What is Cryptocurrency and How Does it Work?

Considering the amount of questions that we have received from clients, we believe that Cryptocurrencies have been a hot topic over the past few years, but the excitement seems to have exploded in 2021. Bitcoin, Ethereum, Dogecoin.

These are just a few of the hottest names in this new and potentially revolutionary industry. But what is a cryptocurrency exactly?

This blog will dive into the high level details of cryptocurrency and some of the potential applications of these so-called “coins.”

What is Cryptocurrency?

Cryptocurrencies are a digital form of currency that can potentially be used in transactions for goods, services, etc. Instead of paying someone $100 for a product, you could pay them using Bitcoin, and the amount is based on the exchange rate at that time.

Now, that doesn’t seem any different than paying in U.S. Dollars or Euros. The main difference is that these cryptocurrencies are fully digital and do not have any physical form. This makes them more inclined to use a credit card rather than cash, but cryptocurrencies operate at a much deeper level.

How Does Cryptocurrency Work?

These digital “coins” are part of a global electronic ledger that secures the information related to the transaction, but also tracks the coin throughout these transactions. This adds a layer of depth that is not found in any other currency.

Also, these coins are not backed by any specific country’s currency, so the potential here is global. One of the biggest potentials for this industry is the adaptation of a single coin globally, which could create a universal currency for all global trade and commerce.

How is Cryptocurrency Made?

The process that creates these coins is called mining and is a very complicated topic. The ledger of transactions is referred to as the Blockchain, and this is where all of the transactions are recorded. Very in-depth and complex algorithms are required to be solved for the next leg of the blockchain to be created.

When the blockchain is extended then more coins are created and more information can be stored in the ledger. This process of mining requires a large amount of computer processing power and is a full-time job for some. When the computer solves the algorithms (complex math problems), more coins are earned for that specific cryptocurrency.

Speculation and Regulation Present Investment Uncertainty

There are plenty of risks to be aware of as it relates to this speculative industry. First, no one knows which coin will become the most popular or how widely accepted this currency will be.

We believe that some countries may try to impose their own regulations on this new currency as well. The complexity of the mining process may deter some individuals, organizations, or countries from using the currencies since they may not fully understand how the currency is created.

Lastly, some clients have mentioned concerns that cryptocurrency may have originally been used to process illegal transactions.

Speak With a Trusted Advisor

If you have any questions about your investment portfolio, retirement planning, tax strategies, our 401(k) recommendation service, or other general inquiries, please contact our office at (586) 226-2100.

Please feel free to forward this commentary to a friend, family member, or co-worker. If you have experienced any changes to your income, job, family, health insurance, risk tolerance, or overall financial situation, please call us so we can discuss them.

We hope you learned something today. If you have any feedback or suggestions, we would appreciate hearing from you.

Best Regards,

Zachary A. Bachner, CFP®

with contributions from Robert Wink, Kenneth Wink, and James Wink

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