Before you invest in cryptocurrency, you should understand it. That sounds obvious, but research shows most people don’t. One poll conducted in November 2021 – long after the crypto market exploded – showed 98 percent of adults failed a 17-question quiz about the basics of this unique digital currency.

Cryptocurrency is a unique financial product that is one-part high-risk investment and one-part currency that can be used to pay for things. So, while people like Elon Musk are getting rich stoking buying frenzies on crypto exchanges, an estimated 46 million people plan to use cryptocurrency for purchases in the near future.[1]

But regardless of what you plan to do with it, it’s important that you understand it—just like you should with any financial product or investment.  This beginner’s guide to cryptocurrency will explain the basics of how it works. how it gets brought and sold and what risks to avoid if you are looking to get involved.

Table of Contents

What Is cryptocurrency?

Cryptocurrency is simply data stored in a computerized database, much like your bank accounts. But unlike traditional currency that’s backed by a government, cryptocurrency doesn’t obey any borders. Instead, private groups or individuals make it. Users govern cryptos and the market essentially decides if they’re worth anything.

Currently, the world’s crypto market is valued at over $3 trillion and is growing fast.

Individuals and institutions have become investors in this growing but volatile market, and you may be thinking about joining them. It may seem tempting, but don’t let “FOMO” (Fear of Missing Out) rush you into the wrong decision. You should understand how cryptocurrency works and the different types of “coins” you can invest in before you jump into the crypto market.  And like any investment, you need to have a handle on your finances before you launch a crypto investing strategy.

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Bitcoin vs altcoins vs stablecoins vs shitcoins

Bitcoin is the original cryptocurrency. Everything else is referred to as an altcoin.  Bitcoin and most altcoins tend to fluctuate in value. As the demand for a coin goes up because more users want to buy it,  the price goes up and the value of the coins you own does as well. But the market can be volatile and the flotations can be quick and dramatic.

Stablecoins are a type of altcoin tied to either a currency or a commodity, often in a one-to-one ratio. These cryptos can offer you stability and lower risk.

By contrast, shitcoins are coins that have no value and no backing.

How do you get cryptocurrency?

You buy and sell crypto through exchanges. Once you sign up for these exchanges, you can buy Bitcoin, the most well-known cryptocurrency, or any number of altcoins. You can keep your crypto in the exchange or in a crypto wallet. A crypto wallet is a physical device or digital program that allows you to securely store the public and private keys related to any crypto you own. Storing your crypto in a physical wallet can help protect your investment and avoid issues with hacking.

How cryptocurrency works

In some ways, cryptocurrency works like any currency, like the dollar. You can buy goods or services or give crypto as a gift. You can accept payments in cryptocurrency as well.

Technically, however, cryptocurrency works very differently from the dollar. There is no central agency like The Federal Reserve. Transactions occur digitally through blockchain, where decentralized software networks process transactions into blocks and then connect those blocks into chains.[2] Blockchain means that cryptocurrency transactions can be traced fully, providing a full record of where the cryptocurrency came from and how it eventually make its way into your crypto wallet.

According to noted crypto researcher Jan Lansky, Ph.D., any cryptocurrency must follow six rules to be effective and ultimately legitimate:

  1. There’s no central authority that governs it.
  2. Its ownership can be digitally certified.
  3. In most cases, new units are defined and limited
  4. Ownership can be proven cryptographically
  5. Ownership is verified before transactions occur
  6. The system only does one transaction at a time

Mining cryptocurrency

When you “mine” crypto, you use computers to solve mathematical questions to gain new crypto and update the blockchain ledger.

Mining for cryptocurrency can be a way to set up passive income. It isn’t easy to make money from mining, but it is possible.

To mine crypto, you’ll need a few fast computers as well as the right software.

Software for mining is generally free and is open-source. There are also online communities set up to help new miners.

While professional miners have complete server farms, similar to cloud computing companies, hobbyists can get by with a few older computers, good graphic cards, or even with raspberry pi computers.[3] If you are planning to get more serious, you can invest in specially built mining computers with ASICs (application-specific integrated circuits)[4]Some cryptos such as Bitcoin are much harder to mine, others such as Dogecoin are easier.

Aside from the computers, your main expense will be the cost of electricity.

If you’re thinking about getting in on cryptocurrency mining, it can be helpful to join a mining pool. In a mining pool, a group of miners uses a network of computers connected by the internet to each other to increase their power and make it easier to mine for crypto.[5]

You can look online and find mining pools for the crypto you want to mine. So, for example, if you want to mine bitcoin, you’ll search for a bitcoin mining group, or if you like doge, you’ll find one that mines doge.

Mining is very technical, and you should do detailed research before you begin investing in time and equipment.

Does mining cryptocurrency harm the environment?

Cryptocurrency by itself does not harm the environment any more than any other computer functionality. But, because it takes a large amount of energy to process mining or minting, the extra energy production can harm the environment.

Elon Musk noticed this too, and even though he initially accepted Bitcoin as payment for Tesla automobiles, he stopped because of the “rapidly increasing use of fossil fuels for bitcoin mining.”

In the past decade, there was a lot of mining in China, where electricity is very cheap but also very polluting because of the use of coal power plants. [6] However, China’s government banned cryptocurrency and crypto mining in 2021. Now mining companies are moving their operations quickly to nations with better environmental standards such as the US and Canada. This may mean a reduction in overall pollution.

The future of cryptocurrency

The future of crypto is exciting, but the days of it being unregulated are coming to a close. Here are some things you should expect:

Increased regulation

Nations worldwide have noticed and are beginning to put regulations on crypto. There are some extremes—China outright bans all crypto, while El Salvador accepts Bitcoin as legal tender.[7] But most nations fall somewhere in the middle.

Currently, in the US, the sale of crypto is only regulated if it “(i) constitutes the sale of a security under state or Federal law, or (ii) is considered money transmission under state law or conduct otherwise making the person a money services business (“MSB”) under Federal law.”[8]

Essentially, this means that currently, crypto is treated and taxed much like stocks are. In fact, the tax rates for crypto are identical to capital gains tax rates for stocks.

But we can expect more regulations to come. The Biden administration has proposed legislation that would subject those who sell stablecoins to the same or similar rules as banks now have.[9]

And federal agencies from the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) to the Securities and Exchange Commission have said they plan to look closely into crypto regulations in 2022. SEC Chair Gary Gensler said the agency would work to close regulatory gaps, saying the SEC has “taken and will continue to take our authorities as far as they go.” [10]

Adoption

The list of organizations that take cryptocurrency at the register or thru an app is diverse and growing. Large companies, including Amazon, Home Depot, Starbucks, Etsy, Microsoft, PayPal, and Wholefoods take crypto. Charities, including Four Paws International, recently received a large donation with cryptocurrency. Recently Twitter gave users the ability to send and receive bitcoin.[11]

Types of cryptocurrencies

There are currently over 8,000 cryptocurrencies and that list is constantly growing and changing. Here are some of the most popular cryptocurrencies:

  • Bitcoin – The “original” crypto, it’s the most widely accepted and the most valuable.
  • Ethereum – Ethereum allows software writers the ability to create smart contracts.
  • Litecoin – The “silver” to Bitcoin. Compared to precious metals, Bitcoin is gold, Litecoin is silver.
  • Cardano – An alternative to Ethereum, it is also environmentally friendly.
  • Polkadot – Helps multiple chains in a network that would otherwise be isolated and data wouldn’t be shared.
  • Bitcoin Cash – A faster and cheaper crypto to use than Bitcoin.
  • Stellar – Stellar is used to trade, send or even create crypto.
  • Dogecoin – One of the original “meme” coins created as a joke. Since then, it has grown in popularity and value.
  • Binance Coin – A crypto designed to be used on the Binance exchange and now used on other exchanges.
  • Teather – A stablecoin that has a one-to-one ratio to the US dollar.

Are cryptocurrencies a good investment?

Currently, cryptocurrency can be a very risky investment, and there are no guarantees. But there are also opportunities. There are rare cases of individuals who have become millionaires by investing early in the right crypto, but plenty of others have lost money.

While still very volatile, crypto is quickly becoming a mainstream investment. You now can buy ETF’s (exchange-traded funds) that are an investment already regulated by the Securities and Exchange Commission (SEC). EFTs specialize in cryptocurrency futures.

If you decide to invest in crypto, you need to be smart about it. Investing in cryptocurrency should wait until you have an emergency savings fund set up first. You should also have a handle on your debt, particularly high-interest credit card debt.

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Cryptocurrency is more of a gamble than an investment. When you invest in the stock market, you’re investing in companies that make products and offer services. Crypto is a digital currency that you hope others will want later more than you did today. That’s akin to collecting comic books or classic cars. You can definitely make a lot of money that way. But you can definitely lose it all, too.”
EXPERT: Howard Dvorkin, Howard Dvorkin, Debt.com Chairman and CPA

How to make money with cryptocurrency

As with many other investments, such as stocks, the best way to profit from cryptocurrency is to buy and HODL (hold on for dear life). Don’t expect overnight riches, and expect a lot of volatility. But understand that crypto, as a whole, is increasing in value long-term.

Here are some of the other popular strategies that people use to make money with crypto:

  • Buy low and sell high: If you can time a currency correctly, you may make a lot of money.
  • Mining: You can purchase mining computers or use a cloud miner to mine for Bitcoin or other cryptocurrencies. When you use a cloud miner, you rent space on a cloud computer to mine instead of having physical computers at your location.
  • Staking: You can “stake” certain currencies to earn interest. When you stake, you give part of your crypto to help mine. You get rewarded with interest earnings, similar to other investment products but usually with much better rates.
  • Day trading: You can take advantage of daily fluctuations in price and day trade.
  • Accept crypto as payment: Accepting crypto as payment allows you to charge small fees.
  • Exchange-Traded Fund: Several ETFs invest in cryptocurrency futures. You can invest with them in various online brokers such as E*TRADE and others.
  • Make your own crypto: You can make cryptocurrency and make money as the value rises.

The risk of cryptocurrency

Remember that there are no backups with cryptocurrency. Unlike a bank or credit card, you can’t call up the exchange to get your crypto back after a scam. So, use extra caution and never give your information to an organization or individual you aren’t sure about.

There are many scams in the crypto world. Watch out for Reddit posts or Discord groups that make claims without evidence, or pump and dump schemes where a conman gets a group to buy a shitcoin then dumps it while it’s high.

There is also potential for crypto hacking. Hackers have stolen crypto and crypto accounts. Exchanges put a large amount into security but that is not foolproof. The better option is to have a hardware crypto wallet, which looks like a USB drive. But remember your password key, otherwise, your information will be lost forever. You can also use Apple Pay with some crypto applications.

Cryptocurrency FAQ

Q:What is blockchain?

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A: A Blockchain is a database containing a digital ledger that stores information in blocks. As those blocks fill up with data, new ones form and are linked together cryptographically. The technology behind this makes it difficult to change or hack the blockchain. Blockchain is used to track the transaction history for cryptocurrency, providing a complete, transparent transaction history for each coin.

Outside of the uses of blockchain in cryptocurrency, blockchain is essential because it delivers immediate, shareable, and transparent information.

Even if you don’t own any crypto coins, you use blockchain when using companies such as Microsoft, Amazon, Walmart, PayPal, and others.

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Q:Is cryptocurrency legal?

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A: People still ask if “Is cryptocurrency legal?” And the answer is yes. Cryptocurrency is permitted in the US, Japan, the UK, Europe, and most other nations. However, just because it’s legal, that doesn’t make it legal tender. You can use crypto to pay for certain things, but not others. It’s usually up to the discretion of the person or company.

As part of the upcoming regulations, the legal use of cryptocurrency will likely be clarified, including practices and standards.

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Q:How does cryptocurrency gain value?

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A: Cryptos gain value when more people purchase them and when communities arise around the currency. Billionaires, including Elon Musk and Mark Cuban, have talked about cryptocurrencies like Dogecoin and Bitcoin. In a buildup to a Saturday Night Live appearance, Elon Musk built up hype around Dogecoin, which raised its value to a record high. Many hopeful investors were crushed after Dogecoin crashed on the very same night. However, Dogecoin is up by 216% since December of 2020. [12] and a large community of Dogecoin enthusiasts means it may continue to gain value.

A cryptocurrency can also rise in value after a “coin burning.” In coin burning, the total volume of a cryptocurrency is reduced. The resulting scarcity can lead to an increase in the price. This practice has been successful with many cryptocurrencies, including Stellar, Ripple, Tron, and Binance Coin.

Initial coin offerings are a type of funding that works similarly to crowdfunding, often for startups. Investors or speculators trade more established currencies for the ICO in hopes they will share a significant profit. Purchasing an ICO is a risk, but the crypto can go up in value.

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Sources
[1] https://www.pymnts.com/study/cryptocurrency-payments-merchants-bitcoin-purchases-crypto/#wpcf7-f1074080-o1

[2] https://www.moneycrashers.com/cryptocurrency-history-bitcoin-alternatives/

[3] https://www.tomshardware.com/how-to/mine-cryptocurrency-raspberry-pi

[4] https://www.buybitcoinworldwide.com/mining/hardware/

[5] https://www.analyticssteps.com/blogs/mining-pools-economic-way-mine-crypto

[6] https://www.cnbc.com/2021/05/06/chinas-greenhouse-gas-emissions-exceed-us-developed-world-report.html

[7] https://www.investopedia.com/ask/answers/121515/bitcoin-legal-us.asp

[8] https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/

[9] https://time.com/nextadvisor/investing/cryptocurrency/biden-admin-regulations-stablecoins/

[10] https://www.reuters.com/legal/transactional/us-crypto-framework-begins-evolve-special-report-update-2021-10-22/

[11] https://www.newsweek.com/you-can-now-tip-bitcoin-twitter-heres-how-1632157

[12] https://www.statista.com/statistics/1200235/dogecoin-price-index/

Article last modified on December 15, 2021. Published by Debt.com, LLC