Understanding Cryptocurrencies and Their Place in Our World

Author: Corey McLaughlin

Although they’ve been around since 2008, cryptocurrencies continue to draw fascination from every corner of the globe, making their way into TV news reports, investor meetings and even cocktail party conversations. But what are they? How do they work? And do they represent the future of a digital, cashless society?

This innovative asset class presents many opportunities and, along with it, significant risks. One thing is for certain: some embrace cryptocurrencies, some do not and some still don’t understand the idea enough to choose a side. Below are a few basic questions and answers to help remove some of the mystery surrounding these “new” currencies.

What is a cryptocurrency, and how does it compare to traditional currencies?

Traditional currencies, such as the U.S. dollar, are regulated by a government/central authority and take a physical form that can be handed to someone to complete a transaction. Cryptocurrencies are solely electronic. Instead of being backed by a centralized system, they operate via a decentralized peer-to-peer network, which uses specialized encryption techniques as a secure way to record transaction activity. While there are more than 1,500 cryptocurrencies, each with varying degrees of risk, liquidity, value, etc., Bitcoin is the original and probably most commonly known cryptocurrency today.

How can a new currency just be created and have its own value?

Anyone can, theoretically, create a private currency. What matters is that each person in the transaction has faith in the currency as a legitimate and authentic exchange of value. The value of most currencies is largely driven by two primary beliefs. First, the issuing government has the ability to back the currency. Obviously, this belief works best in developed and stable countries. A lack of faith in government-issued currency can be crippling to unstable countries. In some cases where using a decentralized currency is viewed as a positive, the use of cryptocurrencies has helped spur economic growth.

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