Cryptocurrency: What It Is, Pros & Cons

Updated: May 16, 2022Written By: Kent ThuneReviewed By: Jason Kirsch, CFP

Almost every investor has heard of cryptocurrency, or may know a little about it. This article will discuss what it is and how it impacts investors.

Bitcoin cryptocurrency stock market exchange chart. Bank market and virtual crypto currency value 3D graph
Violka08/iStock via Getty Images

What Is Cryptocurrency?

Cryptocurrency, also known as "crypto", is a digital currency designed to act as a medium of exchange and a store of value but, because it's new, it's more commonly held as a speculative investment asset.

Cryptocurrency uses blockchain technology to record transactions in a ledger system. The most important aspect of this technology is that it can be viewed publicly but it can't be changed or controlled by any single entity, making cryptocurrency secure for online transactions and nearly impossible to counterfeit.

What Does Blockchain Mean?

A blockchain can be described as a digital ledger of transactions, which uses cryptography, a network of computers, and electricity to build blocks of data. This system of recording makes it difficult or impossible to change or manipulate the data.

How Many Cryptocurrencies Are There?

There are thousands of cryptocurrencies that are publicly traded today, as others continue to come on the market. Many of these cryptos are not well known and don't have much trading volume.

Examples of popular, more widely traded cryptocurrencies include:

Cryptocurrency is legal in the U.S., as well as most developed market countries, such as the U.K., Germany, and Japan. Some countries have either banned it or restricted its use. For example, China has heavily restricted Bitcoin use but has not made it illegal to hold bitcoins.

How Does a Cryptocurrency Gain Value?

As of Spring 2022, the value of all cryptocurrencies exceeds $3 trillion. Like other currencies, the value of cryptocurrency is primarily driven by the supply of the currency and its demand in the market. However, unlike traditional currencies, cryptocurrency is not issued by a central bank or backed by a government. For this reason, monetary policy, inflation, and economic growth do not influence the value of cryptocurrency.

Forces that may influence the value of a given cryptocurrency include:

  • Supply and demand of the currency in the market
  • The cost of production (mining process)
  • The supply and demand of competing cryptocurrencies
  • The exchanges it trades on
  • Any governing regulations or restrictions upon it

Pros & Cons of Investing in Cryptocurrency

There's no shortage of financial media coverage on the rapid growth and popularity of cryptocurrency. But like other types of financial assets, there are some significant risks and disadvantages that come along with the growth potential and benefits.

Pros of Cryptocurrency

  • Anonymity: Cryptocurrency transactions are completely anonymous, which is a benefit for users wanting privacy.
  • Transparency: Although transactions are anonymous, the data is recorded on an open ledger using blockchain technology. This means that data is transparent and publicly available at any time.
  • Decentralization: Since cryptocurrency is not issued by a central bank or backed by a federal government, there is no interference from government or influence from monetary policy.
  • Potential for quick gain: The popular cryptocurrency, Bitcoin, has had many short periods of significant gains, such as the first four months of 2021, where it more than doubled in price before falling again. Some of the top daily gains in crypto have surpassed 200% (coinmarketcap.com).

Cons of Cryptocurrency

  • Price volatility: While quick gains are a big attraction to crypto for many interested investors, there is also potential for fast and extreme declines in value. An example is Bitcoin's 50% price drop in just two months from April to June 2021. Thus far in 2022, Bitcoin is down over 30% from its high in January (CNBC).
  • Excessive cost to produce: Many cryptocurrency types require vast sums of electricity and other resources to mine. For example, according to Harvard Business Review, the energy required to mine Bitcoin represents the majority of costs associated with it.
  • Regulatory restrictions: While cryptocurrencies are generally legal in many developed countries, the currency is not formally regulated by central governments. The risk of investing in cryptocurrency will be elevated until federal governments adopt and regulate it in the same way as fiat currencies, such as the U.S. dollar.
  • Risk of losing coins: Many cryptocurrencies like Bitcoin require a private key to access the currency tokens that are stored in a digital "wallet." If you lose your key, or if your computer hardware fails, you lose your tokens, which are not recoverable in any other way.

Where To Buy & Trade Cryptocurrency

Although there are thousands of cryptocurrencies in existence today, there are only a handful of trading platforms that offer the option to buy or trade Bitcoin and other popular cryptos. Crypto trading platform examples include Robinhood and Sofi Active Investing. Another option is Coinbase (COIN), which is a popular exchange where users can buy, sell, transfer, and store digital currency.

Here are the basic steps to buy and trade cryptocurrency:

  1. Choose a trading platform or exchange.
  2. Create an exchange "wallet" to store your cryptocurrency.
  3. Add a payment method, such as a debit card, to fund your account.
  4. Buy your chosen cryptocurrency.

Is Cryptocurrency a Good Investment?

Individuals interested in cryptocurrency should be aware of its unique risks before buying. Determining whether or not cryptocurrency is a good investment will depend on its suitability for a given investor's investment goals and risk tolerance. For example, cryptocurrency does have potential for outsized gain but there's also the risk for significant decline or permanent loss in the principal amount invested.

FAQs

  • Cryptocurrency taxation will vary depending upon the country where you reside. For example, in the US, cryptocurrency is taxed in the same way as other assets that are considered to be property, such as real estate or stocks. This means that you'll owe capital gains tax for profits that you realize.

    The amount of capital gains taxes owe on the sale of cryptocurrency will depend upon the gains you realize, your federal income tax bracket, and the holding period of the asset. Check out our guide on crypto taxes to find the latest short- and long-term capital gains tax rates. 

  • Whether or not cryptocurrency is safe depends upon how you plan to use it. In terms of security and anonymity for use in digital transactions, cryptocurrency is considered to be relatively safe. But from an investment perspective, cryptocurrency is considered to be high in risk because of its speculative and volatile nature.

    Cryptocurrency exchanges offer secure storage of your coins through an exchange wallet, which provides access with a private key. While the storage of cryptocurrency is secure, your private key is still susceptible to hacking, if not secured safely. Also keep in mind that cryptocurrency is not FDIC-insured like bank savings accounts.

This article was written by

Kent Thune profile picture
555 Followers
Kent Thune, CFP®, is a fiduciary investment advisor specializing in tactical asset allocation and portfolio management with a focus on ETFs and sector investing. Mr. Thune has 25 years of wealth management experience and has navigated clients through four bear markets and some of the most challenging economic environments in history. As a writer, Kent's articles have been seen on multiple investing and finance websites, including Seeking Alpha, Kiplinger, MarketWatch, The Motley Fool, Yahoo Finance, and The Balance. Mr. Thune's registered investment advisory firm is headquartered in Hilton Head Island, SC where he serves clients all around the United States. When not writing or advising clients, Kent spends time with his wife and two sons, plays guitar, or works on his philosophy book that he plans to publish later in 2022.
Follow

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Recommended For You

Comments (2)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.