What is cryptocurrency? Cryptocurrency is a digital payment system that doesn’t rely on banks to verify transactions. It’s a peer-to-peer system that can enable anyone, anywhere, to send and receive payments. Instead of being physical money carried around and exchanged in the real world, cryptocurrency payments exist purely as digital entries to an online database describing specific transactions. When you transfer cryptocurrency funds, the transactions are recorded in a public ledger. Cryptocurrency itself is stored in digital wallets, or “e-wallets”.
Cryptocurrency received its name because it uses encryption to verify transactions. This means advanced coding is involved in storing and transmitting cryptocurrency data between wallets and public ledgers. The aim of encryption is to provide security and safety. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation. The first cryptocurrency was Bitcoin, which was founded in 2009 and remains the best known today.
How does cryptocurrency work?
Cryptocurrencies run on a distributed public ledger called “blockchain,” a record of all transactions updated and held by currency holders. Units of cryptocurrency are created through a process called “mining,” which involves using computer power to solve complicated mathematical problems that generate coins. Users can also buy the currencies from brokers, then store and spend them using cryptographic wallets.
If you own cryptocurrency, you don’t own anything tangible. What you own is a key that allows you to move a record or a unit of measure from one person to another without a trusted third party. Even though Bitcoin has been around since 2009, cryptocurrencies and applications of blockchain technology are still emerging in financial terms, and more uses are expected in the future. Transactions including bonds, stocks, and other financial assets could eventually be traded using the technology.
Cryptocurrency examples
There are thousands of cryptocurrencies. Some of the best known include:
- Bitcoin: Founded in 2009, Bitcoin was the first cryptocurrency and is still the most commonly traded. The currency was developed by Satoshi Nakamoto – widely believed to be a pseudonym for an individual or group of people whose precise identity remains unknown.
- Ethereum: Developed in 2015, Ethereum is a blockchain platform with its own cryptocurrency, called Ether (ETH) or Ethereum. It is the most popular cryptocurrency after Bitcoin.
- Litecoin: This currency is most similar to Bitcoin but has moved more quickly to develop new innovations, including faster payments and processes to allow more transactions.
- Ripple: Ripple is a distributed ledger system that was founded in 2012. Ripple can be used to track different kinds of transactions, not just cryptocurrency. The company behind it has worked with various banks and financial institutions.
Non-Bitcoin cryptocurrencies are collectively known as “altcoins” to distinguish them from the original.
Volatility of cryptocurrencies
Like most commodities, assets, investments, or other products, cryptocurrency prices depend heavily on supply and demand. Cryptocurrencies’ market value is primarily affected by how many coins are in circulation and how much people are willing to pay. If you’re looking to use cryptocurrencies to preserve capital or grow your assets, its price is highly volatile—there is no guarantee that you will see any returns; you’re just as likely to lose everything you invest as you are to make any gains.
What are the legal risks to cryptocurrency investors?
Along with the explosion of interest in cryptocurrency, there is a growing need for clarity regarding the legal implications of these new currencies and the technologies that drive them. Regulatory agencies, tax authorities, and central banks around the world all are working to understand the nature and meaning of digital currencies. The regulation of cryptocurrencies remains in an unsettled state.
The wise cryptocurrency investor should consider reporting their holdings as foreign assets, although the requirements remain unclear. As of January 2022, federal law does not view a foreign cryptocurrency account as a type of “reportable account.” Owners of cryptocurrency wallets may soon be required to file FinCEN Form 114, the report required of U.S. taxpayers with substantial holdings in foreign bank accounts.
One fact is definite: Profits in cryptocurrency trading are taxable as capital gains in the U.S. The IRS has defined cryptocurrencies as property rather than currencies. This means that individual investors are subject to capital gains tax laws when it comes to reporting cryptocurrency profits and expenses on their annual tax returns, regardless of where they purchased digital coins. Internal Revenue Service. Virtual Currencies
The lack of a centralized authority can be a legal and financial risk to cryptocurrency owners. Because cryptocurrencies are decentralized, their use can lead to legal confusion between parties in various types of digital currency transactions, and the path of legal recourse in these situations can be difficult to assess. Also, the decentralized nature of cryptocurrency can lead to fraud and cryptocurrency scams. Investors who find themselves in the unfortunate position of being a victim of financial crime do not likely have the same legal options as traditional victims of fraud.
Investing in cryptocurrencies and other initial coin offerings (ICOs) is highly risky and speculative, and this article is not a recommendation by Cleveland Heights – University Heights Public Library or the writer of this blog. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions.
Want more information?
Wikipedia
What Is Cryptocurrency? Here’s What Investors Should Know NerdWallet
What Is Cryptocurrency? Forbes
What is cryptocurrency? A beginner’s guide to digital currency Cointelegraph
Playing With Crypto? You’ll Need a Wallet (or Several) Wired