[MUSIC] Cryptocurrency might sound
like money of the future,
but it shares a lot of qualities with
the currency you use every day.
In fact, many cryptocurrencies seek to solve
the problem with our traditional centralized currencies.
Hi. I'm Kate from the Motley Fool,
and I'm going to walk you through the basics of
cryptocurrency step by step.
Let's first start by breaking
cryptocurrency into its two main parts.
Crypto and currency.
The crypto in cryptocurrency is named for cryptography,
which is the secure communication technique.
Cryptocurrencies use a distributed ledger,
usually stored as a blockchain,
which guarantees the security
of transactions and participants,
including protection from double spending independent
from a central authority.
If you're unfamiliar with what the blockchain is,
don't worry, we'll get there I promise.
Currency is a medium of exchange for goods and services.
Our financial structure revolves
around currency through your paycheck,
taxes, purchases, services, housing,
just to name a few.
Not too long ago,
our currency followed the gold standard.
Where the formation of currency was backed by
precious metals like gold or silver.
The US dollar was regulated under the gold standard,
which is a monetary system where
the standard economic unit of account
is based on a fixed quantity of gold.
Then we moved to Fiat money,
the money we use today,
which is a type of money that is not backed
by any commodities such as silver or gold.
It gets its value from
the government back trust that is placed on it.
The United States and other countries left
the precious metal back standard because
it constrained them with increasing
or decreasing the circulating supply.
But open your wallet for me.
Most of the time it's not
dollars and cents you have in your wallet.
It's a debit card, credit card,
or maybe a gift card you got
for your birthday stashed in there.
Most of the money we use in
everyday life we don't actually touch.
My debit card has an account number on it,
essentially acting as my digital wallet,
which is associated with a bank account number.
I have a password or pin number to access that account.
When money is deposited into my account at the bank,
the bank's ledger is adjusted to reflect my new balance.
On the crypto side,
a crypto wallet is like a bank account
without a physical card associated with it.
But you are in complete control of that wallet.
A bank does not hold onto
that currency for security sake,
but also cannot deny or limit
transactions with your crypto currency.
One thing to note, if you lose access
to that wallet or forget the password,
it will be lost forever.
The basis of Bitcoin's creation
and all virtual currencies that have followed
was to fix a number perceived flaws with
the way money is transmitted from one party to another.
For example, think about how long it could
take for a bank to settle a cross-border payment.
Or how financial institutions
have been reaping the rewards of
fees by acting as
third-party middlemen during transactions.
Cryptocurrencies work around
the traditional financial system
with blockchain technology.
But how does that happen without
the middleman structures that
exist in our centralized financial system?
I've mentioned this term a couple of times,
so let's break it down.
The blockchain.
Cryptocurrencies aren't tracked with
an internal third-party like
a bank or centralized government.
They use the blockchain.
The blockchain is not a cryptocurrency.
It's the technology that is used to
organize transactions on the ledger.
If you buy Bitcoin,
sell Bitcoin, use your Bitcoin to buy a pizza,
every time you pay for something with a cryptocurrency,
that information is gathered as
a block in the chain to be verified.
The same goes for other cryptocurrencies.
Now you may be wondering,
how do blockchain transactions get verified.
After all there are logistics involved like
making sure that a coin isn't spent twice.
Often this verification falls onto
a group of folks known as miners.
Cryptocurrency miners are nothing
more than people with high powered computers
competing against one another with
high power computers to solve complex math equations.
These equations are a product of the encryption
designed to protect the transactional data
on the digital ledger.
The first miner to solve the equation and
in the process verify transactions on the ledger,
get a reward, which is known as a block reward.
This reward is paid out in virtual coins and is
an example of how Bitcoin transactions are verified.
This process is referred to as proof of work.
How do I exchange my
traditional currency for cryptocurrencies?
If you want to purchase cryptocurrencies,
you need to get an account on an exchange or coin swap.
This is essentially the stock market for cryptocurrency.
You need to research which coins or
tokens that you want to invest in.
Because each exchange has slightly different variations
of which cryptocurrencies they offer listed for trading.
Why are so many people investing in cryptocurrencies?
Investors are hoping the cryptocurrencies they
invest in become a usable value source,
which would make their investment grow in value.
But which cryptocurrency should you invest in?
That's dependent on a number of factors,
like how quickly the blockchain technology
is being adopted by bigger businesses?
How quickly merchants are willing to
accept virtual currencies as a form of payment?
Whether governments around the world will accept
cryptocurrencies as legal tender
or choose to ban them entirely.
Not all cryptocurrencies have a coin with
a clear cut use or
enhance the value of the underlying blockchain.
That's why valuing the individual projects
sometimes can be difficult.
There are a couple of problems with
cryptocurrencies as they're being developed.
The three ones I'm going to discuss are volatility,
environmental concern, and the criminal element.
First volatility.
Cryptocurrency is in the investor phase
where we're finding the value of
the currency in question.
That's why you see so much volatility
in investing in crypto now.
Environmental concern.
Proof of work blockchains
require a lot of computing power.
Due to the numerous computer sources
were the ledger lives and is
verified and the complex puzzles
the computers need to solve.
That's what makes them so secure,
but it does create a fundamental inefficiency.
The reverse argument is that
traditional banking systems separate
and centralized use more electricity.
There are newer coins being built with
the intention of being more energy efficient.
The criminal element. Most cryptocurrencies
aren't as anonymous as you think.
Sure you don't have to
supply your social security number or
bank account information to begin
trading or investing in cryptocurrencies.
But any transaction you make is still going to be
recorded in the underlying digital ledger.
Recently, the Internal Revenue Service
won a court case against cryptocurrency exchange,
Coinbase that required the exchange to turnover
information on 14,355 users,
who between 2013 and 2015
exchanged at least $20,000 worth of Bitcoin.
While the IRS sought this information to go
after possible capital gains tax evaders
the bigger idea here is
these transactions are not as anonymous as you think.
There is however a group of
cryptocurrencies known as Privacy Coins that
have a sole purpose of beefing up
the anonymity and privacy of a transaction.
They use specialized protocols to help
hide the identity of the sender of a payment.
Cryptocurrency is continually growing in
adoption and has real world usability.
Even while it still works to
change and fit into everyday life.
It will be interesting to see if adoption continues to
grow and how the space changes our financial world.
I hope this video helped you on your investor journey.
At The Motley Fool, our purpose is to make
the world smarter, happier, and richer.