Cryptocurrency is a rapidly growing asset class that has boosted and damaged portfolios in dynamic fashion. It has a unique digital landscape, distinctive underlying technology, and specialized vocabulary. But it isn’t always easy to understand. Here are some key points to keep in mind.
The fundamental idea behind cryptocurrency is that a system can be created where banks and other traditional financial intermediaries are not necessary to verify trust and facilitate transactions between two parties. These transactions are recorded on decentralized computer networks, known as blockchains, and are public to all network participants. This eliminates a central authority and makes it very difficult to change records once they are made. Bitcoin is the best-known cryptocurrency, but many others have surged to prominence as well.
To buy cryptocurrencies, you will typically go to a cryptocurrency exchange, a business that allows users to purchase and sell cryptocurrencies at the current market price. Once purchased, you will need to store your coins in a secure wallet, either on your own device or through a third-party service like Coinbase. Lastly, you can use your coins to pay for goods or services.
While the growth of cryptocurrencies has ushered in an age of “decentralized finance” (DeFi), it has also brought with it new challenges. For example, the lack of centralized control over the transfer of assets can make it easier for criminals to launder money and avoid financial regulations. It can also be used to evade sanctions, such as the ones the United States has imposed on Iran and Russia.
Another concern is that cryptocurrencies don’t offer the same consumer protections as credit cards, including the ability to reverse charges if a product or service isn’t delivered. As the world continues to grapple with these emerging issues, government regulators and lawmakers will need to continue working to develop rules that limit traditional financial risks while encouraging innovation in this new sector.
The taxation of cryptocurrencies is complex, but they are generally treated as property or capital gains for income taxes. The amount you pay will depend on how long you hold your cryptocurrency and how it is used. For example, if you trade cryptocurrencies for the purpose of earning income, you may be required to pay capital gains taxes, while if you use them as a store of value, you may only be required to pay ordinary income taxes.
Investors should consider the tax implications of their investment in cryptocurrencies carefully before making any decisions. In addition, because of the regulatory uncertainty and volatile price fluctuations associated with this new asset class, investors should only invest what they are willing to lose. To reduce risk, they should spread their investments across a variety of cryptos and seek out projects with strong communities that can survive longer-term market pressures. They should also avoid investing in cryptocurrencies that rely on centralized management or programming, as they are more susceptible to unethical or deceptive behavior.