Initially hailed as a rebellious technology that would upend the world’s financial institutions and free people from the onerous fees and controls of the banking establishment, cryptocurrency has since been tarnished by criminal activity and wild market speculation. And while everyone has heard of crypto names like Bitcoin, very few people understand the fundamentals of how cryptocurrencies actually work — especially in the context of personal finance. Here’s what you need to know to prevent you from getting ripped off, and also help you determine if cryptocurrencies are for you:
Cryptocurrency is basically a digital way to hold and transfer value online. You can purchase cryptocurrency tokens or coins online (with a credit card or “traditional” money), and there is typically no one person or bank that controls a particular cryptocurrency. There are dozens of different cryptocurrencies available online, the biggest and most well-known ones being Bitcoin or Ethereum.
The value of any cryptocurrency at any given time depends on supply and demand. There’s usually a fixed amount of any currency available at any given moment, so the more people want to use it, the higher the price. In late 2017, for example, the price of a single Bitcoin soared to roughly $20,000 and then took a drive to around $4,000.
It’s relatively easy to purchase most cryptocurrencies — and considerably more difficult to unload them.
Sites like CoinBase are exchanges where you can purchase a variety of digital coins. There are also apps called digital wallets that enable you to keep cryptocurrencies yourself and send funds to others with relative ease. With such a wallet, the private keys (that represent ownership) are stored directly on your device.
If you have your own wallet under your own digital lock and key, you can “send” people digital funds. To do this, most people tend to use online vaults, like those provided by Coinbase. The process is very similar to traditional online services: you simply enter the amount of money you want to send and the company you want to pay.
Some vendors accept cryptocurrencies. Microsoft will let you add Bitcoin to your account online using your digital wallet, for example. And there’s a growing list of things you can purchase with cryptocurrency, including everything from fine art to real estate. In many cases, the adoption of cryptocurrency payments has been more of a marketing move than a practical financial one, but it can give cryptocurrency tokens more stability.
On the downside, you should be aware that most of the outlets that accept cryptocurrency also put significant restrictions and limitations on it. In the first place, most only accept the leading cryptocurrencies, Bitcoin and Ethereum. Second, you may not be able to use the credit for every service. For example, Microsoft will let you use Bitcoin to buy games, movies, and apps in Windows and Xbox stores — but you can’t use it in the Microsoft online store or buy gift cards with it.
Are there any hidden fees?
Of course there are! Most of the independent and startup exchanges that will buy and sell cryptocurrencies for you also charge some sort of fee for the service. And, like real stock brokers, they get you coming and going, whenever you buy or sell a currency. The fees are usually a percentage of the total deposit or payment. However, even if you have to pay 1.5 percent of the total, it’s much less than some other conventional services. Paypal, for example, typically charges closer to 3 percent.
That depends on your perspective. It is true that cryptocurrencies that use blockchain technology ensure that transactions are recorded properly and make it very difficult to hack. Blockchain software is essentially a decentralized ledger that no single person or institution controls because the record of all transactions is maintained across multiple nodes, offering redundancy and making it extremely difficult for any one user to tamper with.
However, if a cryptocurrency token is stolen from a digital wallet, in most cases that means the money is gone for good and untraceable. Furthermore, some vaults have been hacked to the tune of several million dollars, again leaving customers without any recourse because the funds are not guaranteed or insured by any government institution (contrast this with traditional bank accounts in the US, which the FDIC covers for up to $200,000). Last year, over $1 billion was stolen from cryptocurrency exchanges.
Historically, crypto was the realm of criminals and digital speculators who were likely attracted by the ease with which Bitcoin can be traded online without compromising anonymity. Unsurprisingly, people who traffic in stolen data and drugs on the dark web were big initial proponents of cryptocurrency. However, it has gained legitimacy over the past few years because of its flexibility for transferring digital money online without the need for any form of institutional banking. It has also gained favor in countries like Venezuela where the local currency is unstable and subject to wild inflationary swings. In these situations, cryptocurrency can offer some protection against political unrest.
In a word, no. The fundamental problem with all cryptocurrencies is the unpredictable fluctuation in their value. So while you hold onto any particular digital denomination, you could be losing (or gaining) money until you use it to buy something or unload it. Traditional money (what crypto proponents refer to as “fiat” currency) tends to be more stable, since it’s supported by governments and a much larger network of global trading markets.
Yes and no. The speculative bubble of 2017 in the world’s most popular cryptocurrency, Bitcoin, did burst — but Bitcoin is still widely used. People do business in Bitcoin in the equivalent of up to $800 million a day. That may sound like a lot, but it’s less than half of what one traditional service, Paypal, does every single day.
However, it is gaining acceptance as a category of currency, largely due to the fact that private companies see a tremendous marketing potential — and another source of revenue — in launching their own cryptocurrencies (see ICOs below).
Initial coin offerings (ICOs) are a way for companies to raise money by issuing virtual tokens. Much like crowdfunding, you purchase these virtual tokens using traditional money or another cryptocurrency like Bitcoin or Ether, and the company supposedly uses it to create products and expand. It allows the company to avoid the legal and financial requirements for raising venture capital or issuing stock. This new form of crowdfunding is rife with risk, however.
Generally, you can only use the tokens you buy to purchase services or products from that company. So ICOs are worthless anywhere else and there is always the danger that the company will fail to produce anything worth buying — and there’s no way to get your money back. Furthermore, ICOs have been issued in several scams, leaving buyers high and dry. And there’s a considerable speculative market as well, with some secondary markets springing up and traders exchanging the tokens online and driving up their value.
A spin-off concept from ICOs is for private companies to issue their own cryptocurrency to be used only at its own stores. It can also be used like bonus miles or points, redeemable in the future for the company’s services. One big player working on its own cryptocurrency for online money exchanges is Facebook. However, its success — like that of all types of cryptocurrency — will depend on how much people trust it.