Cryptocurrency: Exploring the Opportunities and Risks in the Digital Economy
What Is Cryptocurrency?
A cryptocurrency is a digital or virtual currency secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Most cryptocurrencies exist on decentralized networks using 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.
KEY TAKEAWAYS
A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of governments and central authorities.
Some experts believe blockchain and related technologies will disrupt many industries, including finance and law.
The advantages of cryptocurrencies include cheaper and faster money transfers and decentralized systems that do not collapse at a single point of failure.
The disadvantages of cryptocurrencies include their price volatility, high energy consumption for mining activities, and use in criminal activities.
Understanding Cryptocurrencies
Cryptocurrencies are digital or virtual currencies underpinned by cryptographic systems. They enable secure online payments without the use of third-party intermediaries. "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.
Central to the appeal and functionality of Bitcoin and other cryptocurrencies is blockchain technology. As its name indicates, a blockchain is essentially a set of connected blocks of information on an online ledger. Each block contains a set of transactions that have been independently verified by each validator on a network.
1 Every new block generated must be verified before being confirmed, making it almost impossible to forge transaction histories. The contents of the online ledger must be agreed upon by a network of individual nodes, or computers that maintain the ledger.
2 Experts say that blockchain technology can serve multiple industries, supply chains, and processes such as online voting and crowdfunding. Financial institutions such as JPMorgan Chase & Co. (JPM) are using blockchain technology to lower transaction costs by streamlining payment processing.
Types of Cryptocurrency
Many cryptocurrencies were created to facilitate work done on the blockchain they are built on. For example, Ethereum's ether was designed to be used as payment for validating transactions and opening blocks. When the blockchain transitioned to proof-of-stake in September 2022, ether (ETH) inherited an additional duty as the blockchain's staking mechanism.
3 Ripple's XRP is designed to be used by banks to facilitate transfers between different geographies.
4 Because there are so many cryptocurrencies on the market, it's important to understand the types of cryptocurrencies. Knowing whether the coin you're looking at has a purpose can help you decide whether it is worth investing in—a cryptocurrency with a purpose is likely to be less risky than one that doesn't have a use.
Most of the time, when you hear about cryptocurrency types, you hear the coin's name. However, coin names differ from coin types. Here are some of the types you'll find with some of the names of tokens in that category:
Utility: XRP and ETH are two examples of utility tokens. They serve specific functions on their respective blockchains.
Transactional: Tokens designed to be used as a payment method. Bitcoin is the most well-known of these.
5 Governance: These tokens represent voting or other rights on a blockchain, such as Uniswap.
6 Platform: These tokens support applications built to use a blockchain, such as Solana.
7 Security tokens: Tokens representing ownership of an asset, such as a stock that has been tokenized (value transferred to the blockchain). MS Token is an example of a securitized token. If you can find one of these for sale, you can gain partial ownership of the Millenium Sapphire.
8 If you find a cryptocurrency that doesn't fall into one of these categories, you've found a new category or something that needs to be investigated to be sure it's legitimate.
Are Cryptocurrencies Legal?
Fiat currencies derive their authority from the government or monetary authorities. For example, each dollar bill is backstopped by the U. S. government.
But cryptocurrencies are not backed by any public or private entities. Therefore, it has been difficult to make a case for their legal status in different financial jurisdictions throughout the world. It doesn't help matters that cryptocurrencies have primarily functioned outside most existing financial infrastructure.
9 Although cryptocurrencies are considered a form of money, the Internal Revenue Service (IRS) treats them as financial assets or property for tax purposes. And, as with most other investments, if you reap capital gains selling or trading cryptocurrencies, the government wants a piece of the profits. How exactly the IRS taxes digital assets—either as capital gains or ordinary income—depends on how long the taxpayer held the cryptocurrency and how they used it.
10In the United States in July 2023, courts ruled that cryptocurrencies are considered securities when purchased by institutional buyers but not by retail investors purchased on exchanges.
11Enthusiasts called it a victory for crypto; however, crypto exchanges are regulated by the SEC, as are coin offerings or sales to institutional investors. So, crypto is legal in the U.S., but regulatory agencies are slowly gaining ground in the industry.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies were introduced with the intent to revolutionize financial infrastructure. As with every revolution, however, there are tradeoffs involved. At the current stage of development for cryptocurrencies, there are many differences between the theoretical ideal of a decentralized system with cryptocurrencies and its practical implementation.
Advantages
-Removes single points of failure
-Easier to transfer funds between parties
-Removes third parties
-Can be used to generate returns
-Remittances are streamlined
Disadvantages
-Transactions are pseudonymous
-Pseudonymity allows for criminal uses
-Have become highly centralized
-Expensive to participate in a network and earn
-Off-chain security issues
-Prices are very volatile
Mili Agrawal
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