After years of being an object of fascination for techies and self-styled revolutionaries and libertarians, cryptocurrencies have broken into the mainstream in recent months. That change is thanks largely to the phenomenal growth of Bitcoin, which soared 2,000% in the 12 months before it reached its nearly $20,000 high in mid-December 2017. Seemingly overnight, people who had bought Bitcoins when they were worth just a few dollars had become multi-millionaires.
However, since then predictions about what’s next for cryptocurrencies have been all over the map, with one analyst predicting Bitcoin will lose 90% of its value in 2018 while another predicts Bitcoin could soar to an eye-popping $125,000 by 2022. To help make sense of where all these disparate predictions are coming from, it’s useful to step back and take a big-picture look at what cryptocurrencies actually are and how they work.
What is Cryptocurrency?
A cryptocurrency is a type of currency, like the U.S. dollar or euro, but one that can only be used online and only exists in the digital world. What makes cryptocurrencies different from regular currencies is that cryptocurrencies are neither printed nor backed by any government. Rather, cryptocurrencies are decentralized and every cryptocurrency works on what is called a blockchain.
A blockchain is an extremely important feature of cryptocurrencies–with some even seeing blockchain technology as being more revolutionary than cryptocurrencies themselves. A blockchain is a constantly growing public ledger and any transaction made in a particular cryptocurrency gets added to the blockchain. Why is that so revolutionary? Because once added, the transaction is time stamped and cannot be altered without altering the entire blockchain (something that would inevitably be noticed since the blockchain is public). As a result, cryptocurrencies are, by design, incredibly resistant to manipulation or tampering.
Bitcoin and All the Rest
Bitcoin was the first cryptocurrency and it remains the most well-known. Conceived by the mysterious Satoshi Nakamoto (who may or may not be a real person), his white paper “Bitcoin: A Peer-to-Peer Electronic Cash System” laid out his vision for a peer-to-peer cash system and blockchain technology. Since then, Bitcoin has grown to become the most popular cryptocurrency, although others have also sprouted in its wake.
Ethereum is another popular cryptocurrency that addresses many of Bitcoin’s perceived weaknesses. For example, Ethereum enjoys much faster transaction times and lower transaction fees than Bitcoin does.
Litecoin, meanwhile, is another popular cryptocurrency that was derived from Bitcoin and resembles Bitcoin in many ways. It does have some additional security features, however, and also enjoys faster transaction times.
What Can You Purchase with a Cryptocurrency?
A number of large retailers have announced in recent years that they will begin accepting Bitcoins and other cryptocurrencies and a few Bitcoin ATMs have even popped up in major cities allowing people to convert Bitcoins into hard cash. However, cryptocurrencies still have a few major hurdles to overcome before they will be used as a widespread form of currency. As mentioned above, transaction times and fees, especially for Bitcoin, are long and high.
Even more importantly, the stratospheric rise in the value of cryptocurrencies in recent months, while making some people very rich, makes their use as an actual currency difficult. After all, if you don’t know how much your cryptocurrency is worth from one hour to the next, then it is hard for retailers to price their goods and services or for consumers to know how much they are actually spending when they make a purchase. Imagine trying to buy a pizza with a currency that is so volatile that it can lose half of its value literally overnight. That extreme volatility makes cryptocurrencies an unattractive choice for most casual consumers.
That being said, there are some big retailers and companies currently accepting Bitcoin and a few other cryptocurrencies, including Overstock.com, Microsoft, Expedia, Dish, and Shopify. Many other retailers are taking a “wait and see” approach to cryptocurrencies before accepting them as a form of payment.
Using Cryptocurrency as a Currency vs. Using as a Stock
Cryptocurrency’s thus far limited use as an actual currency has called into question its long-term viability. However, the extreme growth that Bitcoin and other digital currencies have witnessed in the past year have increased interest in cryptocurrencies as an investment tool. Indeed, if you were one of the lucky ones to buy some Bitcoin early on when they could be had with just a few dollars each you would today be enjoying a very comfortable retirement.
However, it is important not to get carried away by all the hype surrounding cryptocurrencies, especially since greed can make people do irrational things. The fact of the matter is that nobody knows what the future holds for cryptocurrencies. They are so new that any prediction, whether it is for their continued growth or their sudden demise, is based on very little evidence, since nothing like them has been seen before.
Governments, from China to the U.S., could decide to crack down on cryptocurrencies, cryptocurrency exchanges could be subject to a cyberattack (which could result in you losing your entire investment), or investors could simply start selling off their cryptocurrencies en masse, leading to a sudden price drop. Remember, cryptocurrencies are still very much the Wild West of investing and any money you put into a cryptocurrency should be money that you can afford to lose.
Now hopefully you understand what is cryptocurrency.