What Is Cryptocurrency?

Cryptocurrencies use cryptographic protocols, or extremely complex code systems that encrypt sensitive data transfers, to secure their units of exchange.

Cryptocurrency developers build these protocols on advanced mathematics and computer engineering principles that render them virtually impossible to break, and thus to duplicate or counterfeit the protected currencies. These protocols also mask the identities of cryptocurrency users, making transactions and fund flows difficult to attribute to specific individuals or groups. This article from Benzinga Money has more on the basic principles of cryptography.

Decentralized Control
Cryptocurrencies are also marked by decentralized control. Cryptocurrencies’ supply and value are controlled by the activities of their users and highly complex protocols built into their governing codes, not the conscious decisions of central banks or other regulatory authorities. In particular, the activities of miners – cryptocurrency users who leverage vast amounts of computing power to record transactions, receiving newly created cryptocurrency units and transaction fees paid by other users in return – are critical to currencies’ stability and smooth function.

Exchange With Fiat Currencies
Importantly, cryptocurrencies can be exchanged for fiat currencies in special online markets, meaning each has a variable exchange rate with major world currencies (such as the U.S. dollar, British pound, European euro, and Japanese yen). Cryptocurrency exchanges are somewhat vulnerable to hacking and represent the most common venue for digital currency theft by hackers and cybercriminals.

Finite Supply
Most, but not all, cryptocurrencies are characterized by finite supply. Their source codes contain instructions outlining the precise number of units that can and will ever exist. Over time, it becomes more difficult for miners to produce cryptocurrency units, until the upper limit is reached and new currency ceases to be minted altogether. Cryptocurrencies’ finite supply makes them inherently deflationary, more akin to gold and other precious metals – of which there are finite supplies – than fiat currencies, which central banks can, in theory, produce unlimited supplies of.

Benefits and Drawbacks
Due to their political independence and essentially impenetrable data security, cryptocurrency users enjoy benefits not available to users of traditional fiat currencies, such as the U.S. dollar, and the financial systems that those currencies support. For instance, whereas a government can easily freeze or even seize a bank account located in its jurisdiction, it’s very difficult for it to do the same with funds held in cryptocurrency – even if the holder is a citizen or legal resident.

On the other hand, cryptocurrencies come with a host of risks and drawbacks, such as illiquidity and value volatility, that don’t affect many fiat currencies. Additionally, cryptocurrencies are frequently used to facilitate gray and black market transactions, so many countries view them with distrust or outright animosity. And while some proponents tout cryptocurrencies as potentially lucrative alternative investments, few (if any) serious financial professionals view them as suitable for anything other than pure speculation.