A cryptocurrency is a digital or virtual currency that uses cryptography and is difficult to counterfeit. Cryptocurrencies let you buy goods and services, or trade them for profit. Here’s more about what cryptocurrency is, how to buy it and how to protect yourself.
1. What is cryptocurrency?
A cryptocurrency (or “crypto”) is a form of payment that can circulate without the need for a central monetary authority such as a government or bank. Instead, cryptocurrencies are created using cryptographic techniques that enable people to buy, sell or trade them securely.
Cryptocurrencies can be exchanged for goods and services, though they often are used as investment vehicles. Cryptocurrency is also a key part of the operation of some decentralized financial networks, where digital tokens are an important tool for carrying out transactions.
The most popular cryptocurrency, Bitcoin, has had a historically volatile price. In 2021, it hit an all-time high above $65,000 before falling back.
2. How do I invest in cryptocurrency?
While some cryptocurrencies, including Bitcoin, are available for purchase with U.S. dollars, others require that you pay with bitcoins or another cryptocurrency.
To buy cryptocurrencies, you’ll need a “wallet” — an online app that can hold your currency. Generally, you create an account on an exchange, and then you can transfer real money to buy cryptocurrencies such as Bitcoin or Ethereum
What online brokers offer cryptocurrencies?
If you’re more accustomed to traditional brokerage accounts, there are a few online brokers that offer access to cryptocurrencies as well as stocks. Of the online brokers reviewed by NerdWallet, these include Robinhood, Webull, SoFi Active Investing and TradeStation. If you’re looking for an exchange that operates solely within the cryptocurrency world, look for pure-play crypto exchanges. These platforms, such as Coinbase, Gemini and Kraken, won’t give you access to core assets like stocks and bonds, but they typically have a much better selection of cryptocurrencies, and more wallet functionality.
3. How many cryptocurrencies are there? What are they worth?
More than 16,600 different cryptocurrencies are traded publicly, according to CoinMarketCap.com, a market research website. And cryptocurrencies continue to proliferate. The total value of all cryptocurrencies on Jan. 10, 2022, was about $1.9 trillion, having fallen off an all-time high above $2.9 trillion late in 2021.
4. Why are cryptocurrencies so popular?
People invest in cryptocurrencies for a variety of reasons. Here are some of the most popular:
- Supporters see cryptocurrencies such as Bitcoin as the currency of the future and are racing to buy them now, presumably before they become more valuable.
- Some supporters like the fact that cryptocurrency removes central banks from managing the money supply, since over time these banks tend to reduce the value of money via inflation.
- Other supporters like the technology behind cryptocurrencies, called blockchain, because it’s a decentralized processing and recording system and can be more secure than traditional payment systems.
- Some speculators like cryptocurrencies because they’re going up in value and have no interest in the currencies’ long-term acceptance as a way to move money.
5. Are cryptocurrencies a good investment?
Cryptocurrencies may go up in value, but many investors see them as mere speculations, not real investments. The reason? Just like real currencies, cryptocurrencies generate no cash flow, so for you to profit, someone has to pay more for the currency than you did.
That’s what’s called “the greater fool” theory of investment. Contrast that to a well-managed business, which increases its value over time by growing the profitability and cash flow of the operation.
“For those who see cryptocurrencies such as bitcoin as the currency of the future, it should be noted that a currency needs stability.”
Some notable voices in the investment community have advised would-be investors to steer clear of them. Of particular note, legendary investor Warren Buffett compared Bitcoin to paper checks: “It’s a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money too. Are checks worth a whole lot of money? Just because they can transmit money?”
6. Are cryptocurrencies legal?
There’s no question that they’re legal in the United States, though China has essentially banned their use, and ultimately whether they’re legal depends on each individual country. Also be sure to consider how to protect yourself from fraudsters who see cryptocurrencies as an opportunity to bilk investors. As always, buyer beware.
7. How do I protect myself?
If you’re looking to buy a cryptocurrency in an ICO, read the fine print in the company’s prospectus for this information:
- Who owns the company? An identifiable and well-known owner is a positive sign.
- Are there other major investors who are investing in it? It’s a good sign if other well-known investors want a piece of the currency.
- Will you own a stake in the company or just currency or tokens? This distinction is important. Owning a stake means you get to participate in its earnings (you’re an owner), while buying tokens simply means you’re entitled to use them, like chips in a casino.
- Is the currency already developed, or is the company looking to raise money to develop it? The further along the product, the less risky it is.
It can take a lot of work to comb through a prospectus; the more detail it has, the better your chances it’s legitimate. But even legitimacy doesn’t mean the currency will succeed. That’s an entirely separate question, and that requires a lot of market savvy.
But beyond those concerns, just having cryptocurrency exposes you to the risk of theft, as hackers try to penetrate the computer networks that maintain your assets. One high-profile exchange declared bankruptcy in 2014 after hackers stole hundreds of millions of dollars in bitcoins. Those aren’t typical risks for investing in stocks and funds on major U.S. exchanges.