Cryptocurrencies: What Are They?

Bitcoin first came onto the scene in 2009—and ever since then, interest in cryptocurrency has soared. But what is cryptocurrency exactly? Ahead, we'll explore that and more, including:

• How does cryptocurrency work?
• The first cryptocurrency: Bitcoin
• Popular types of cryptocurrency
• Cryptocurrency terminology

Cryptocurrency, or crypto, is a form of digital currency that can be used for internet-based electronic payments or as a store of value. The idea of "digital cash" isn't new—credit cards, PayPal, Venmo, and other payment methods permitting easy, traceable electronic transactions came before. But there are important differences. 

A big one is that transactions using these earlier methods were settled using traditional "fiat" currencies. Fiat currencies—such as the U.S. dollar and euro—are those issued by governments and whose supply is managed by central banks. 

In contrast, cryptocurrencies are considered a "non-fiat" medium of exchange because they function independently of any government or central bank, using unique algorithms to record transactions and determine supply. 

Cryptocurrencies have no intrinsic value, unlike a fiat currency (whose value stems from the fact that it is legal tender authorized by a government) or earlier commodity-based currencies (such as those tied to gold or silver). 

Instead, a crypto currency's price is based on the quality of the underlying technology, as well as supply and demand dynamics determined in part by technology that limits the creation of additional units and investor sentiment. Like with any traded item—think baseball cards—scarcity can influence value: The fewer units available, the higher the price potential buyers are willing to pay.

"Crypto" refers to the cryptography—i.e., the unique software code underpinning a virtual currency.

Cryptocurrencies are rooted in blockchain technology. A blockchain is an open-source database—essentially a public ledger—that is distributed across a decentralized computer network (in this case, the internet) and forms a permanent record of transactions between parties. Each transaction represents a "block" of data about who owns what at a given time, and together these blocks form a "chain" that can't be altered or counterfeited. 

Having a public ledger obviates the need for a central authority to confirm the database's accuracy or to clear transactions, as each new transaction is recorded across the entire network. 

So, you could think of a cryptocurrency transaction as a series of electronic messages that record information about the parties involved, the timing, and the quantity of currency being traded. Note that ownership of bitcoin or other cryptocurrencies is not an investment in blockchain, the technology, or its current or future uses.

While cryptocurrencies are perhaps the most famous application of this technology, blockchains have many potential uses beyond payments. They include "smart" contracts, which are executed automatically once the agreed terms and conditions are fulfilled. They can also be used to manage supply chains and provide financial services.

Bitcoin is the first and the most well-known cryptocurrency. Its creation is credited to a founder who goes by the pseudonym Satoshi Nakamoto. Though it traces its roots to an individual, no person or agency currently regulates or manages bitcoin. As outlined above, bitcoin is instead governed by its cryptography and a decentralized network of computers that record and verify the blockchain transactions. 

Bitcoin isn't considered legal tender in most countries. Like physical gold, bitcoin's value stems from supply and demand dynamics, and the perception that it can be a store of value, an anonymous means of payment, or a hedge against inflation—though none of these characteristics have yet to establish a long-term track record.

To buy and sell cryptocurrencies, you'll need to visit a cryptocurrency exchange, where you can swap dollars (or other currencies) for crypto. Then you'll need to have a specialized "digital wallet" to store your crypto units. 

You can also buy investment products linked to crypto. On that score, early 2024 marked a milestone for bitcoin specifically. On January 10, 2024, the Securities and Exchange Commission (SEC) approved trading in ETFs that hold spot bitcoin. (The spot market, also known as the cash market, refers to forums where securities and other assets can be immediately exchanged between buyers and sellers.) That marked the first time a cryptocurrency had been authorized for use as an underlying asset in such a widely held, actively traded investment product. 

To be clear: An investor who buys one of the new spot bitcoin ETFs isn't purchasing bitcoin. The new ETFs are securities designed to track the price of the underlying cryptocurrency.

The IRS treats cryptocurrencies as property, not as a currency, meaning any transactions that use crypto will be subject to the capital gains tax rules. Most people don't think of shopping as a taxable event, but it can be if you use virtual currencies. When you buy something with cryptocurrency, you're effectively selling a portion of your crypto holdings and using the proceeds to cover the cost of the purchase.

Whether the transaction results in a gain or a loss is calculated by taking the difference between the fair market value of the goods or services you purchased and your adjusted cost basis for the crypto used in the transaction—generally the amount you paid for your cryptocurrency, plus any fees.

If you make money on a cryptocurrency transaction and don't report the capital gains or income, you could be in hot water.

As you might expect with a highly speculative investment, cryptocurrencies carry notable risks, including:

• Volatility: Cryptocurrency prices historically have been highly volatile, and fluctuations could result in significant financial losses.
• Fraud and scams: According to the Federal Trade Commission, "Many people have reported being lured to websites that look like opportunities for investing in or mining cryptocurrencies, but are bogus."  
• Lack of recoverability: You need login credentials to access a cryptocurrency exchange, but these can be stolen or lost. With conventional financial accounts, there's normally a recovery process if you forget or misplace your login credentials. If you lose your cryptocurrency "key," however, you cannot retrieve your cryptocurrency. Similarly, if you lose access to the place where you store your key, you will effectively lose possession of your cryptocurrency.

While Bitcoin is the best known and most widely held cryptocurrency, there are thousands of types of cryptocurrencies. Here are the most popular cryptocurrencies (based on market cap) that are available today:

• Bitcoin (BTC)
• Ethereum (ETH)
• Tether (USDT)
• XRP (Ripple)
• BNB (Binance Coin)
• Solana (SOL)
• Dogecoin (DOGE)
• USD Coin (USDC)
• Cardano (ADA)
• TRON (TRX)

Many of the less famous cryptos are worth fractions of a penny and traded little, if at all. Bitcoin and a handful of others, dominate daily trading volume and market value, with bitcoin's market capitalization accounting for more than 50% of overall market cap.