You’ve probably heard the word “cryptocurrency” or “crypto” over the past few years. Maybe you’re even familiar with Dogecoin? But what exactly is cryptocurrency? It’s a digital currency that is a form of digital token or coin that exists on a distributed ledger called a blockchain.
Satoshi Nakamoto is the name used by the person presumed to have developed Bitcoin and devised the first blockchain database. Read these 6 facts to understand the basics of how cryptocurrency works.
- Cryptocurrency is 100% electronic. Most money systems produce physical coins or paper money issued by a financial institution, such as a central bank, and are backed by a government. Cryptocurrency is a decentralized finance digital asset that is electronic, non-tangible and stored as a crypto asset. It’s essentially digital money.
- Many cryptocurrencies are based on blockchain technology. Blockchain refers to a database that collects information in sets or “blocks” linked together using cryptography. When the blocks are filled, they’re connected or “chained” to the previous blocks and can’t be changed. The transaction and verification processes use mathematical algorithms, which make them more secure and very difficult for hackers to target. When you purchase crypto, your coin ownership records are stored electronically.
- You can buy, sell and use cryptocurrency to buy services or goods. Anyone can process a cryptocurrency transaction through a dedicated medium of exchanges. These crypto exchanges typically charge a fee based on the size of your transaction. To hold your purchases, you’ll create a cryptocurrency wallet (an app that holds your currency) or digital wallet.
- The value of various cryptocurrencies can change rapidly. Unlike the U.S. dollar, there’s no central authority that maintains the crypto’s value; as a result, there’s more volatility as the value can move up and down quickly. For that reason, buying crypto as an investment can be risky. If you’re thinking of using cryptocurrency to diversify your investment portfolio, you may want to consider investing in large companies that are investing in the technology instead.
- There are thousands of different cryptocurrencies being traded. In the early days, there was only one type of coin available: Bitcoin, the first cryptocurrency. Today, there are thousands of different types of cryptocurrencies and other alternate coins, or “altcoins.” New coins are brought to market all the time, often raising money through initial coin offerings. Some of the more popular cryptocurrencies are Bitcoin; Ethereum, a virtual currency that’s used to create decentralized financial systems; and Litecoin, which is very similar to Bitcoin but has a faster block generation rate. Secure peer-to-peer platforms or cryptocurrency exchanges, such as Coinbase and Binance Coin, make it easy to buy and sell cryptocurrency without the involvement of a central authority. Cardano is another blockchain platform that facilitates peer-to-peer transactions using its internal cryptocurrency.
- Cryptocurrencies are taxable. The IRS treats cryptocurrencies as property. If you’re trading one cryptocurrency for another, you may need to pay taxes to the IRS.
Navy Federal Credit Union does not offer or endorse any particular cryptocurrency, digital asset, or associated technologies.
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.