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Cryptocurrency Definition

Cryptocurrency is digital money that can be exchanged in an encrypted and decentralized distributed ledger.

Last Updated: 11/14/2022
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What Is Cryptocurrency?

Cryptocurrency, commonly referred to as crypto, is virtual currency using secure cryptography — a protected, coded information transmission method. Crypto is also a payment system type. However, unlike traditional systems, it doesn’t rely on banks and isn’t regulated by a central monetary authority. Instead, it runs on blockchain technology.

Crypto, as a concept, was introduced in1998. By 2009, Bitcoin, the first and most well-known cryptocurrency, became a reality.

Today, there are thousands of cryptocurrencies available worldwide. Many countries like the United States consider them financial assets and some consider them tradeable investments.

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Understanding Cryptocurrency

Cryptocurrencies are relatively new and elusive to most people. They’re not as straightforward as using traditional, government-issued currency, which can be intimidating to some. In addition to being used for payments and some purchases, crypto can be an investment option if used correctly.

Learn more about how cryptocurrency works and how it differs from fiat currency.

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    Fiat money

    Fiat money refers to government-issued currency, such as the U.S. dollar. It doesn’t have intrinsic value and a physical commodity like gold doesn’t back it. Most major global paper currencies are considered fiat money.

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    Fiat money value

    Fiat money value, as a legal tender, depends on the issuing government’s creditworthiness. It relies on supply and demand and central banks use it. They’re in charge of issuing and controlling their countries’ monetary policies to manage the economy. For instance, central banks can adjust the supply of money to control inflation and maintain price stability.

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    Cryptocurrencies & fiat money

    Cryptocurrencies aren’t considered legal tenders like fiat money. They have no physical form and aren’t backed by central banks or governments. They can be considered the antithesis of the current banking system. Once there’s widespread use of digital currency, central banks may find it challenging to keep economies stable through traditional monetary policy tactics.

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    Cryptocurrencies & financial transactions

    Financial transactions can be completed by cryptos, like purchase payments. However, they are decentralized. There is no single governing authority. They run on peer-to-peer technology called the blockchain. Instead of a central bank, an algorithm controls supply.


Main Types of Cryptocurrency

There are different types of cryptocurrencies on the market, based on how they function and are built. When talking about cryptos, people typically think of a virtual currency they can use for payments. While this may be true for some cryptos, others don’t function like fiat currencies.

Additionally, some may not rely on the same blockchain technology that supports Bitcoin, depending on the type of crypto. Explore the main types of crypto in the table below.

  • Type of Cryptocurrency
    Description
  • Proof of Work (PoW)

    Bitcoin (BTC) relies on the blockchain technology that uses Proof of Work (PoW). It’s used by many cryptos, including Ethereum (ETH).

    Blockchain technology generally refers to a distributed ledger system. The network is accessible to multiple participating computers known as nodes. Each node must maintain a complete copy of the ledger.

    When a new transaction’s added, the nodes try to solve the problem representing the transaction data. Once solved, it will broadcast the answer to the other nodes for verification and validation. This process is called mining. The node that gets the response first receives a reward from the blockchain network.

    PoW requires evidence that nodes have worked to achieve a consensus, and that is why there’s a verification process. It also prevents nodes from printing extra coins or double-spending. It also makes it challenging to alter a blockchain.

  • Proof of Stake (PoS)

    Scalability and energy consumption are the biggest issues with PoW. The Proof of Stake (PoS) was developed to address these issues.

    PoS typically runs in consensus mechanisms like PoW to prevent double-spending of digital money. However, there are some main differences between the two.

    In PoW, the miners — nodes verifying and validating — are also the participants. They can add blocks by having more computational power.

    In PoS, the miners likely win blocks by having more money and showing proof of having a stake.

    There are two main players in PoS: validators and delegators.

    Validators are in charge of verifying the transaction data transmitted in the blockchain network. These are network node operators. They need to stake a certain amount of their coins/tokens to serve as collateral.

    Delegators can be considered investors. They vote for a specific validator by giving them temporary power over their coins or tokens. The delegator gets a share of the rewards the validator wins.

    Currently, PoS is used by many cryptos like Binance Coin (BNB), Solana (SOL), Cardano (ADA) and Polkadot (DOT). Ethereum also shared its plans to move to PoS when it launched Ethereum 2.0 in 2020.

  • Stablecoins

    Stablecoins are a hybrid of crypto and fiat currency. While they are digital, they’re pegged to stable reserve assets like gold or the U.S. dollar (USD). Combining the stability of traditional assets and the flexibility of digital assets.

    Crypto exchanges use stablecoins to help facilitate trades. In doing so, investors can buy and sell their crypto assets using these stablecoins.

    The USDC coin (USDC) is a good example of a stablecoin. This stablecoin adheres to and complies with regulators. It follows a 1:1 ratio. That means one USDC and one USD have the same value.

    Tether is another example of a stablecoin. It’s also pegged to the USD. It currently represents about 90% of stablecoin trading.

    An issue faced by stablecoins is being prone to crashes. For instance, the recent Luna crash and its associated terra USD (UST) stablecoin led to over $17 billion in crypto value being wiped out.

    Regulation of U.S. stablecoin has been highlighted since the crash. There are draft laws created and Congress will soon discuss stablecoin regulation.

Coins vs. Tokens

There are two forms of cryptocurrency: coins and tokens. Many use coins and tokens interchangeably. However, they’re not the same.

Coins and tokens are found in blockchain networks. The difference lies in whether the crypto has a blockchain or not.

Coins have underlying blockchains. They function like digital money and are used for payments. Meanwhile, tokens operate using other blockchains. They are digital assets that can be bought, sold, traded and stored.

Understanding the difference between these forms of crypto can help have a better grasp of what cryptocurrency is and how crypto markets run. It will also give you an idea of what type of crypto is suitable for your needs and goals.

Differences Between Coins & Tokens

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Coins

To determine if a specific crypto is a coin, check the blockchain network. Coins operate on independent blockchains created for them.

As the name suggests, coins are general-purpose currency. They typically facilitate payments. Similar to traditional cash, these cryptos are fungible and divisible. However, they utilize encryption techniques and can be mined.

When talking about crypto coins, most people would think of Bitcoin. Other examples of coins are Ethereum (ETH) and Litecoin (LTC).

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Tokens

Crypto tokens exist in blockchain networks. They are valuable assets that can be bought, sold, transferred and traded. They can also be stored in blockchain wallets, like hardware devices or programs.

These cryptocurrencies function as tokens within a system. They give the holders the right to participate in the blockchain network and access products or services. Tokens can also represent company shares or act as a representation of physical assets. Examples of tokens include Chainlink (LINK), Tether (USDT), Crypto.com coin (CRO) and Shiba Inu (SHB). These tokens were built on Ethereum and made for specific uses.


Hard Forks vs. Soft Forks

Change and development are part of technology. Crypto is no exception. Through the years, it has experienced changes. Given that it’s still a relatively new technology, a lot stands to change in the future. Changes can be categorized into hard forks and soft forks in the cryptocurrency world.

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    Hard Forks

    A radical change to protocol is called a hard fork. These fundamental changes occur when the crypto developers, miners or user base decide that a change is necessary for the blockchain. If the change causes previously valid blocks and transactions to become invalid or vice versa, it’s a hard fork.

    To help you further understand hard fork, here are some examples:

    • Bitcoin Hard Fork: Perhaps one of the most notable examples of a hard fork is the Bitcoin Cash (BCH), created in 2017. BHC is the result of a disagreement on scaling bitcoin.
    • Ethereum Hard Fork: Another example is the hard fork associated with the Decentralized Autonomous Organization (DAO), a member-owned community in the Ethereum network. A hard fork on block number 1,920,000 of the chain enabled malicious individuals to siphon Ethereum (ETH). This issue led to the splitting of Ethereum into two networks — ETH and Ethereum Classic (ETC).
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    Soft Forks

    When rule changes require updates but don’t result in creating a new blockchain, a soft fork has occurred. That means the original blockchain remains. It only involves modification. Even with the update, old blocks remain valid.

    Here are some examples of soft forks:

    • SegWit: The hard fork resulting in Bitcoin started with the Segregated Witness (SegWit), initially implemented as a soft fork. It freed up some space within blocks to accommodate more transactions. Since old blocks could still interact with the new blocks that had extra free space, the SegWit adoption was considered a soft fork.
    • Pay-to-script: In 2012, pay-to-script-hash (P2SH) was introduced. It’s a soft fork that only enhances codes without the need to change the blockchain network’s structure. This amendment is under BIP16 and allows transactions to be sent to a script hash.

Top Cryptocurrencies Examples

Even though cryptocurrency is a new technology, markets are seeing an increase. Currently, there are more than 19,000 cryptos in existence. Some of these are considered dead — they’ve been abandoned, are scams, insufficiently funded or have low liquidity. There are more than 10,000 active cryptos.

Cryptocurrency Types

With thousands of cryptocurrencies in the market, finding the right one for you can be a bit challenging. The following breakdown highlights some of the most popular cryptos to help you learn more about your options.

  • Cryptocurrency
    Description
  • Bitcoin (BTC) is the most popular cryptocurrency and what most people think of when they stumble upon the term crypto. It was introduced in 2009 by a person who goes by the name, Satoshi Nakamoto (their true identity is still unknown).

    Bitcoin is an example of a crypto coin. It uses a consensus network to enable a decentralized payment system. BTCs are used to pay for goods and services and can be traded. Competitive mining also helps users earn them.

    Some people may see BTC as a simple digital wallet. However, it’s more than that. It’s a blockchain network, which means it shares a public data ledger.

    While BTC is the first cryptocurrency, it gained popularity only in 2017. Its total value exceeded the $100 billion mark in 2018.

  • Ethereum (ETH) is an open-source cryptocurrency platform. It’s the second-largest crypto and is considered the second most popular. It was created in 2013 and is well-known for its smart contract aspect.

    ETH uses the currency ether. It’s digital money that runs in a peer-to-peer network. Ether is a crypto coin.

    Bitcoin innovation built ETH’s concept. However, ETH is programmable. This feature makes it a marketplace for various financial services. Decentralized finance (DeFi), non-fungible tokens (NFTs) and DAOs can use it.

  • USDC can be considered the digital dollar. It’s the best example of a stablecoin. This digital currency is managed by Centre Consortium, co-founded by Circle and Coinbase.

    The idea behind USDC is to have a crypto coin backed by fiat money to make it a more stable asset. It’s pegged to the value of the dollar. That means 1 USDC is equal to $1.

    Despite the name, the U.S. government didn’t issue USDC. It relies on an open-source network and is smart contract-based.

    It’s a crypto token available as any of the following:

    • Ethereum ERC-20
    • Algorand ASA
    • Avalanche ERC-20
    • Flow FT
    • Hedera SDK
    • Solana SPL
    • Stellar asset
    • TRON TRC-20

    Aside from payments, USDC can be used in trading, lending and investing.

Growth and Adoption of Cryptocurrencies

Cryptocurrency market capitalization (market cap) determines how big certain digital currency is. It can help in comparing cryptos in the market. Checking the market cap can help investors and aspiring investors decide where to invest.

In total, the current market cap is $1.26 trillion. Bitcoin remains the top-ranking in terms of market cap with Ethereum typically coming in second.

In 2017, the world saw significant interest in crypto. But the market cap of cryptos was already worth billions of dollars before the boom. That said, it crashed in the succeeding years. For instance, in 2018, crypto experienced an 80% plunge.

The recent crypto market cap increase shows signs of recovery. However, the high volatility and consistent change of crypto are likely to continue.

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IMPORTANT NOTE

Market Cap is =/= Market Price. Market Cap refers to the total value of the blockchain’s coin/token. For example, if there are 100 coins being sold at $1 each, that makes the Market Cap $100.

The constant change in the crypto market cap demonstrates how its growth can be unpredictable.

Let us take BTC as an example.

In May 2013, the crypto’s market cap reached $1.25 billion. It continued to grow from there. It significantly increased in December 2017 to $326.50 billion. A huge dip occurred in February 2018 as the BTC market cap only totaled $198.39 billion.

The next peak was in April 2021 at $1.15 trillion. A month after that, crypto fell to $648.06 billion. Another peak came in November 2021 at a $1.20 trillion market cap. In January 2022, BTC fell again to $878.95 billion. Fluctuations continued and the BTC is currently at $581.46 billion.

The case of BTC isn’t unique. Overall, cryptocurrencies have seen growth in market cap, price and popularity over the past decades since their inception. However, they have also experienced fluctuations. Crashes have been observed, with some years recording significant decreases.

Adoption of Cryptocurrencies

Cryptocurrency has been a buzzword recently. As more people become aware of it, more individuals are interested in it as an investment option. Additionally, many see its decentralized nature as an advantage, since cryptos do not rely on central banks and governments.

Individual investors are not the only ones who find cryptocurrencies appealing — it’s been expanding into more common use. Many mainstream companies have adopted the use of crypto. These range from financial institutions to retailers. Supply chain management is even using it.

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EXAMPLES OF COMPANIES USING CRYPTO

Below are some examples of the adoption of cryptocurrencies.

  • Visa: Visa, the digital payments processor, announced the launch of its Global Crypto Advisory practice in late 2021. The move aims to help partners and clients with their crypto journey through Visa’s consulting and analytics division. According to Visa, this program is a result of consumer interest in crypto solutions, as seen in its research study.
  • Mastercard: In 2021, Mastercard announced that it would be supporting certain cryptocurrencies, allowing Mastercard customers to use some of them easily. Additionally, Mastercard partnered with Gemini to launch a crypto rewards credit card.
  • U.S. Bank: U.S. Bank launched crypto custody services in 2021, aimed at the bank’s Global Fund Services clients. It’s intended to serve institutional investment managers with private funds in the U.S. or the Cayman Islands. The custodian for this service is the financial technology firm NYDIG.
  • Amazon: Online retail giant Amazon is also interested in crypto. The company appears to be planning a crypto token launch in 2022. This news was discovered when Amazon posted a job for a product leader overseeing the development of the company’s digital currency and blockchain strategy. Amazon also offers Amazon Managed Blockchain. This service helps interested parties join public networks. It can also create and manage scalable private networks using Ethereum or Hyperledger Fabric.
An illustration of Uncle Sam holding a magnifying glass and examining Bitcoin.

Legality, Regulation and Taxation of Cryptocurrency

The legality of cryptocurrencies depends on the country. For instance, BTC is legal in at least 11 states and territories. These include the U.S., Canada, the European Union (EU), the United Kingdom, Japan, Australia, El Salvador and Spain. In some countries, it’s legal to use bitcoin but restricted, while others have completely banned its use.

Regulation and taxation are also on a per-country basis. For instance, the U.S. Securities and Exchange Commission (SEC) regulates the issuance and resale of digital assets or tokens that constitutes security. Security, in this case, refers to investment contracts.

Legality and Regulations

Regulation uncertainty is one of the drawbacks experienced with cryptos. However, many governments recognize the need to regulate digital currencies and assets.

In the U.S., regulation of digital tokens is a moving target. In March 2022, the White House released an Executive Order on Ensuring Responsible Development of Digital Assets. President Biden reiterated the need for a policy governing digital assets to protect consumers, investors and businesses in the country. The crypto regulation discussions continue.

The use of cryptos is legal in the U.S. However, they’re not considered legal tenders. Companies can conduct crypto transactions. Interested businesses may need to find a payments partner and learn how to convert payments into cash.

In Canada, cryptos are legal but aren’t considered legal tender. That means individual businesses can accept crypto payments at their own risk. However, the Canadian Securities Administration (CSA) doesn’t take it as a form of tax payment.

While cryptos are widely considered legal across the EU, regulation varies per member-state. According to EU laws, cryptos and digital assets are considered qualified financial instruments. Financial institutions, such as banks and investment firms, can offer services or hold crypto assets. Cryptos are not legal tenders in the EU.

Taxation

Whether cryptos are taxed or not will depend on where you live. The best way to determine how much you need to pay for crypto tax is to review the country’s regulations. For instance, cryptos are tax-free in Germany, Belarus, El Salvador, Singapore, Malaysia, Malta, Cayman Islands, Puerto Rico and Switzerland.

In the U.S., the IRS treats virtual currency as property. The general rules for property transactions apply to federal tax. Transactions involving crypto are taxable because cryptocurrencies aren’t accepted as legal tender in the country.

For instance, by paying an employee in virtual currency, the employer must report the wages using a W-2. The said wages are subjected to federal income tax withholding and payroll taxes.

Canada and the United Kingdom (U.K.) are other examples of countries where cryptos are taxable. Canada considers cryptos as digital assets. That means holding cryptos isn’t taxable. However, the sale of these assets is subject to taxes.

Similarly, any act that would lead to earning capital gain like selling, trading, exchanging or gifting of cryptos requires the payment of taxes. That said, only 50% of the capital gain is taxable.

The U.K. treats cryptos as capital assets. That means the disposal of cryptos, such as selling, exchanging or paying goods or giving away tokens, would lead to taxes. The country’s tax rate on crypto depends on the taxpayer’s overall taxable income.

Cryptocurrency: Benefits & Risks to Consider Before Diving In

Cryptocurrencies can create a diverse investment portfolio. Whether one should invest in crypto depends on an individual’s situation, needs and goals. Overall, an investor should aim for a balanced investment portfolio.

Before diving in, make sure you weigh the pros and cons. Below is a simple comparison of well-known benefits and risks to help you get started. You can also compare multiple cryptocurrencies available in the market to see which one is suitable for your needs.

Benefits & Risks

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Benefits
  • Investing could yield high return potential
  • Uses numerical identifiers, which offer anonymity
  • Decentralized system lessens the risk of a single point of failure
  • Faster and easier transactions eliminate the need for a middleman
  • Easily accessible and adaptable, making cross-border payments possible
  • Anyone can participate and permission from a financial authority isn’t necessary
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Risks
  • Coins and tokens value fluctuate
  • It’s not entirely anonymous (digital trails can be followed)
  • Wallets and exchanges are still prone to being breached
  • Used as a tool for criminal activities, such as money laundering
  • Huge energy costs due to consumption necessary for mining
  • Volatility due to lack of regulation

Cryptocurrency FAQs

Knowing what cryptocurrency is can help you make well-informed investment decisions. MoneyGeek answers some of the frequently asked questions (FAQs) about cryptocurrencies and how they work.

Expert Insights

As a relatively new technology, many find cryptocurrency challenging to navigate and understand. We reached out to several industry experts to share their insights to help you better understand what crypto is and how it works.

  1. Are cryptocurrencies legal?
  2. Can I use cryptocurrencies for purchases similar to fiat currency?
  3. How risky is it to invest in cryptocurrencies?
  4. What are some key points any first-time investor should know before diving into cryptocurrency?
Milan Singh
Milan Singh

Entrepreneur, Investor and Finance Content Creator at Milan Singh

David Harris
David Harris

Economist in Great Falls, Montana

Dr. Kortney Ziegler
Dr. Kortney Ziegler

Founder and CEO at Well-Money.com

Jeremy Britton
Jeremy Britton

Co-founder & CFO at BostonTrading.co

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About the Author


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Nathan Paulus is the director of content marketing at MoneyGeek. Nathan has been creating content for nearly 10 years and is particularly engaged in personal finance, investing, and property management. He holds a B.A. in English from the University of St. Thomas Houston.


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