Cryptocurrency Fundamentals - Illuminating Cryptocurrency

Cryptocurrency is exactly like real currency except it is entirely digital. Each cryptocurrency coin is a collection of digital letters and numbers. There are thousands of cryptocurrencies just like there are hundreds of “real world” currencies. Each cryptocurrency is different and is used as a way to buy goods and services online.

Why was cryptocurrency created?

The first cryptocurrency, Bitcoin, was created by Satoshi Nakamoto in 2013. It was created to offer a decentralized way to buy goods and services online, free from any third-party interference, such as government, or any centralized authority. Some benefits of using Cryptocurrency include: very little to almost no cost when conducting transactions, no limits to the amount of transactions a person can do, people have 24-hour access to their money, no extra delays or extra charges on international transactions, and paperwork isn’t required to use cryptocurrency.

What is the purpose of cryptocurrency?

The main purpose is to fix the many problems associated with fiat, or government issued currency. Cryptocurrency networks allow people to lend, save, and borrow without an identity, credit score, or bank and at very low cost.

What is a cryptocurrency wallet?

Essentially, a cryptocurrency wallet is like a bank account without a physical card. It is used to store and retrieve your digital assets. Any cryptocurrency held in your wallet is held by you, not a third party like your bank. This means no one can shut down your wallet because you have total control it. The downside of a cryptocurrency wallet is that if you lose access to your wallet or forget to write your recovery phrase when you make one you will permanently lose your cryptocurrency, so you must ensure you have the information written down in a safe place.

What is blockchain and what is its importance in cryptocurrency?

Blockchain is used to record data in a way that makes it incredibly difficult to change, hack, or cheat a system. It ensures records of data are enduring, unchanging, and secure, resulting in high levels of trust without the need of a third party. Information can be shared between all parties that have access to it through an application. Cryptocurrencies, such as bitcoin, show how crucial blockchains are in maintaining security and a record of transactions.

What is the difference between centralized and decentralized cryptocurrency exchanges?

A decentralized exchange (or DEX) conducts transactions directly between cryptocurrency traders. It is a peer-to-peer marketplace. Decentralized Exchanges allow financial transactions that are not governed by any bank or any other third party. Some advantages of using Decentralized Exchanges are much lower susceptibility to hacks due to users being required to secure their accounts themselves, and greater anonymity/privacy as there is no “Know Your Customer” (KYC) regulations required. Some popular Decentralized Exchanges include Uniswap, run on the Ethereum blockchain, and Spookyswap, run on the Fantom blockchain.

A centralized cryptocurrency exchange uses a third party to help conduct transactions. Buyers and Sellers of centralized exchanges must rely on these third parties to handle their assets. Some advantages of centralized exchanges are higher reliability when it comes to transactions and trading due to the transaction being conducted through a developed, centralized platform, and a much more user-friendly experience over decentralized exchanges, which can be very challenging to figure out and work with initially. Popular centralized exchanges include Binance, run on the Binance blockchain, and Coinbase, run on the Ethereum blockchain.

What is the difference between a cryptocurrency coin and a cryptocurrency token?

In cryptocurrency, all coins are tokens but not all tokens are coins. Coins and tokens both represent a store of value, similar to currencies such as dollars and euros. The difference between the two is digital coins are a form of currency/money, while digital tokens are something that can be assigned a price. Tokens can be used to represent a physical or intellectual property, such as a work of art, a piece of music or a book (a popular example would be a non-fungible token or NFT).

Is cryptocurrency safe to invest in?

Cryptocurrency works on blockchain technology making cryptocurrency very secure. Blockchain is a digital record-keeping system that makes it incredibly difficult to change, hack, or cheat the system the data is stored on. As an investment, cryptocurrency can be notoriously volatile since it isn’t backed by a government authority. This results in cryptocurrency not having the same protections that many standard currencies throughout the world are able to rely upon. Now, although cryptocurrency is recognized as being one of the riskiest assets to hold, an increasing number of big, powerful players around the world are validating crypto’s potential. Almost all of the largest banks, to include JPMorgan Chase, Wells Fargo and Goldman Sachs, now have cryptocurrency-focused employees on their payroll. Even Countries are beginning to embrace this new asset class with El Salvador being the first to recognize crypto as legal tender in 2021. Each year, more investors and major financial institutions agree that with proper precautions cryptocurrency can make a great addition to anyone’s portfolio.

Why should you invest in cryptocurrencies instead of government backed/fiat currencies?

At one point in history fiat currencies were backed by gold but that is no longer happening. Since then, all fiat currencies have been losing value because the only thing that maintains government backed currencies today is the trust we have in those governments. That trust has been decreasing over time due to overprinting and manipulation of currencies at the expense of the average person. The result of this overprinting and manipulation of money has been excessive inflation that incentivizes spending over saving.

Cryptocurrency is valuable because it is a digital payment system that doesn’t rely on banks to verify transactions, is a peer-to-peer system, and it enables anyone anywhere to send and receive payments. Bitcoin has value because it has a max supply and the supply created is cut in half every four years. If demand stood the same for bitcoin it would result in bitcoin doubling in price every four years but demand has only increased since inception which continues to make bitcoin more valuable over time. Another example, Ethereum, is valuable due to its utility. It can be used to create cryptocurrency tokens, decentralized apps and websites that can’t be shut down. All transactions related to creating and moving tokens and interacting with the apps requires ether to pay for gas fees. This means the demand for Ethereum rises as it gains further adoption.

What can you buy with cryptocurrency, and how?

Cryptocurrency can be used to purchase anything government backed currencies can purchase, such as a cup of coffee, clothes, jewelry, cars, and real estate. Cryptocurrency debit and credit cards make paying using cryptocurrency incredibly simple and are available through many crypto exchanges such as crypto.com, coinbase.com, and blockfi.com.

How can you make money with cryptocurrency?

There are a number of ways to make money using cryptocurrency (this list is not all-inclusive):

Trading – A short-term strategy involving frequent transactions, such as the buying and selling of stocks, commodities, or currency pairs. The goal of a trader is to produce better returns than a “buy-and-hold” investor.
Investing – A long-term strategy requiring a “buy-and-hold” approach that can earn higher returns as the investment grows over time.
Staking – A way to earn passive income by locking up crypto holdings in order to obtain rewards or earn interest.
Lending – A way to allow investors to lend their cryptocurrencies for a fee or interest.
Mining – Uses specialized computers, known as nodes or mining rigs, to receive a financial reward, usually cryptocurrency, for completing blocks of verified transactions.

How can you start investing in cryptocurrency?

1) Select a broker or cryptocurrency exchange. Some popular options include Robin Hood, Coinbase, and Binance. 2) Create and verify your account. Buying and selling cryptocurrency is usually not allowed until the verification process is complete. 3) Deposit cash to invest. You need to ensure your account has funds before you can buy crypto. 4) Place your order. There are thousands of cryptocurrencies to choose from and each broker and exchange supports various cryptocurrencies so ensure the cryptocurrency you are interested in is supported by the broker or exchange you choose to go with. 5) Select a storage method. Your options include to either leave the crypto in the exchange you purchased it from or to move it to a wallet for storage.

Which cryptocurrencies should you invest in and how can you minimize your risk?

Deciding which cryptocurrency you should buy can be a really nerve-wracking process. Some suggestions are to decide if you have a low-risk tolerance (stick to most of the top 15 cryptocurrencies), or high-risk tolerance (all other cryptocurrencies. As you go lower down the list of cryptocurrencies the risks increase). You should always do proper research before buying any cryptocurrency. Ensure the desired cryptocurrency meets all of your researched criteria. It is also almost always a good idea to dollar cost average (DCA) into positions. As a very simple example, if you have $500 to invest in a particular cryptocurrency use $100 to make an initial purchase. Each month after that, continue to purchase more of the cryptocurrency in increments of $100 until your $500 has been spent. This very simple strategy helps to minimize your down-side risk (not financial advice).

Do you have to pay taxes on cryptocurrency investments in the United States?

Yes, cryptocurrency is taxable income in the United States, except for Puerto Rico. Puerto Rican residents pay zero taxes on cryptocurrencies.

Will cryptocurrency be around in 10 or 20 years?

No one knows the future so it is tough to say, but many indicators are pointing to cryptocurrency continuing to grow. Mass adoption is slowly happening and major institutions, as well as governments, are getting involved in cryptocurrency. The trend is pointing to continued mainstream adoption. This adoption will not be a straight line upward though; cryptocurrency is highly volatile and will have many spikes to the downside, but over time the long-term trend has continued to go upwards so the future of cryptocurrency looks bright.