If you find cryptocurrency confusing, you are not alone. Cryptocurrency, “crypto” for short, is a form of money, or currency that only exists digitally. Crypto got its name because transactions are encrypted with complex digital codes sent over powerful computer networks. It is used very differently than other common currencies, such as the dollar, euro, and peso. However, comparing crypto to a common currency, such as the dollar, makes it easier to understand.
Consider what gives a US dollar value. A dollar has value because it is an accepted means of buying and selling, particularly in the United States. A dollar buys a dollar’s worth of goods because the government says so. This is called fiat. The government supports the dollar’s value, and our Central Bank, the Federal Reserve, helps regulate the value. A dollar bill is simply a piece of paper that represents the ability to buy, but has almost no value in itself.
Cryptocurrency, on the other hand, is a peer-to-peer version of cash. Presently, it is not issued by a government and is primarily unregulated. Like paper dollar bills, the units of cryptocurrency have no value by themselves. It is a way for money to be sent between individuals without it going through a bank. The people that own it, use it, and trade it, determine its value, and the major cryptocurrencies have their value reported daily in financial news sources.
There are many available cryptocurrencies. Some of the more familiar names are Bitcoin, Ethereum, Dogecoin, and Tether. Bitcoin has the highest value in circulation. Ethereum is second in total value. At the time of this article, each Etherium unit has a much lower value than Bitcoin but there are many more in circulation. Dogecoin started as a joke between a couple of friends, and quickly became popular sue to social media. Tether is considered a stablecoin and named after its mission to tether its value to a standard currency.
Currency is what makes trading easy. In the US, we trade dollars for the items we buy. Using money to buy things means we don’t need to barter, and it is easy to determine value. We understand what it means when a box of mac-n-cheese costs $1.00, a book is $15.00, and a car sells for $15,000.
The best way to explain how cryptocurrency works is with a simple and fun illustration.
Suppose there are three individuals, Lamar, Olivia, and William. Lamar sells llamas, and wants to buy oats to feed them. Olivia sells oats, and wants to buy a wagon to carry them. William sells Wagons, and wants to buy llamas to pull them. Instead of trying to barter or using their government’s established currency, they decide to create a new cryptocurrency among themselves that they can use to pay each other over the internet. They name their new currency “logancoin,” after their product types, and decide at that time that each logancoin is worth one llama, or 20 wagons, or 100 bushels of oats. As the value of llamas, oats, and wagons change, or new products are added, the value of logancoins would change. Then each can decide how many logancoins, or fraction of a logancoin, each product is worth to them. That is the general idea behind cryptocurrency.
Why is cryptocurrency so frequently in the news? Crypto is a relatively new form of currency. New currencies, and the technology that supports them, are constantly being created and rules are changing. Crypto’s appeal has risen and fallen many times since it was introduced in 2009. The more people and business accept these digital coins as payment, the more popular these currencies become. Demand increases what people are willing to pay for each digital coin. The opposite is also true. Events such as scams, hacking, and illegal activities diminish demand as investors sell their coins and leave the networks. Cryptocurrency has quickly evolved into more of a speculative investment than a means of exchange. It will be interesting to see what the future holds.