Everything You Need to Know to Sound Smart About Cryptocurrencies
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"The potential rewards of cryptocurrency investing are inarguably high... but the risks are just as steep."

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Cryptocurrencies are a bit like the Kardashians: You’ve probably heard of them, but you may not really be sure why. They’re completely over-exposed in the media, but still somehow shrouded in mystery. To help you keep up with the cryptocurrencies, we’re answering some of the most-asked questions.

1. What's a cryptocurrency, and what are the different types?

A cryptocurrency is exchanged in the digital world using cryptography, which is essentially a system of secret messages. In other words: There’s no physical coin or bill to put in your wallet—it’s all virtual. But cryptocurrencies do have a dollar value (and they can fluctuate wildly on a day-to-day basis).

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The cryptography is how the creation and transactions of units is controlled and kept secure, and all the transactions are public. There’s no central banking system, like the Federal Reserve, managing it—nobody’s in charge, and everybody is in charge.

Bitcoin was the first cryptocurrency to be fully implemented and has the most name recognition, but there are more than 1,000 different ones out there. Other popular types include Ripple, Ethereum, Bitcoin Cash, Cardano and Litecoin.

2. What is mining?

As with gold or diamonds, if you want to uncover new cryptocurrency units, you have to roll up your sleeves and dig—albeit through virtual terrain. Instead of pickaxes, pans and shovels, the tools required for cryptocurrency mining include the right computer setup, software and high-level math. Miners will run software, for example, to try and solve the algorithms needed to verify bitcoin transactions and add them to the public ledger. Once they do, they're rewarded with bitcoins for their efforts.

Different currencies call for different approaches, which can change over time. For example, as Bitcoin gained in popularity and value, mining it has required an increasing amount of computational and electrical power. While you once could’ve used a personal computer, now entire mining operations with networks of specialized hardware are on the job. Other currencies can still be mined on a smaller scale.

3. What is a blockchain?

A blockchain is the automatically and constantly updated public ledger of all cryptocurrency transactions. The blockchain can be shared with anyone in the network, but cannot be altered—making it the key to operating without a Fed-like centralized system at the helm. (The Bitcoin blockchain is public and can be accessed by anyone. Check out blockchain.info.)

Many people think that blockchain technology is the core of the cryptocurrency craze and perhaps the real thing worth investing in. Companies like Microsoft, IBM and JPMorgan are developing and integrating blockchain systems into their businesses.

4. How is the value determined?

The price of Bitcoin, like stocks, is largely speculative. Unlike gold, it does not have intrinsic value, and unlike U.S. dollars, no government grants it legal tender status. So it’s really only worth anything because someone’s willing to pay that price for it (with the belief that someone else is willing to pay more). And many other cryptocurrencies are priced in part based on Bitcoin’s value.

5. What are the risks of investing?

Just like when investing in individual stocks, you risk losing your money if your cryptocurrency of choice tanks. Unlike with individual stocks, you have no real way of evaluating the odds of your investment doing well, and we have little historical data to analyze broader trends—making it tough to determine a fair price to pay or when it’s time to sell.

Plus, with such minimal regulatory oversight (which is the appeal for some), cryptocurrency accounts are not protected by the FDIC. So this area is rife with fraudsters looking to sell you a crypto-scam.

(Editor's note: This page has been updated to clarify the mining process.)

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January 19, 2018

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