Crypto inspires passionate opinions ranging from those who believe it is a transformational technology to others who fear it’s just a fad. Understanding what it is and how it works can help you decide if you want to participate in this wild ride.
At its core, cryptocurrency is a record-keeping system that eliminates the need for middlemen to verify transactions or sign documents. Instead, it uses programs called “blockchains” to encrypt data, create hashes (strings of numbers and letters) and then store the data on a network of computers. Each computer, or node, on the blockchain network serves a specific function, like relaying transactions or hosting a copy of the ledger. When a document is added to the blockchain, all the participating computers compare the new hash with the previous ones to make sure the addition was made correctly.
If the program finds it was, it is then added to the chain of encrypted documents. Because the records are time stamped and linked together, it’s nearly impossible to tamper with or remove an entry without altering all subsequent documents in the chain. This makes blockchains extremely secure, compared with traditional database systems that are vulnerable to hacking and other security breaches.
Using blockchains also eliminates the need for third-party verification, which can save money for both consumers and businesses. For example, when a credit card is used to buy something, the consumer pays a small fee to the bank or payment-processing company that verifies the transaction. Blockchains could replace those services, as well as eliminate fees charged by notaries and banks for transferring funds.
Some cryptocurrencies use a process called “proof-of-work,” in which computers compete to add new information to the blockchain ledger and earn a reward in the form of cryptocurrency. That competition uses a lot of energy. But other cryptocurrencies don’t require as much power, and some even use energy more efficiently than the energy required to run a single Apple smartphone.
In its early days, crypto was popular among people who wanted to avoid the scrutiny of the banking system. This included criminals, tax evaders and political dissidents who may have been banned from using more mainstream services. But many of the same issues that plague other financial markets — including insider trading and market manipulation — have been seen in crypto as well.
Whether you should invest in crypto depends on many factors, including your tolerance for risk in both financial and psychological terms and your investment time horizon. In addition, the price volatility of crypto can be unpredictable and may cause you to lose money. It is important to research thoroughly before investing any money in an asset that can go up or down in value quickly and dramatically. Then decide if the benefits outweigh the risks for you.
