What is cryptocurrency?
Cryptocurrency is a digital form of currency that uses cryptography to secure the processes involved in generating units, conducting transactions and verifying the exchange of currency ownership.
Most modern currency is often referred to as "fiat" currency, which is regulated and produced by a government entity. The U.S dollar, for example, is a fiat currency. In contrast, cryptocurrency is not issued by any government authority. It is typically not directly managed by a single authority but rather works in a distributed consensus approach.
Cryptocurrency gains its name from the combination of "cryptography" and "currency." At the heart of all cryptocurrencies is a cryptographic algorithm with complicated encryption. Cryptocurrency is created by solving a piece of a cryptographic hashing algorithm in a long chain. It is not a physical unit, like a coin or a dollar bill, but rather a mathematical computation. Cryptocurrency assets are often stored in a digital wallet that keeps track of the cryptocurrency.
A decentralized, distributed ledger monitors all cryptocurrency transactions around the world. In the case of the popular cryptocurrency Bitcoin, the distributed ledger is what is known as a blockchain, which is a digital system that keeps track of cryptographic hash blocks.
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What are the different types of cryptocurrency?
There are many different types of cryptocurrency, much in the same way that there are many different fiat currencies issued by global governments. While Bitcoin is arguably the best known, many other cryptocurrencies have emerged over the years. These include the internet-popular Dogecoin and Ethereum. The following is a breakdown of popular cryptocurrencies:
Bitcoin is a general-purpose cryptocurrency and is a main pioneer in the industry. It operates using blockchain, which allows Bitcoin to digitally exchange anonymous, heavily encrypted hash codes across a peer-to-peer network. It was created by Satoshi Nakamoto, whose real name has never been revealed.
Code: BTC, XBT
First released: 2009
Created by: Satoshi Nakamoto
Estimated market capitalization: $883 billion USD
Average price: $47,000 USD per bitcoin
Dogecoin, often referred to simply as Doge, was created as a parody based on the Doge internet meme. It was a near worthless currency until Tesla CEO Elon Musk and investor Mark Cuban began popularizing it in 2021.
First released: 2013
Created by: Jackson Palmer and Billy Markus
Estimated market capitalization: $32 billion USD
Average price: $0.25 USD per coin
Ethereum emerged in recent years to be a primary cryptocurrency competitor to Bitcoin. It introduced a number of capabilities that were not present in Bitcoin, using an open source, distributed blockchain and smart contracts via Ethereum's Solidity programming language. The cryptocurrency created by Ethereum is called Ether. In September 2022, Ethereum changed the way that it executes and validates transactions, moving from a proof of work (PoW) model for a consensus algorithm to a proof of stake (PoS) approach. The change from PoW to PoS occurred in an event known as "The Merge." Activities on the legacy Ethereum Mainnet blockchain, which used PoW, were merged with the newer Beacon chain, which uses PoS. The goal with the move to PoS is to provide better transaction speed, while reducing the resource required to execute and validate transactions.
First released: 2015
Created by: Vitalik Buterin and Gavin Wood
Estimated market capitalization: $396 billion USD
Average price: $3,400 USD per Ether
As an early altcoin or Bitcoin alternative, Litecoin initially rose to prominence thanks to its use of the Scrypt hashing algorithm, which was seen by advocates as being easier to manage than the SHA-256 encryption used by Bitcoin.
First released: 2011
Created by: Charlie Lee
Estimated market capitalization: $12 billion USD
Average price: $153 USD per coin
Using a public distributed ledger, Monero gained a degree of unwanted notoriety in 2018 and 2019 as being the cryptocurrency of choice for cryptomining attacks. Attackers attempted to deploy hidden Monero miners on unsuspecting users' systems, as the cryptocurrency is easier to create via the mining process than Bitcoin.
First released: 2014
Created by: Nicolas van Saberhagen
Estimated market capitalization: $4.6 billion USD
Average price: $271 USD per coin
Stellar has its own unique protocol known as the Stellar Consensus Protocol for settling transactions across a distributed ledger. Low-cost currency transfers allow easy transactions between any two currencies, which some organizations find attractive as a resilient mechanism for commerce.
First released: 2014
Created by: Jed McCaleb
Estimated market capitalization: $7.5 billion USD
Average price: $0.32 USD per lumen
How do you get cryptocurrency?
Most cryptocurrencies are created via a process commonly referred to as cryptomining. With cryptomining, high-powered GPU systems are used to decrypt the cryptographic hash to create a new block. Each type of cryptocurrency has a finite number of blocks that can be mined. Over time, it becomes increasingly more complex and difficult to mine coins from an established cryptocurrency. For example, in 2010, a regular user with a GPU-powered system might have been able to mine Bitcoin. However, computing requirements are significantly more complex today, making cryptomining increasingly complicated.
In the early days of some cryptocurrencies, the currency's creators often simply give away coins to help promote usage. For example, Dogecoin was well known for providing users with free coins prior to 2020, via what was known as a Doge Faucet.
A popular way to help bring interest and value to a new cryptocurrency is with an Initial Coin Offering (ICO). With an ICO, the group launching a cryptocurrency offers potential investors a given amount of the new cryptocurrency in exchange for a fixed rate of either fiat currency or another cryptocurrency, typically Bitcoin or Ethereum.
Currently, the most common way of acquiring cryptocurrency is via a cryptoexchange. At a cryptoexchange, users buy a given cryptocurrency either with a fiat currency, such as the US dollar, or with another cryptocurrency. For example, a user could buy Dogecoin with Bitcoin and vice versa. Cryptocurrency exchanges are also where individuals convert a given type of cryptocurrency into cash or a fiat currency.
Practical use of cryptocurrency
Today, cryptocurrency holds the attention of major financial institutions and is seen by some as a good investment opportunity. For investors who don't want to directly acquire and hold cryptocurrency, there are also a variety of Exchange Traded Funds (ETFs), such as the Hashdex Nasdaq Crypto Index ETF (HDEX.BH), which tracks a basket of cryptocurrencies.
In the early days of Bitcoin, many hoped that the cryptocurrency could and would be used to buy everyday items, such as a pizza. In 2010, Laszlo Hanyecz bought $41 worth pizza from Papa John's, for which he paid 10,000 bitcoin at the time. In 2021, that amount of bitcoin would have been worth over $380 million.
Tesla and other big companies have toyed with the idea of accepting Bitcoin in recent years. However, major brands tend not to stick with the concept for long. The inherent instability in the value of Bitcoin and other cryptocurrencies has made using them for practical day-to-day usage challenging.
In 2021, the government of El Salvador became the first nation to accept Bitcoin as an official currency. As such, citizens should be able to use Bitcoin to pay taxes and other government services.
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Reformed tax law
In the beginnings of cryptocurrency, global governments did not have active policies for how cryptocurrency should be taxed. As the value of cryptocurrencies has increased, governments have recognized that there are tax revenues that can be collected.
In the United States, the Internal Revenue Service (IRS) first provided guidance on how cryptocurrency should be handled for tax purposes in 2014. The IRS does not consider cryptocurrency to be legal tender, but rather as an asset that can be taxed. However, it hasn't always been clear how gains should be reported.
As part of the Infrastructure Investment and Jobs Act (H.R. 3684), the U.S. Congress mandates that brokers report cryptocurrency transactions to the IRS, much in the same way that other equities and financial trades are reported. The goal is to eliminate any reporting gap and provide visibility to the IRS about potentially taxable capital gains that individuals may accrue from cryptocurrency trading. The impact on cryptocurrency traders is that trades and gains that might not have been reported or taxed previously will no longer avoid IRS scrutiny.