As the price of Bitcoin breaks through the $4,000 ceiling for the first time, many investors are asking what is a cryptocurrency and how do they work?
Cryptocurrency is an umbrella term for digital money outside of any government control that is designed as secure and anonymous.
The crypto bit of the name means the software developers have encrypted financial transactions in hard to break code.
Bitcoin was the first cryptocurrency, unleashed online in 2009.
Today, nearly 1,000 cryptocurrencies have taken the Bitcoin idea for a run, but few are known to more than a handful of developers.
How do cryptocurrencies work?
The whole process is online and automated. Most have decentralised servers that record and manage transactions while holding virtual cash in an electronic wallet.
The database that holds the details of who has paid what to whom is called a blockchain.
Users can get hold of cryptocurrency in two ways –
- Mining – This involves receiving cryptocurrency rewards for solving complicated math problems
- Trading – Buying and selling from brokers
Who supervises cryptocurrencies?
No one. The whole point is cryptocurrencies are outside of influence from central banks and governments. However, this freedom leaves them open to abuse and accusations that their anonymity helps terrorists, drugs barons and organised crime fund their illicit operations.
As a cryptocurrency user, be aware that although virtual money has all the trappings of currency, it unrecognised by most governments. This means trades are treated as investments and are subject to income and capital gains taxes on profits.
Which cryptocurrencies are the most popular?
Bitcoin is by far the most-used cryptocurrency, with holdings totalling around $45 billion in circulation.
Although users like to publish a US dollar v Bitcoin exchange rate, no official exchange rate exists.
Ethereum is the next most commonly traded cryptocurrency, with an equivalent of $18 billion in circulation.
Other popular cryptocurrencies include Ripple and Litecoin. Together, the amount of these cryptocurrencies adds up to around $8 billion.
Cryptocurrency investment risk
Cryptocurrency investments are extremely volatile and can make investors rich or poor overnight.
They are also prone to fraud and theft, with the history of Bitcoin and Ethereum peppered with broker collapses, lost stashes and scams.