What Is Crypto? (And How Does It Work?)

What you'll learn:

➤ What Is Crypto?

Before diving into the high-stakes world of cryptocurrency, it’s essential to answer the fundamental question: “What is crypto?”

In 2021, during the peak of the cryptocurrency craze, investors flocked to this cutting-edge investment and the blockchain technologies it’s built upon. Many, however, ventured in without a clear understanding of what cryptocurrency truly is.

At the forefront of this digital revolution is Bitcoin, the world’s largest cryptocurrency, which reached an astounding all-time high near $68,000 in November 2021.

But in the following year, it experienced a 75% drop in value as investor confidence waned due to the Federal Reserve’s implementation of rising interest rates to combat inflation.

This shift in the investment landscape impacted all cryptocurrencies, including Bitcoin, and prompted a period of reflection. Nearly a year later, some semblance of sanity has returned to the digital currency market.

As a result, we are here to offer a comprehensive primer for those new to the world of cryptocurrency and the intricate industry that surrounds it.

Vanguard, a global heavyweight in the world of asset management, offers a concise definition of cryptocurrency in its “How to Invest” section on their website:

“A cryptocurrency is a digital asset stored on blockchain technology that serves as a type of currency or store of value. Unlike traditional currencies, cryptocurrencies aren’t backed by major governments or developed economies,” as per Vanguard’s explanation.

➤ How Does Blockchain Work?

The term “blockchain” often appears in discussions about cryptocurrencies, but what is its connection to these digital assets?

Blockchain technology acts as the backbone that empowers cryptocurrencies like Bitcoin to track and verify transactions between two parties.

This tracking occurs within a decentralized network of users called nodes. Instead of relying on a central authority or intermediary, these nodes are responsible for validating and recording transactions.

Consider the Bitcoin blockchain, for instance, which houses a comprehensive record of every Bitcoin transaction ever executed, neatly organized into blocks. When these blocks are sequentially linked together, they form a chain of blocks, aptly named a blockchain.

Coinbase, a well-known cryptocurrency exchange platform, offers insights into the inner workings of the Bitcoin blockchain: “Mining is the process through which new blocks are discovered and published.

Approximately every 10 minutes, a miner who successfully solves a block receives a portion of bitcoins. Miners play a crucial role in securing the network and are rewarded in this manner.

This system guarantees the validity of all transactions and safeguards the Bitcoin network against fraudulent activities.”

➤ Why Invest in Crypto?

The inception of Bitcoin in 2009 triggered a question that continues to resonate with investors: “Why own crypto?”

Proponents of these digital assets argue that cryptocurrency’s true power lies in decentralizing finance, wresting control of money creation from central banks and bankers, thereby democratizing the global financial system.

Cryptocurrencies excel in the swift and efficient transfer of funds across borders, making them a lifeline for individuals in countries plagued by volatile currencies or stringent cross-border regulations.

Cryptocurrencies, Bitcoin in particular, are also considered an investment. A prevailing belief is that these assets offer a hedge against inflation.

For cryptocurrency to truly embody this, it must fulfill several criteria.

First, it should serve as a store of value over time, maintaining or increasing its worth.

Second, it should be readily exchangeable for assets like gold and U.S. dollars.

Finally, it must boast limited supply growth over the years.

Take Bitcoin, for instance, which imposes a strict cap of 21 million units.

Currently, there are approximately 20 million Bitcoins in circulation, with about 6.25 new Bitcoins mined and released into the market every 10 minutes.

Experts project that this cap won’t be reached until the year 2140.

While this scarcity may theoretically drive up Bitcoin’s value as the limit approaches, the actual outcome remains speculative.

➤ Pros and Cons of Investing in Crypto

Cryptocurrency, a financial frontier, offers several compelling advantages:

Pros of Crypto

Accessibility: Cryptocurrency markets operate around the clock, seven days a week. Whether you’re in your living room at 3 AM or traveling abroad, you can trade digital assets. The accessibility of cryptocurrencies knows no bounds, appealing to both novices and seasoned investors.

Speed: In the ever-evolving world of finance, speed matters. Cryptocurrencies address this need by facilitating faster transaction speeds, a critical factor for their wider adoption. Quick transactions are vital, especially when dealing with everyday purchases, such as buying a cup of coffee.

Transparency: Cryptocurrencies are built on open-source code, ensuring real-time transparency. This feature is invaluable for auditors and regulators as it offers accurate insights.

Regulators benefit from a significantly higher seizure rate for illicit funds within the crypto sphere, a whopping 27% compared to the traditional financial system’s meager 0.1%.

In a rapidly evolving financial landscape, cryptocurrencies are reshaping accessibility, transaction speeds, and transparency, making them a fascinating subject of interest for investors and regulators alike.

Cons of Crypto

While cryptocurrencies promise innovation and financial transformation, they come with their share of challenges:

Regulatory Scrutiny: The rise of cryptocurrencies has prompted governments worldwide, including the U.S., to consider stricter regulations.

Recent developments in June 2023 saw the U.S. Securities and Exchange Commission (SEC) filing lawsuits against two major crypto exchanges: Binance and Coinbase Global.

Binance faced accusations of operating an unregistered exchange and offering unregistered securities, involving 12 cryptocurrencies, while Coinbase was charged with similar offenses.

Regulatory Uncertainty: Cryptocurrency newcomers should be aware that the industry is still evolving, marked by regulatory uncertainties and challenges.

The SEC, among other agencies, continues to grapple with how to regulate this dynamic space, which translates to potentially heightened volatility and above-average risks for investors, even when considering diversified crypto exchange-traded funds (ETFs).

Navigating the complex regulatory landscape in the cryptocurrency sphere is imperative for investors, as the industry continues to experience growing pains.

➤ Final Thoughts

In conclusion, the world of crypto is a dynamic and evolving landscape. While it offers numerous advantages, including accessibility, faster transactions, and transparency, it’s not without its challenges.

Regulatory scrutiny and the ever-changing nature of the market can introduce volatility and risk.

As the crypto industry continues to mature, staying informed and exercising caution are essential for investors.

Whether you’re intrigued by the potential of decentralized finance or considering cryptocurrency as an investment, being well-prepared and understanding the nuances of this digital frontier is key to navigating this exciting but complex space.

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Should You Invest in Crypto? (Pros, Cons, and More)