What Is Cryptocurrency? Heres What You Should Know

Cryptocurrencies let you buy goods and services, or trade them for profit. Heres more about what cryptocurrency is, how to buy it and how to protect yourself.

At NerdWallet, we strive to help you make financial decisions with confidence. To do this, many or all of the products featured here are from our partners. However, this doesnt influence our evaluations. Our opinions are our own.

Like any currency, cryptocurrencies can be used to buy goods and services. But unlike other currencies, cryptocurrencies are digital and use cryptography to provide secure online transactions.

While cryptocurrencies can be used to buy things, much of the interest in these unregulated currencies is to trade them for profit, with speculators at times driving prices skyward.

Here are seven things to ask about cryptocurrency, and what to watch out for.

2.How many are out there, and what are they worth?

Cryptocurrency is a form of payment that can be exchanged online for goods and services. Many companies have issued their own currencies, often called tokens, and these can be traded specifically for the good or service that the company provides. Think of them as you would arcade tokens or casino chips. Youll need to exchange real currency for the cryptocurrency to access the good or service.

Cryptocurrencies work using a technology called blockchain. Blockchain is a decentralized technology spread across many computers that manages and records transactions. Part of the appeal of this technology is its security.

More than 2,200 different cryptocurrencies are traded publicly, according to , a market research website. And cryptocurrencies continue to proliferate, raising money through initial coin offerings, or ICOs. The total value of all cryptocurrencies on June 6, 2019 was about $246 billion, according to CoinMarketCap, and the total value of all bitcoins, the most popular digital currency, was pegged at about $136 billion.

Cryptocurrencies appeal to their supporters for a variety of reasons. Here are some of the most popular:

Supporters see cryptocurrencies such as bitcoin as the currency of the future and are racing to buy them now, presumably before they become more valuable

Some supporters like the fact that cryptocurrency removes central banks from managing the money supply, since over time these banks tend to reduce the value of money via inflation

Other supporters like the technology behind cryptocurrencies, the blockchain, because its a decentralized processing and recording system and can be more secure than traditional payment systems

Some speculators like cryptocurrencies because theyre going up in value and have no interest in the currencies long-term acceptance as a way to move money

Cryptocurrencies may go up in value, but many investors see them as mere speculations, not real investments. The reason? Just like real currencies, cryptocurrencies generate no cash flow, so for you to profit someone has to pay more for the currency than you did.

Thats whats called the greater fool theory of investment. Contrast that to a well-managed business, which increases its value over time by growing the profitability and cash flow of the operation.

For those who see cryptocurrencies such as bitcoin as the currency of the future, it should be noted that a currency needs stability.

As NerdWallet writers have noted, cryptocurrencies such asbitcoin may not be that safe, and some notable voices in the investment community have advised would-be investors to steer clear of them. Of particular note, legendary investor Warren Buffett compared bitcoin to paper checks: Its a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money too. Are checks worth a whole lot of money? Just because they can transmit money?

For those who see cryptocurrencies such as bitcoin as the currency of the future, it should be noted that a currency needs stability so that merchants and consumers can determine what a fair price is for goods. Bitcoin and other cryptocurrencies have been anything but stable through much of their history. For example, while bitcoin traded at close to $20,000 in December 2017, its value then dropped to as low as about $3,200 a year later. In May 2019 it topped $8,000.

This price volatility creates a conundrum. If bitcoins might be worth a lot more in the future, people are less likely to spend and circulate them today, making them less viable as a currency. Why spend a bitcoin when it could be worth three times the value next year?

While some cryptocurrencies, including bitcoin, are available for purchase with U.S. dollars, others require that you pay with bitcoin or another cryptocurrency.

To buy cryptocurrencies, youll need a wallet, an online app that can hold your currency. Generally, you create an account on an exchange, and then you can transfer real money to buy cryptocurrencies such as bitcoin or ethereum. Heres more onhow to invest in bitcoin.

Coinbase is one popular cryptocurrency trading exchange where you can create both a wallet and buy and sell bitcoin and other cryptocurrencies. Also, the online brokerRobinhoodoffers free cryptocurrency trades (Robinhood Crypto is available in most, but not all, U.S. states).

Theres no question that theyre legal in the United States, though China has essentially banned their use, and ultimately whether theyre legal depends on each individual country. Also be sure to consider how to protect yourself from fraudsters who see cryptocurrencies as an opportunity to bilk investors. As always, buyer beware.

If youre looking to buy a cryptocurrency in an ICO, read the fine print in the companys prospectus for this information:

Who owns the company? An identifiable and well-known owner is a positive sign.

Are there other major investors who are investing in it? Its a good sign if other well-known investors want a piece of the currency.

Will you own a stake in the company or just currency or tokens? This distinction is important. Owning a stake means you get to participate in its earnings (youre an owner), while buying tokens simply means youre entitled to use them, like chips in a casino.

Is the currency already developed, or is the company looking to raise money to develop it? The further along the product, the less risky it is.

If youre looking to buy a cryptocurrency in an ICO, you should read the fine print in the companys prospectus.

It can take a lot of work to comb through a prospectus; the more detail it has, the better your chances its legitimate. But even legitimacy doesnt mean the currency will succeed. Thats an entirely separate question, and that requires a lot of market savvy.

But beyond those concerns, just having cryptocurrency exposes you to the risk of theft, as hackers try to penetrate the computer networks that maintain your assets. One high-profile exchange declared bankruptcy in 2014 after hackers stole hundreds of millions of dollars in bitcoins. Those arent typical risks for investing in stocks and funds on major U.S. exchanges.

If youd prefer to stay in the more established realm of stock investments, see our round-up of thebest online stock brokers.

James F. Royal, Ph.D., is a former NerdWallet writer. His work has also been featured in the Washington Post, New York Times and the Associated Press.Read more

Kevin is a personal finance writer at NerdWallet. He has covered financial issues for 20 years, including for The Wall Street Journal and .Read more

Power Trader? See the Best Online Trading Platforms

Power Trader? See the Best Online Trading Platforms

New Investor? See the Best Brokers for Beginners

New Investor? See the Best Brokers for Beginners

We want to hear from you and encourage a lively discussion among our users. Please help us keep our site clean and safe by following ourposting guidelines, and avoid disclosing personal or sensitive information such as bank account or phone numbers. Any comments posted under NerdWallets official account are not reviewed or endorsed by representatives of financial institutions affiliated with the reviewed products, unless explicitly stated otherwise.

California: California Finance Lender loans arranged pursuant to Department of Business Oversight Finance Lenders License 60DBO-74812.

Disclaimer:NerdWallet strives to keep its information accurate and up to date. This information may be different than what you see when you visit a financial institution, service provider or specific products site. All financial products, shopping products and services are presented without warranty. When evaluating offers, please review the financial institutions Terms and Conditions. Pre-qualified offers are not binding. If you find discrepancies with your credit score or information from your credit report, please contact TransUnion® directly.