Cryptocurrency is a form of digital currency designed to serve as a medium of exchange. Over the past decade, cryptocurrency has gained popularity, with Bitcoin emerging as the most widely followed alternative currency. Typically, cryptocurrency exists only in digital form and does not have a physical counterpart — the graphic shown at the top of the page is simply an artist’s representation of digital currency.
One of the key appeals of cryptocurrency is its decentralized nature, allowing it to be managed without the involvement of a central bank. This eliminates concerns related to secrecy and manipulation by central authorities. Cryptocurrency also holds appeal due to its potential to retain value and resist inflation caused by excessive money printing by central banks. The blockchain ledger system, which manages the currency, makes counterfeiting extremely difficult.
Cryptocurrencies have gained traction in the investment realm, with some coins experiencing significant appreciation since their inception. However, cryptocurrencies also faced substantial declines when the Federal Reserve increased interest rates, impacting speculative investments. Despite this, popular coins like Bitcoin and Ethereum rebounded from their previous lows in 2023 and 2024.
This article delves into what cryptocurrency is, how it operates, and the notable risks associated with it.
Understanding the Functionality of Cryptocurrency
Cryptocurrencies are generated, tracked, and managed through distributed ledgers such as blockchain. In a decentralized network, computers process the movement of the currency to uphold the integrity of financial data and ownership of the cryptocurrency. This system essentially functions as an endless receipt of all transactions within the network, continually verified by all participants.
The decentralized nature of many cryptocurrencies, like Bitcoin, eliminates the need for a central authority. This aspect is a major draw for enthusiasts as it keeps governmental and central bank interference at bay. Some cryptocurrencies impose limits on the total number of units of currency, such as Bitcoin’s cap at 21 million bitcoins.
Cryptocurrency comes into existence through a process known as mining, where powerful computers (miners) perform calculations and transaction processing on the ledger. Miners are rewarded with units of the currency for their efforts, but the process demands significant computational power and energy consumption.
Currency owners store their holdings in cryptocurrency wallets, which are digital apps enabling them to transact the currency. To execute a transaction, users require a “key” to update the public ledger with the money transfer. While the key may be linked to a specific individual, their identity is not immediately tied to the transaction, offering a level of anonymity.
The limitless potential for creating cryptocurrencies has led to the emergence of thousands of currencies in recent years, especially following Bitcoin’s surge in popularity in 2017. Some of the prominent cryptocurrencies include Bitcoin, Dogecoin, Ethereum, Tether, and XRP.
List of the Top 10 Cryptocurrencies
The size of a cryptocurrency is determined by the number of coins in circulation and their price. Multiplying these values provides the currency’s market capitalization, representing the total value of all coins. Therefore, when experts reference the largest cryptocurrencies, they are referring to this market capitalization figure rather than the individual coin price.
As of mid-July 2024, here are the top cryptocurrencies and their approximate market caps according to CoinMarketCap:
- Bitcoin – $1.3 trillion
- Ethereum – $419 billion
- Tether – $113 billion
- BNB – $85 billion
- Solana – $75 billion
- USD Coin – $34 billion
- XRP – $33 billion
- Toncoin – $19 billion
- Dogecoin – $18 billion
- Cardano – $16 billion
Given the volatility in the cryptocurrency market, these values can fluctuate significantly within a short period.
Applications of Cryptocurrency
Cryptocurrency serves various purposes depending on its intended use. While commonly associated with payment systems, it is more apt to view cryptocurrency as a token facilitating specific actions, akin to tokens in a video arcade. Each cryptocurrency was developed for distinct purposes, shaping its utility.
For instance, Bitcoin’s primary function is enabling money transfers, positioning it as a currency. However, despite its capabilities, few merchants accept Bitcoin as a standard currency due to its relatively slow transaction processing compared to conventional payment networks (further elaborated below).
On the other hand, Ethereum permits users to create “smart contracts,” self-executing agreements once specified conditions are met. Internet Computer, another cryptocurrency, empowers users to develop apps, websites, and web-based services. These digital currencies stand in contrast to Dogecoin, created humorously to parody Bitcoin’s hype.
While cryptocurrencies may offer practical applications (or not), speculation remains one of their primary uses. Speculators drive price fluctuations, aiming to profit from trading activities. Consequently, many buyers engage in cryptocurrency solely for the purpose of speculative trading, rather than utilizing it for its intended functions.
Converting Cryptocurrency to Cash
Converting cryptocurrencies into traditional currencies like dollars or euros is relatively straightforward. Owners can trade cryptocurrency directly through exchanges for fiat currency or other digital currencies, albeit incurring substantial transaction fees.
Alternatively, individuals may hold cryptocurrency via payment apps like PayPal or CashApp, allowing seamless conversion to dollars. Some users may even access dollars through Bitcoin ATMs for immediate cash needs.
Those holding crypto via Bitcoin futures can sell their positions on open markets during trading hours, though selecting reputable brokers is essential for regular trading activities.
However, immediate access to funds often entails accepting prevailing market prices, which may deviate significantly from the initial purchase price. Cryptocurrency’s volatility surpasses that of other high-risk assets, coupled with substantial fees for transactions and tax implications further complicating the process.
Key Risks Associated with Cryptocurrency
While proponents champion digital currencies like Bitcoin, these currencies pose significant risks in their current form. While profitable trading opportunities exist, certain drawbacks render Bitcoin and other cryptocurrencies ineffective as a standard currency or medium of exchange.
Renowned investors like Warren Buffett have criticized Bitcoin, with Buffett labeling it “rat poison squared” and his business partner Charlie Munger denouncing cryptocurrency trading as “dementia.” Buffett’s skepticism stems from Bitcoin’s lack of intrinsic value, contrasting it with assets like stocks and real estate that generate tangible returns.
Some of the primary risks associated with cryptocurrency include:
Costly and Polluting Mining Process
Cryptocurrency mining, involving extensive computational efforts, consumes substantial energy and generates pollution. The energy-intensive nature of mining operations has raised concerns about environmental sustainability, with Bitcoin’s energy consumption ranking among the highest globally.
As of July 2024, Bitcoin’s electricity usage would place it 27th in global electricity consumption and 68th in greenhouse gas emissions, according to the Cambridge Bitcoin Electricity Index. Critics argue that cryptocurrency’s energy consumption is unjustifiable amid the climate crisis.
Fixed Supply of Some Cryptocurrencies
Advocates of Bitcoin emphasize its finite supply as a positive attribute safeguarding against devaluation by central authorities. However, restricting the total currency supply can lead to deflationary risks akin to a gold standard, potentially triggering economic downturns during periods of instability.
Under a fixed supply model, economies may encounter deflationary spirals when money circulation diminishes due to hoarding by consumers and businesses. This hoarding behavior impedes economic transactions, potentially culminating in severe economic crises. Modern economies have transitioned away from the gold standard to fiat currencies, enabling central banks to stimulate economic activity during downturns by injecting money into the economy.
Unstable and Volatile Currency
The limited coin supply, speculative fervor, and narrative appeal contribute to the volatile price fluctuations of Bitcoin and other cryptocurrencies. While volatility may attract traders seeking profit opportunities, it undermines the currencies’ utility as a stable medium of exchange.
Stability is a crucial attribute for currencies, ensuring consumers can rely on their purchasing power. A volatile currency, akin to Bitcoin, impedes consistent trade and undermines trust in its value, rendering it unsuitable for widespread adoption as a standard currency.
Rising Regulatory Scrutiny
Cryptocurrency remains subject to government regulations, which can either bolster or impede the prospects of digital currencies based on the regulatory framework. Stringent regulations may diminish the viability of cryptocurrencies through bans or restrictions, hampering their utility within specific jurisdictions.
For instance, China has prohibited financial institutions from supporting cryptocurrencies like Bitcoin and imposed a halt on mining activities. Other countries like Tunisia have enforced crypto bans, while Bolivia recently lifted a decade-long ban in June.
In the U.S., the Biden administration has upheld existing SEC regulations, making it challenging for regulated financial institutions to offer crypto-related products. Regulators aim to enhance consumer protection and ensure compliance with tax laws, signaling a concerted effort to regulate the cryptocurrency sector.
While regulations may stifle cryptocurrency innovation, they can also foster a more secure and transparent market environment, instilling trust among participants and offering legal recourse in case of malfeasance.
Additional Limitations
Cryptocurrencies present various drawbacks, including inadequate security measures in digital wallets, their association with criminal activities, and slower transaction processing compared to traditional networks like Visa and Mastercard. Moreover, the IRS classifying Bitcoin as an asset rather than a currency subjects every transaction to potential capital gains taxation, necessitating comprehensive reporting on tax returns.
Conclusion
Cryptocurrency harbors potential benefits alongside significant drawbacks, rendering it impractical as a standard currency at present. Investors are advised to adopt a cautious approach towards cryptocurrency investments due to their volatility and inherent risks. Those interested in exploring cryptocurrency should exercise prudence, maintaining small position sizes and investing only what they can afford to lose.
— Note: This article was updated with contributions from Bankrate’s Brian Baker.