What is Cryptocurrency?

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robertstevens

Robert has reported for a variety of international publications including the Associated Press, The Guardian, Vice, and Decrypt. Current areas of interest include the political economy of technology, cryptocurrencies, and privacy. Robert has a Bachelor of Science from UCL, and a Master's degree from the University of Oxford's Internet Institute.

Cryptocurrency is a little like CrossFit or veganism: it’s polarizing, and its fans can’t seem to get through a conversation without bringing it up. But considering the increasing number of people interested in crypto — including many legacy investment firms who have added it to their portfolios — it’s a topic any investor should be familiar with.

Is crypto right for you? As with any investment, that’s something you’ll have to decide for yourself. But we are here to teach you what you need to know to make that decision.

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The history of cryptocurrency

Bitcoin is the first and best-known cryptocurrency. As of May 2022, it dominates the market, with a market capitalization (the total value of all bitcoins held) of $685 billion.

Its origin story is somewhat vague: the alleged creator is Satoshi Nakamoto, an anonymous person or group of people who released a whitepaper in 2008 explaining the vision for Bitcoin. Following the whitepaper, however, Satoshi — who still holds hundreds of millions of dollars worth of Bitcoin — disappeared. Many have claimed to be him or to know him, but his identity remains a mystery.

Despite his anonymity, Satoshi’s legacy is profound. Bitcoin used to go for fractions of a penny, but in the 14 years since its inception, that price has hit a value of almost $67,600. As of May 6, 2022, it’s under $40,000, but that’s still an exponential rise for many early investors.

Cryptocurrency, defined

Cryptocurrencies are virtual currency: digital assets that can’t be stored in the wallet you keep in your purse or back pocket. They run on something called a blockchain, which is basically a worldwide network of computers, or nodes, that all hold copies of the same balance sheet. If one node tries to cheat or steal from someone, the others just show their copies of the balance sheet and the bad guy’s transactions are denied.

This network is called a decentralized ledger — decentralized because, unlike a traditional financial system, there is no one entity controlling it, and ledger because it’s a statement of accounts. With no one person or company in charge, blockchains are maintained by everyone who uses them. They can’t be tampered with — one of the benefits of there being so many copies of the balance sheet — and all transactions recorded on the ledger are available for anyone to see.

When people talk about the cryptocurrency market, they’re talking about trading cryptocurrencies like Bitcoin, Ethereum, and thousands of others. (There are more than 15,000 cryptocurrencies as of May 2022.) These coins all have their own different uses, but nearly all of them can be held for speculation and treated like any other investment in a diversified portfolio.

Cryptocurrency mining, explained

Cryptocurrency mining accomplishes two things: 1) it adds transactions to the ledger, and 2) it mints new digital money. You can shake away thoughts of soot-covered boots and pickaxes, though. Virtual currencies are mined using complex computer software, mathematics, and blockchain technology.

Billions of dollars’ worth of transactions take place on Bitcoin, Litecoin, Zcash, Ethereum, and other crypto networks each day. With Bitcoin, every 10 minutes or so, these new transactions are grouped together to create a block — a new grouping of authorized transactions recorded on the blockchain. All blocks are linked through an encoded system, so if you try to change one of the blocks in the chain, every link after it will break down.

All of the computers that make up the network are called miners. There are different types of crypto networks and different types of miners, but since Bitcoin is the largest digital currency, we’ll focus on that.

Bitcoin uses a system called proof of work. In order to validate transactions and receive a reward (more bitcoin), miners compete to solve a difficult mathematical problem. All that math takes computing power, and all that power takes energy. Which costs money — so much money that any attempts to game the network by running thousands of miners would be more costly than beneficial. The integrity of the miners is established by their willingness to pay in electricity.

When a miner solves the problem and gets to validate a block of transactions, they receive a reward of newly minted bitcoin. It’s a big business, and in 2021, bitcoin mining alone generated over $15 billion in revenue. Satoshi limited the total number of bitcoin that could ever be created to 21 million coins, and in order to not have it all mined at once, he set it up so that every few years, the bitcoin reward is halved. The current reward is 6.25 bitcoin per block. Sometime in 2024, that number will fall to 3.125.

These days, with so many people competing to mine bitcoin and earn that reward, mining computers need to be very powerful in order to make as many guesses to solve the math problem as they can. The process is so energy intensive that it’s estimated that bitcoin mining produces 0.5% of the global energy expenditure, which is equivalent to Finland’s entire annual usage. In response, some miners build there operations in areas with low electricity prices or with renewable energy sources.

The legality of crypto

Cryptocurrencies are legal in most places, but often unregulated. While many Bitcoin purists want it to stay that way, many governments do not. The United States’ Securities and Exchange Commission has repeatedly said bitcoin — and other cryptocurrencies — are not securities. What you really need to pay attention to, though, are the laws around crypto exchanges — large platforms where you can buy and sell digital currencies. That’s because the majority of cryptocurrency trading happens on exchanges, which allow you to withdraw significant amounts of crypto to fiat currency.

Because of the stringent U.S. securities laws, a lot of coins struggle to reach the American market. For instance, as of February 21, 2022, Binance, a major crypto-exchange of the world, based in Malta, lists around 406 coins, all trying to become bigger than bitcoin. Binance.US, however, Binance’s American outpost, lists just 60 coins.

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Cryptocurrency legality in Canada

Cryptocurrency isn’t classified as legal tender in Canada, due to the fact that it isn’t regulated. But it’s not illegal, and it is popular: according to a report by the Canadian Chamber of Digital Commerce, crypto is a big business in Canada. Canadians numbering 1.2 million reportedly owned some form of cryptocurrency in 2021.

In regard to income tax, Canada’s Currency Act lists cryptocurrency as a commodity under your income tax assessment. It’s subject to many of the rules of traditional barter transactions, and any gains/losses are required to be reported (and taxed) as capital gains.

The following cryptocurrency transactions may incur tax liabilities in Canada:

  • Selling crypto

  • Buying crypto

  • Gifting crypto

  • Exchanging crypto on an exchange

  • Converting cryptocurrency to CAD and other fiat currencies

If in doubt, always speak with your financial advisor. There are many fees associated with cryptocurrency, which can impact your tax burden.

Where to buy cryptocurrencies

On CoinMarketCap.com, which lists nearly all of the coins currently trading, there are 17,677 coins as of February 21, 2022. That number is so high, in part, because it’s so easy to create a coin and there aren’t many regulations. But it’s not as though most of those coins will amount to anything. Fewer than half of those coins have a trade volume of more than $1 million a day.

Here are some key facts about the cryptocurrency market in 2022 you need to know:

  • Bitcoin is the most well-known cryptocurrency; however, it isn’t the most traded. That title typically goes to a stablecoin called tether.

  • The top 10 cryptocurrencies comprise around 88% of total market share.

  • There are more than 80 million users of blockchain technology.

  • There are currently no central bank digital currency options, as cryptocurrency transactions are completely decentralized.

  • Most cryptocurrency owners store their coins in digital wallets and on crypto-exchanges, although hardware wallets — external drives that can be unplugged from the internet to provide additional security — are becoming popular as well.

As of May 6, 2022, by market capitalization, bitcoin leads the pack — by far — with a current market cap of nearly $700 billion. The next biggest is ethereum, with a market cap of about $325 billion. After that, tether, with $83 billion. Binance coin, cardano, and solana are just some of the other coins that have high market caps in 2022.

What you can do with crypto

Because cryptocurrency trades can be anonymous, they’re well-known for their use on illegal, “dark web” markets, where people can trade cryptocurrencies for things like drugs or weapons. But the blockchain industry has become far more legitimate in recent years.

Cryptocurrencies can be used at an increasing number of retail outlets. You can spend cryptocurrencies at Overstock, Microsoft, and Newegg. And WooCommerce, which handles payments for around 30% of online retailers, just added a plug-in that lets you pay with crypto. Some companies even pay salaries in crypto.

You can also trade cryptocurrencies on the market, as you would a stock. Most trading is done on exchanges or crypto platforms like Wealthsimple, where signing up for an account is about as easy as joining PayPal. Most accept transfers of cryptocurrencies, but you’ll have to use a credit card or wire transfer (make sure to ask your bank if they allow crypto buying/selling or not) if you want to buy with fiat currencies.

You can also invest in initial coin offerings (ICOs), where you buy a company’s new coin before it launches on exchanges, in the hopes it’ll become the next bitcoin. It’s kind of like a company’s IPO on a traditional stock exchange, only much riskier.

Pros and cons of crypto investing

The benefits of cryptocurrency include the relative ease of entry into the market and the fact that you can buy and sell online — and, yes, for some, the option to trade anonymously is appealing. Cryptocurrencies are incredibly volatile, and, because the market is based on speculation, it’s impossible to predict future performance.

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One big negative of crypto are the bad actors. One report, presented to the SEC in March 2022, showed that around 95% of cryptocurrency trading volume reported by exchanges was faked; exchanges commonly sold coins and bought them back themselves.

A lack of regulation can hurt investors: in one instance, the owner of what was Canada’s biggest currency exchange, QuadrigaCX, died — taking the keys to the funds with him — meaning that up to $190 million of investors’ money was stuck in exchanges. Yet regulators are starting to make progress. Exchanges like Binance and Coinbase are working with regulators, like the CFTC, the SEC, and the NYDFS, to regulate the market, and the SEC is considering cryptocurrencies seriously.

As always, only invest the amount of money into crypto that you can afford to lose. Take precautions to stay safe, learn more about crypto so you know what you’re getting into, and be familiar with cryptocurrency tools. Keep the access code to your wallet secret; hold your assets in non-custodial, cold (not-internet-connected) wallets if you can; and invest only in exchanges backed by regulators.

Frequently Asked Questions

Crypto is a virtual currency that only exists electronically and runs on blockchain. One purported benefit is that, unlike paper money, crypto can’t be counterfeited. Unlike fiat currency, when you buy crypto, you buy a virtual asset that is based on an algorithm. These digital assets are represented as tokens. These tokens show a specific crypto amount you own based on the ongoing market value. You can buy goods or transfer value globally using cryptocurrencies without the need for a middleman like a bank. Digital currencies like bitcoin and ether are decentralized, meaning they are not controlled by any central authority.

As of February 21, 2022, there are 17,677 digital currencies listed on CoinMarketCap. By market capitalization, the top 10 cryptocurrencies are bitcoin (BTC), ether (ETH), tether (USDT), binance coin (BNB), USD coin (USDC), ripple (XRP), cardano (ADA), solana (SOL), terra (LUNA), and avalanche (AVAX).

That’s a question only you can answer. No one can predict what any cryptocurrency will do — although many will try. Many people consider coins with larger market cap to be better investments, but their price and performance is no more assured than any other coin. One thing larger coins have going for them is that they are more established and less likely to disappear (along with your money).

Cryptocurrencies can be divided into various categories like store of value tokens (bitcoin), DeFi tokens, yield farming tokens, and much more. Be careful, there are many new crypto tokens that are scams and only exist to steal investors’ money. This is why most crypto investors prefer to invest in the top 10 cryptocurrencies, especially bitcoin and ether, because of their large market cap and popularity.

As of February 21, 2022, with a market capitalization of $713.3 billion, bitcoin is the largest digital asset right now. It’s popular among crypto enthusiasts, as well as large institutions that are looking to add new blockchain-based virtual assets to their portfolio. Many famous entrepreneurs and business owners have invested heavily in bitcoin because they believe in its technology and expect it to grow even more down the road. Ether is the second most invested cryptocurrency after bitcoin.

As of February 21, 2022, there are several cryptocurrencies that are backed by gold, including tether gold (XAUT), paxos gold (PAXG), digix gold (DGX), and perth mint gold token (PMGT).

Last Updated June 2, 2022

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