Cryptocurrency is a form of virtual money that doesn’t rely on banks or government institutions to verify transactions. Instead, it’s secured by a technology called the blockchain—an online, constantly updated and verified record of transaction data that’s impossible to alter or hack. The blockchain is made up of a series of digital “blocks” that contain transaction records. When you buy cryptocurrency, the block that contains your purchase is added to the blockchain. If you own a large enough chunk of crypto, its value can rise or fall depending on if other users believe that it’s worth buying or selling.
Investors are drawn to crypto for its decentralized nature and the fact that it’s not linked to a company—like stocks—that may be in financial trouble. But the risk with crypto is that you’re essentially betting on online speculation, which can be difficult to predict. It’s also a new investment, and there isn’t much historical data on how its values correlate with other assets.
Some of the other risks that come with crypto include its high volatility, which can make it challenging to use as a means of payment (though many merchants are now accepting it). It’s also not backed by any government or central bank, so if it loses popularity, you could potentially lose all your holdings. Additionally, crypto trading platforms can be hacked and some have failed. And, because cryptocurrencies are not regulated like securities or deposits, they don’t offer the same protections against fraudulent or unethical management practices that investors have experienced in other markets.
You can buy and sell cryptocurrencies on digital exchanges, which are similar to stock exchanges. But it’s important to note that some exchanges charge fees—often a percentage of the total sale price—for using their services. It’s also a good idea to create multiple accounts on each exchange—using two-factor authentication when possible—to protect your funds from hackers.
Once you have a wallet, you can spend your crypto at participating merchants—from Overstock to Microsoft—or send it to someone else to pay for goods or services. Keep in mind, however, that the IRS considers any cryptocurrency transaction a taxable event if you sell it for profit or exchange it for a good or service at a gain.
It’s important to remember that cryptocurrencies are considered a risky investment, and they shouldn’t be more than 10% of your portfolio. That’s because investments with higher risk typically provide lower returns than those with less risk, and they can also fluctuate more in value over time. You can reduce the risk of loss by diversifying your crypto—by purchasing a range of different assets that may rise or fall at different rates or over different periods. This can help you establish a stable, balanced portfolio that meets your desired level of risk.