What Is Cryptocurrency?

A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.

Understanding Cryptocurrencies

Cryptocurrencies are systems that allow for secure payments online which are denominated in terms of virtual “tokens,” which are represented by ledger entries internal to the system. “Crypto” refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions.

Types of Cryptocurrency

The first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most valuable. Today, there are thousands of alternate cryptocurrencies with various functions and specifications. Some of these are clones or forks of Bitcoin, while others are new currencies that were built from scratch.

Bitcoin was launched in 2009 by an individual or group known by the pseudonym “Satoshi Nakamoto.” As of November 2021, there were over 18.8 million bitcoins in circulation with a total market cap of around $1.2 trillion, with the figure updating frequently. Only 21 million bitcoins will ever exist, preventing both inflation and manipulation.2

Best cryptocurrencies by market capitalization

These are the 10 largest trading cryptocurrencies by market capitalization as tracked by CoinMarketCap, a cryptocurrency data and analytics provider.

Cryptocurrency

Market Capitalization

Bitcoin

$1.2 trillion

Ethereum

$548.4 billion

Binance Coin

$103.8 billion

Tether

$73.9 billion

Solana

$69.4 billion

Cardano

$67.9 billion

XRP

$55.8 billion

Polkadot

$45.3 billion

USD Coin

$34.4 billion

Dogecoin

$33.8 billion

Cryptocurrencies appeal to their supporters 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, the 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

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?”

For those who see cryptocurrencies such as bitcoin as the currency of the future, it should be noted that a currency needs stability so that merchants and consumers can determine what a fair price is for goods. Bitcoin and other cryptocurrencies have been anything but stable through much of their history. For example, while bitcoin traded at close to $20,000 in December 2017, its value then dropped to as low as about $3,200 a year later. By December 2020, it was trading at record levels again.

This price volatility creates a conundrum. If bitcoins might be worth a lot more in the future, people are less likely to spend and circulate them today, making them less viable as a currency. Why spend a bitcoin when it could be worth three times the value next year?

How do I buy 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. 

Coinbase, Binance and Crypto.com are most popular cryptocurrency trading exchange where you can create both a wallet and buy and sell bitcoin and other cryptocurrencies. Also, a growing number of online brokers offer cryptocurrencies as well.

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.

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.

Should you buy cryptocurrency?

Cryptocurrency is an incredibly speculative and volatile buy. Stock trading of established companies is generally less risky than investing in cryptocurrencies such as bitcoin.

What online brokers offer cryptocurrencies?

Of the online brokerages and cryptocurrency exchanges that NerdWallet reviews, the following currently offer cryptocurrencies.

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Binance

Access to buy and sell nearly 60 cryptocurrencies.

Coinbase

Access to buy and sell nearly 100 cryptocurrencies.

eToro

Trading platform with access to 17 cryptocurrencies.

Crypto.com

Ability to buy and sell more than 50 cryptocurrencies.

Bitfinex

Buy cryptocurrencies including bitcoin, bitcoin cash and ethereum.

KuCoin

Offers more than 30 cryptocurrencies for trading including bitcoin, ethereum and litecoin.