Cryptocurrency is digital money that exists only on computers and networks, with no physical coins or bills

Cryptocurrency is a form of currency that lives entirely in digital form. Unlike dollars in your bank account, which are backed by a government and a bank, cryptocurrency is created and managed by computer networks using math-based systems called blockchain. Bitcoin and Ethereum are the two largest cryptocurrencies by market value, but thousands of others exist.

The key difference from regular digital money — like the balance in your checking account — is that cryptocurrency does not require a bank or government to verify transactions. Instead, a distributed network of computers confirms that transactions are real and records them permanently. This is why cryptocurrency is sometimes called "decentralized" money.

Cryptocurrency can be bought, sold, held in digital wallets, and transferred directly from one person to another without a middleman. The price of any cryptocurrency fluctuates based on supply, demand, and market sentiment, sometimes dramatically and without warning.

Key Takeaways

  • Cryptocurrency is digital money created and verified by computer networks rather than governments or banks.
  • Bitcoin and Ethereum are the largest cryptocurrencies, but the market includes thousands of different digital coins and tokens.
  • Cryptocurrency transactions are recorded on a blockchain, a permanent digital ledger that is copied across many computers.
  • Prices are highly volatile and can change sharply based on news, regulation, and market sentiment.
  • Holding cryptocurrency carries real risks, including loss of access to your wallet, theft, and the possibility that a cryptocurrency becomes worthless.

How blockchain records and secures transactions

A blockchain is a digital ledger — a record book — that is stored on thousands of computers at once instead of in one central location. When someone sends cryptocurrency to someone else, that transaction is broadcast to the network, verified by computers called nodes, and then added to a permanent block of transactions.

Once a transaction is recorded on the blockchain, it cannot be erased or changed. This creates a permanent, transparent record that anyone can view. The math-based system that secures this process is called cryptography, which is where the term "cryptocurrency" comes from.

Different cryptocurrencies use different methods to verify transactions. Bitcoin uses a process called proof of work, in which computers compete to solve complex math problems to earn the right to add the next block. Ethereum has moved to proof of stake, in which validators are chosen based on how much cryptocurrency they hold and are willing to lock up as collateral.

The difference between coins and tokens

A coin is a cryptocurrency that operates on its own blockchain network. Bitcoin and Ethereum are coins because each has its own independent blockchain. A token is a digital asset built on top of an existing blockchain — for example, many tokens run on the Ethereum network but are not Ethereum itself.

Tokens can represent ownership in a project, voting rights, access to a service, or simply a speculative investment. Some tokens have no clear use and exist only because people are willing to buy and sell them. This distinction matters because a coin's security depends on the strength of its own network, while a token's security depends partly on the blockchain it runs on.

How to store and access cryptocurrency

Cryptocurrency is stored in a digital wallet, which is software that holds your private keys — long strings of characters that prove you own the cryptocurrency. Your wallet can be on your computer, your phone, a hardware device that looks like a USB drive, or held by an exchange or service provider.

There are two main types of wallets. A hot wallet is connected to the internet and is convenient for frequent transactions but carries higher risk of hacking. A cold wallet is offline — usually a hardware device or paper record — and is more secure but less convenient to use.

If you lose access to your private keys, you lose access to your cryptocurrency permanently. There is no customer service to call, no password reset, and no way to recover it. If someone else obtains your private keys, they can transfer your cryptocurrency to their own wallet and you cannot reverse the transaction.

Why cryptocurrency prices change so much

Cryptocurrency prices are driven by supply and demand in the open market, with no central authority setting a price. A single news story — a regulatory announcement, a major hack, a celebrity endorsement, or a shift in investor sentiment — can cause the price to swing 10, 20, or 50 percent in hours.

Because cryptocurrency markets operate 24 hours a day, seven days a week, and are less regulated than stock markets, price swings can happen at any time without warning. The smaller the cryptocurrency, the more volatile it tends to be, because a single large buyer or seller can move the price significantly.

This volatility makes cryptocurrency unsuitable as a stable store of value for most people. If you hold cryptocurrency, you should assume you may lose a substantial portion of your investment and be prepared for that outcome.

The risks of holding cryptocurrency

Cryptocurrency carries several distinct risks that do not apply to money in a bank account. Your bank account is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per account holder per bank. Cryptocurrency held in a wallet or on an exchange has no such protection.

If an exchange is hacked, your cryptocurrency can be stolen and there is no insurance to cover the loss. If you send cryptocurrency to the wrong address by mistake, the transaction cannot be reversed. If the private key to your wallet is lost or destroyed, your cryptocurrency is gone forever.

Cryptocurrency is also subject to regulatory risk. Governments around the world are still deciding how to regulate cryptocurrency, and new rules could make certain cryptocurrencies illegal to hold or trade, or could impose taxes that reduce their value.

Cryptocurrency versus traditional money

Traditional money — dollars, euros, pounds — is issued and backed by a government and managed by a central bank. The value of traditional money is relatively stable because the central bank controls the supply. Cryptocurrency is not issued by any government and its supply is controlled by the code that created it.

Traditional money transactions go through banks, which charge fees and take time to process. Cryptocurrency transactions can be sent directly from one person to another without a middleman, though they still require network verification and can take minutes to hours depending on the cryptocurrency.

Traditional money is legal tender — you can use it to pay taxes and settle debts. Cryptocurrency is not legal tender in most countries and is treated as property for tax purposes. This means you may owe capital gains tax when you sell cryptocurrency at a profit, even if you never convert it to dollars.

Frequently Asked Questions

Is cryptocurrency real money?

Cryptocurrency is real in the sense that it has market value and people trade it, but it is not legal tender and is not backed by a government. It is treated as property for tax purposes in most countries. Whether it functions as "money" depends on whether merchants accept it as payment, which most do not.

Can cryptocurrency be hacked?

The blockchain itself is extremely difficult to hack because it is distributed across thousands of computers. However, your personal wallet can be hacked if it is connected to the internet, and exchanges have been hacked in the past. Cold storage wallets are much harder to hack because they are offline.

Who created Bitcoin?

Bitcoin was created by someone or a group using the name Satoshi Nakamoto, but their true identity is unknown. Bitcoin was launched in 2009 and the creator has not been publicly identified. The Bitcoin network is now maintained by thousands of independent computers and developers worldwide.

Can I lose money holding cryptocurrency?

Yes. Cryptocurrency prices can fall sharply and stay low indefinitely. You can also lose access to your cryptocurrency through hacking, lost passwords, or sending it to the wrong address. Unlike bank deposits, cryptocurrency holdings are not insured.

Do I have to pay taxes on cryptocurrency?

In the United States and most other countries, cryptocurrency is treated as property for tax purposes. You owe capital gains tax when you sell it at a profit. Some countries also tax cryptocurrency holdings themselves. You should consult a tax professional about your specific situation.