Bitcoin was the first cryptocurrency to gain mainstream popularity during the global financial crisis of 2007-09, but by January 2021 there were more than 4,000 different crypto coins on the market. By April 2022, the market capitalization of cryptocurrencies sat around $2.1 trillion.

With the popularity rising and with celebrities like Elon Musk and Gwyneth Paltrow endorsing crypto, it is important for potential investors to fully understand how this new asset class works.  

What is Cryptocurrency? 

Cryptocurrency, often referred to as just “crypto,” is a decentralized, digital currency that is based on cryptography – hence, the name. These digital assets are able to circulate without the need for a bank. 

How do Cryptocurrencies Work? 

Cryptocurrencies have blown up in popularity in recent years and in 2022 there are thousands of different coins. Many are built to provide a new feature or function on a given blockchain platform. Crypto is secured by a peer-to-peer network that does not rely on a centralized monetary authority. 

What is Blockchain Technology? 

Most cryptocurrency is supported by blockchain technology, a form of cryptography. Blockchain maintains a secure record of transactions and ownership. The development of blockchain was instrumental to the creation of cryptocurrency as previous digital assets had no mechanism to prevent users from making copies of holdings. The transparency and permanence aid in ensuring the cryptocurrency isn’t duplicated, spent twice, or otherwise manipulated. 

Different cryptocurrencies may have their own unique blockchain. For example, Bitcoin, Binance, and Ethereum all have different blockchains. 

An individual unit of crypto is often referred to as coins or tokens. Cryptocurrencies can have different goals or intentions for use. Some coins are intended to be units of exchange for goods and services while others are intended to be stores of value. Some crypto is even used to participate in online games or purchase online financial products. 

What is Cryptocurrency Mining?

A common way crypto is created is through a process called crypto mining. Mining is an energy-intensive process where computers perform complex calculations to authenticate transactions on a blockchain network. 

Other cryptocurrencies use a variety of other methods to create and distribute tokens – often having a significantly lesser environmental impact. 

What are Crypto Exchanges? 

While there is an emerging market for crypto-based securities such as Bitcoin ETFs, the most common way to trade crypto is on a crypto-specific exchange. Most traditional exchanges do not support the buying and selling of crypto coins on their platforms. Crypto exchanges can be centralized, decentralized, or a hybrid of the two. 

Centralized Cryptocurrency Exchanges 

A centralized cryptocurrency exchange is a platform for buying and selling crypto assets with the help of a third party to conduct transactions. Centralized exchanges most often use a traditional currency (i.e. USD) to execute trades. These companies, like Crypto.com, Coinbase, and Gemini, streamline the process of investing in crypto. 

Centralized exchanges are generally considered the safest and easier option for investors interested in crypto. This is because the company holds the crypto for investors and can theoretically help with any data issues. Many centralized exchanges also offer insurance or guarantees for investors. 

Decentralized Cryptocurrency Exchanges 

A decentralized exchange cuts out the middleman used in centralized exchanges and allows investors to trade directly with each other. Investors looking to trade on a decentralized exchange can create a crypto wallet that they control, then connect the wallet to an exchange. 

Using decentralized exchanges means that the investor is the only one with access to the crypto assets. However, there are fewer protections in place and more room for personal error such as forgetting a password. Popular decentralized exchanges include Curve, Sushiswap, and Uniswap. 

Hybrid Cryptocurrency Exchanges

Hybrid exchanges are less common than decentralized and centralized exchanges, but can still be found. These exchanges aim to combine features of both such as the liquidity of a centralized exchange and the anonymity of a decentralized exchange. 

What are the Risks of Investing in Cryptocurrency? 

Investing always involves taking a risk, and sometimes a big risk can lead to a big return. But it could also mean losing most (or all) of your money. Cryptocurrency is a relatively risky investment, regardless of type. 

Higher Volatility

Volatility refers to sudden shifts in market sentiment that can result in significant and rapid price movements. This is also referred to as price change risk. 

Every asset has some volatility risk, but the intensity and spread of drastic market movements in the crypto space are much higher. For example, the cost for a single Bitcoin was as low as $26,826 and as high as $68,991 from February 2021 to February 2022.

Lower Regulatory Oversight

Cryptocurrencies have had a rocky legal ride in the past two years over the question of if to regulate, and how to regulate crypto assets. As of writing, cryptocurrencies are unregulated by both governments and central banks. 

Cyber Risk 

There are also additional risks when investing in cryptocurrencies—such as the many cryptocurrency-related scams. These can be especially dangerous when you’re not familiar with the cryptocurrency world and feel pressure to act quickly because you’re worried about missing out on the next big opportunity. Additionally, people have been able to develop hacks to steal peoples’ crypto.

This material is provided for informational and educational purposes only. It is not intended to be investment advice and should not form the basis of an investment decision.