After growing in popularity in the trading community, cryptocurrency is securing its place in the financial world with a reputation for high risks and high rewards. If you’re thinking about investing in it, here’s what you need to know about what cryptocurrency is, how it works and how you might get started.
What is cryptocurrency?
Cryptocurrency is more than just digital cash. It’s an entirely different form of currency, designed to be an all-digital alternative to our traditional system. While the U.S. government issues and validates the U.S. dollar, crypto relies on a decentralized, peer-to-peer network based on blockchain technology (more on that in a minute) for its storage and validation. Cryptocurrency can be used as a cash alternative to make purchases, depending on the retailer, or you can invest in cryptocurrency either directly, like you would stocks, or indirectly, such as through a fund.
Take quiz: Which mix of investment accounts is right for you?
What is blockchain?
You can think of blockchain as a digital ledger. When you buy or sell crypto, that transaction is stored as an entry (called a “block”) into the ledger. Every block connects to the last one, creating a never-ending chain that records every transaction. A record on the blockchain is uneditable, which makes it easier to track any transaction: It will always be listed as part of the ledger (i.e. the blockchain).
Blockchain technology is decentralized, meaning no single organization controls it all. Instead, it’s stretched across a network, which keeps any single entity from holding all the power. And blockchain’s use can go beyond cryptocurrency. It’s designed as a way to store data without the need for third parties, like governments or banks.
Cryptocurrencies are unregulated. As a result, they can be extremely volatile.
How does cryptocurrency mining work?
While you may have heard of mining as a method to create new cryptocurrency coins, it’s also one of the ways the blockchain can secure transactions. Mining involves solving extremely complex mathematical problems to validate transactions and add them to the blockchain. Cryptominers automate this process using computers, which can require significant energy. Bitcoin, the first cryptocurrency, is mined, but many newer currencies use other, less energy-intensive methods.
While it can be helpful to understand how mining works, you don’t need to do any mining yourself, if what you’re primarily interested in is the investing or currency side of cryptocurrency.
Popular cryptocurrencies
Just as the U.S. dollar, Euro and yen are forms of physical currency, cryptocurrency has many different varieties. You’ve probably heard of some of these:
Bitcoin
This trendsetter is regarded as the first crypto coin, helping the tech skyrocket onto the scene in the 2010s. Now, Bitcoin is the largest cryptocurrency by market capitalization (total market value).
Ethereum
“Ethereum” can refer to both a blockchain platform and a popular crypto token. The coin, also known as Ether, is second only to Bitcoin by market value. You’ll often hear about Ethereum in connection to NFTs, since many NFTs are secured on the Ethereum network.
Stablecoins (Tether, USDC)
Tether and USDC are both examples of stablecoins. Because of the unpredictable nature of cryptocurrencies, stablecoins were introduced to offer price stability by fixing their value to an external reference, like the U.S. dollar or gold.
Other popular coins
Some other tokens you’ll likely come across include XRP, which, unlike most other coins, is managed by a single company, or BNB, a token tied to the Binance exchange. Meme coins like DOGE and SHIB (short for Shiba Inu) also attract attention.
How do you use cryptocurrency?
A growing number of retailers now accept crypto as a form of payment — most commonly Bitcoin. In order to make a purchase using cryptocurrency, you need a crypto wallet. Some third-party providers also allow you to spend cryptocurrency at places that don’t directly accept it.
Using cryptocurrency for transactions can be complex, due to its fluctuating price, so bear that in mind.
How do you invest in cryptocurrency?
Since bursting onto the scene, cryptocurrency has been a popular, if polarizing, investment vehicle. Since cryptocurrencies are, as a rule, unregulated, they can be extremely volatile. The entire space is speculative, so make sure you fully understand the risks before diving into investing.
You can invest directly in various currencies, as you would individual stocks, using a general trading platform or crypto-specific account — if your brokerage offers it. But there are also ways to expose your portfolio to the crypto market without investing directly in it.
Crypto trusts, for example, are private trusts that invest in and track the price of specific cryptocurrencies. Or, by investing in Bitcoin futures, you can speculate on the future price of Bitcoin without directly owning it. Another method is crypto stocks, or publicly traded companies that buy and hold their own cryptocurrency. You can access some of these through an Ally Invest Self-directed Trading account, which includes a smart suite of tools you can access in your account.
Crypto for you
Crypto has seen its fair share of highs and lows in the market and the news. Still, it remains a popular choice for many investors. With a proper understanding of its ins and outs, you can consider adding cryptocurrency or related funds to your portfolio.
