What is cryptocurrency?
Cryptocurrency is a form of digital currency that can be bought and sold with fiat currency (i.e., traditional forms of money such as the USD or EUR) and is often used to transfer money or purchase goods and services. It is secured by technology called cryptography (hence the “crypto” in cryptocurrency), making it almost impossible to counterfeit. Cryptocurrency is often referred to as “crypto” and commonly associated with its most popular form, Bitcoin.
Generally, there is no central authority that controls cryptocurrency such as a bank or government organization. Instead, cryptocurrencies operate in a decentralized manner, meaning the software that maintains the cryptocurrency runs across many different computers globally rather than one central entity or organization. These computers keep a record of every transaction that takes place creating a public ledger, also known as blockchain.
Types of cryptocurrencies
There are multiple types of cryptocurrencies including crypto coins, tokens, and altcoins. Although often intermingled and used synonymously, they are in fact distinct.
- Coins: These are digital currencies built on their own blockchain that represent a unit of account, serve as a store of value, and can be transferred as digital money. Examples include Bitcoin, Litecoin, and Ethereum.
- Tokens: Tokens are essentially derivatives of coins. They are transferable assets that are built on top of existing blockchains.
- Altcoins: The word comes from “Alternative” and “Coins” combined. In short, altcoins refer to any cryptocurrency other than Bitcoin.
- Stablecoins: These are digital currencies that are directly linked to a “stable” asset such as the USD or even gold.
To put it into perspective, if crypto coins are the equivalent to physical money like the US Dollar, then tokens would be equivalent to a title to a car (whose value is based on USD), and altcoins would be all other physical currencies.
What is blockchain?
Blockchain is an open-source ledger, or list of transactions, that is visible to the public. It behaves much like an accounting ledger, tracking transactions between parties and stores a record of every time someone has sent or received cryptocurrency, then maintains balances based on those transactions. Each crypto coin has its own blockchain of publicly available transactions.
Each time a new cryptocurrency transaction occurs and is verified by the blockchain’s respective network of distributed computers, it is recorded as part of a “block” on the “chain” of transactions (hence, blockchain) for that cryptocurrency. Every block is then added to the entire sequence of blocks preceding it, creating a continuous and unchangeable ledger going back to the very first transaction. Because this ledger is typically visible to the public, anyone can verify and confirm the transactions that have taken place.
One of the key benefits of a blockchain is its ability to maintain a verifiable source of truth across a large and distributed set of users. Public blockchains also make it possible for users to transfer money directly to each other without the need of a bank or financial institution to facilitate the transaction.
Blockchain & cryptography
Cryptography is a way for people to display information using special codes or keys to protect sensitive information. This technology enables two parties to communicate privately over the internet every day, and helps your browser verify the websites you are visiting. In cryptocurrency, people use cryptographic keys to create, authorize, and validate transactions on the network. Using a key, a user can control the funds for a specific account on the blockchain.
Crypto vs stocks
Cryptocurrency is a digital currency while stocks are shares of ownership in a company. Some of the biggest differences between crypto and stocks include:
- Asset type: When you buy cryptocurrency, you are purchasing a digital currency that is listed on a distributed ledger to buy, sell and trade on a peer-to-peer network. When you buy shares of stock, you are purchasing shares of ownership in the underlying company. Both crypto and stock can increase and decrease in value over time.
- Availability: Crypto can be traded 24 hours per day, 7 days per week, 365 days per year. Stocks can only be bought and sold during the operational hours of the major market exchanges, which are 9:30 AM to 4:00 PM EST. (NOTE: Your Crypto Accounts have designated trade windows in which trades are executed.)
- Regulations: Cryptocurrency currently has no central regulatory agency while stocks are heavily regulated by the government agencies such as the US Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA).
- Volatility: Cryptocurrency is historically a much more volatile asset, meaning its price fluctuates on a much larger scale over time. Stocks are generally less volatile in comparison to crypto.
How is crypto taxed?
According to the IRS, cryptocurrency is considered a virtual currency, but it is treated as property (like stocks, bonds, and similar capital assets) rather than a real fiat currency like the US Dollar. As a result, the same tax principles that apply to property also apply to cryptocurrency.
Taxable events are either taxed as a capital gain or as income.
Capital gains taxes include events such as selling your crypto, converting one cryptocurrency to another, or using cryptocurrency to pay for goods and services. Cryptocurrencies held for less than 12 months before a transaction occurs are taxed as short-term capital gains, and cryptocurrencies held for 12 months or longer before being sold are taxed as long-term capital gains.
Events that result in cryptocurrency being taxed as income include providing goods or services in return for cryptocurrency as payment.
We recommend that you consult with a professional tax advisor for questions regarding how your crypto is taxed.
Risks associated with investing in cryptocurrency may include:
- Financial loss and volatility: Cryptocurrency prices can be more volatile than investments such as stocks. Much like investing in stocks, fluctuations in cryptocurrency prices may lead to financial loss if bought and sold at the wrong times.
- Insurance: Accounts holding cryptocurrencies are not protected by SIPC coverage. Cryptocurrencies are also not covered by the FDIC, which may cover fiat currency held in member banks. Existing insurance products are inadequate to cover potential losses if an exchange fails and/or digital wallets are hacked.
- Regulation: Currently, there is no central regulatory agency for cryptocurrency. For example, the Securities and Exchange Commission (SEC) is the regulatory agency for the stock market.
- Knowledge and education: Investors with limited knowledge of the cryptocurrency they are investing in may make mistakes due to the lack of understanding of cryptocurrency, bitcoin, and blockchain.