits of using cryptocurrency might be subject to unpredictable government regulations. This will require investors to pay close attention to the legal and political landscapes of their respective jurisdictions.

How to Buy and Sell Cryptocurrency

If you've weighed the pros and cons of cryptocurrency and have made a final decision to venture into this nascent financial world, the easiest way to do so is by signing up with a third-party wallet service provider. Generally, you can buy whatever amount suits your means, even if it's only a small fraction of one coin. Coinbase and Gemini are some of the most popular cryptocurrency exchange websites.

Signing up for these services is basically the same as signing up on any other website. To get started, you simply enter your email address and create a password. In order to purchase cryptocurrency, you'll need to connect to your traditional bank account, credit card, or debit card. Note that these sites should require you to use two-factor authentication to secure your account, but avoid using SMS or your phone number during this verification process. According to cybersecurity experts, criminals can steal from your cryptocurrency wallet using only your name and phone number. Instead, try Google Authenticator or a security key (like YubiKey) to verify your account.

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