BBB Tip: Get a handle on virtual currencies
Milwaukee, Wis. – Social and traditional media are full of articles and information about virtual currencies. Words and phrases like blockchain, cryptocurrency, distributed ledger, initial coin offerings, and digital tokens have become familiar.
Significant uncertainty surrounds virtual currencies, in general, and their potential value as investments, in particular. Many consider them high risk. Only time will tell whether, and if so which, virtual currencies become a mainstream component of our financial markets—and whether investments in this emerging sector make sense as part of a diversified portfolio.
Before you make any investment decisions, it is critical to understand some of the concepts underlying this emerging world of virtual currencies.
What are Virtual Currencies?
According to the Commodity Futures Trading Commission, virtual currencies are “a digital representation of value that functions as a medium of exchange, a unit of account and/or a store of value.” In other words, each currency is represented by alphanumeric codes that may be generated and recorded on a blockchain network and recognized as a method of payment by users on that network. In some cases, you can spend and trade virtual currencies, but these products do not have the same legal status as money, or “legal tender,” in the United States, Canada, Mexico, and most other jurisdictions.
One popular type of virtual currency is known as cryptocurrency, or simply crypto. The term crypto refers to the process of cryptography, which is a mathematically intensive encryption process designed to enhance data protection and authentication. Some people are interested in cryptocurrencies for their perceived anonymity and ability to keep transactions secret, and one of the earliest and perhaps most well-known cryptocurrencies is bitcoin.
What is Bitcoin?
Bitcoin is exchanged on the Bitcoin Network, a peer-to-peer payment system that operates using cryptography. Users can send and receive bitcoins by broadcasting digitally signed messages to the network using a cryptocurrency wallet. Transactions on the Bitcoin Network are recorded on a publicly distributed ledger called a blockchain and validated by a proof-of-work system called mining.
What is Blockchain?
Blockchain, also known as distributed ledger technology, is the technology that powers bitcoin and many other virtual currencies. In the case of bitcoin, blockchain functions through the participation of many individuals who offer their computing power to maintain the Bitcoin Network and record transactions (for instance, when someone trades or spends bitcoins). Those who employ math and technology to create new bitcoins are known as “miners.”
Blockchain technology is the critical feature of bitcoin because it prevents users of bitcoin from double-spending their coins and creates a permanent record of transactions.
Are There Other Cryptocurrencies?
Bitcoin is one of thousands of cryptocurrencies. The purpose, functionalities, and use of these cryptocurrencies may vary. Some share similarities with bitcoin. For instance, Litecoin, created in 2011 and the brainchild of coding prodigy Charlie Lee, is similar in many respects to bitcoin but it is not identical, since it uses a different mining algorithm.
Ethereum (2015), on the other hand, is in fact a platform for “smart contracts,” which are known as conditional transactions: computer code that enables certain events to be triggered when certain pre-defined conditions are met, such as the ability to unlock real products (renting a car, for instance) when payment is made. Ethereum has its own cryptocurrency known as Ether, which can be the form of payment used on these smart contracts.
Knowing about virtual currencies and investing in them are two very different things. Investing in virtual currencies can take many forms: you can purchase coins in the hope they will appreciate, or invest in platforms that facilitate blockchain technology and other aspects of the virtual currency revolution and hope they succeed. Doing so carries significant risk. Only invest what you can afford to lose, and be aware that you may lose some or all of your investment.
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