Cryptocurrency, or “coins,” are digital assets that enable peer-to-peer financial transactions of varying complexity. Crypto is often held as an investment, but it can also be used to buy a wide range of goods and services. The popularity of cryptocurrencies has grown rapidly, and they’re now traded on exchanges with trillions of dollars in daily volume. They can be volatile, and they’re not backed by any government or central bank.
The most common cryptocurrency is Bitcoin, followed by Ethereum and Litecoin. There are hundreds of other cryptocurrencies, too. While most are designed to be used as currencies, some can serve as store of value, or even represent ownership of digital assets such as movies and software. Each coin has its own unique blockchain, and many use a complex method called proof of work to verify transactions and maintain an accurate record of who owns what on the blockchain network. Incentives are provided for users to help maintain the blockchains, and whoever successfully contributes to the latest block receives cryptocurrency. This is known as mining.
While the growth of crypto has spurred innovation, it’s also created new risks for investors. The technology behind crypto enables decentralized finance, or DeFi, which can be used to bypass traditional financial institutions and transfer money globally without incurring fees. This can be helpful for individuals who want to send money to family abroad, avoid paying high wire fees, or circumvent country-specific restrictions. However, the rapid growth of DeFi has raised concerns about fraud, cybersecurity, tax evasion, and other issues.
Many governments have taken a hands-off approach to crypto, but its rise has forced them to start crafting rules for the sector. Regulations vary widely around the world, and some countries have banned cryptocurrencies altogether.
Investors can invest in crypto by using online exchanges, which act as broker-dealers. They can also purchase cryptocurrency through exchange-traded funds (ETFs), which trade on a stock exchange and hold a portfolio of various crypto assets. ETFs can provide an easy way for investors to gain exposure to the crypto market, though they typically don’t offer as much diversification as individual investments in a variety of cryptocurrencies.
As a risky investment, crypto should be only a small portion of your overall portfolio. One common guideline is to limit it to no more than 10% of your total portfolio. Before you buy crypto, research it thoroughly, and make sure you understand how it works. Look at the website for each cryptocurrency you’re considering, and read independent articles on the topic to ensure you have a full picture of what it offers. Diversifying your portfolio with several different cryptocurrencies can also help reduce your risk by allowing you to benefit from the price appreciation of some coins while offsetting losses in others. You may also want to consider a cold storage wallet, which can be used to keep large amounts of crypto off the exchanges and out of reach from hackers.