What Cryptocurrency – Including Bitcoin – Is and How It Works

It is critical for investors to have a basic knowledge of cryptocurrency, which includes bitcoin, before gaining exposure to the high-risk space.

digital rendition of cryptocurrency with question mark in the middle and blockchain
(Image credit: Getty Images)

Investors' interest in cryptocurrency regained momentum in early 2023 as risk appetite reentered the market. The leader was – and still is – bitcoin, the world's largest cryptocurrency. It hit an all-time high north of $73,000 in March 2024. 

The digital asset continues to hold near these highs suggesting the interest for cryptocurrencies remains strong. However, it hasn't always been like this. Indeed, in 2022, many digital assets were in a crypto winter, with bitcoin sinking below $16,000 that November. 

This volatility is why it's so important for those new to investing to familiarize themselves with cryptocurrency and the industry behind it before putting their hard-earned money into the space.  

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What is cryptocurrency and how does it work? 

Vanguard is one of the most prominent asset managers in the world. Its website's investor resources section provides a good definition of cryptocurrency.

"A cryptocurrency is a digital asset stored on blockchain technology that serves as a type of currency or store of value. Unlike traditional currencies, cryptocurrencies aren't backed by major governments or developed economies," states the Vanguard website

In other words, blockchain technology enables cryptocurrencies like bitcoin to view and verify transactions between two parties through a decentralized network of users known as nodes. These nodes validate and record these transactions rather than through a single authority or middleman.

The bitcoin blockchain, for example, contains every bitcoin transaction that's ever taken place, divided into blocks. When stacked on each other, these blocks create a chain of blocks, or a blockchain. 

"Finding and publishing new blocks is what bitcoin miners do to earn bitcoins," states a Coinbase help page explaining the bitcoin blockchain. "Whenever a new block is broadcast, approximately every 10 minutes, a quantity of bitcoins is received by the miner who solved that block. Bitcoin miners keep the network secure, and this is how they are rewarded. This system ensures that all transactions are valid, and keeps the bitcoin network secure from fraud."

Why own cryptocurrency?

Investors have been asking themselves "Why own cryptocurrency?" ever since bitcoin was created in 2009.

Proponents of the digital asset argue that decentralized finance takes the power of money creation away from central banks and bankers, democratizing the global financial system. 

Cryptocurrencies are especially effective for transferring funds across borders quickly and efficiently to people living in countries with volatile currencies or significant cross-border restrictions, etc. 

The other reason to own cryptocurrencies such as bitcoin is as an investment. There is a school of thought that cryptos provide a hedge against inflation

To be such a beast, they must provide a store of value into the future, meaning they are worth the same or more with time. Further, they must be exchangeable for things like gold, U.S. dollars, etc. Lastly, they must have limited supply increases over time. 

Bitcoin, for example, has a capped limit of 21 million. There are currently around 19.7 million bitcoins. Every 10 minutes, approximately 6.25 bitcoins are mined and put into circulation. The limit is not expected to be reached until 2140.   

This scarcity may make bitcoin more expensive as the limit draws closer, but that's purely hypothetical. 

Advantages of cryptocurrency

Three of the most significant advantages of cryptocurrency are accessibility, faster transactions and transparency.

Market hours for cryptocurrency are 24 hours a day, seven days a week. Whether you're in your living room at three in the morning in the U.S. or traveling overseas, you can buy and sell digital assets without any concern your crypto exchange will be closed. It's always open. 

The benefits of this accessibility to crypto beginners are debatable. However, cryptocurrencies have always been about democratizing finance. Anyone, anywhere, at any time can make a trade. That's what makes it appealing to investors.

Market participants have always been interested in faster and, where humanly possible, cheaper transactions. In the case of cryptocurrencies, faster transaction speeds are critical because they influence the overall adoption of cryptocurrencies.

"For example, if it takes 10 minutes for a bitcoin transaction to be confirmed, it may not be practical for buying a cup of coffee," wrote The Baltic Times in an April 2023 article about cryptocurrency scalability and transaction speeds.

Transparency is a critical benefit of cryptocurrencies too. Their open-source code provides real-time, accurate results for auditors. That's essential for regulators seizing cryptocurrency used in criminal activities.

"According to the Financial Action Task Force (FATF), seizure rates of illicit funds within the traditional financial system are around 0.1% – meaning regulators have recaptured about one-thousandth of the funds known to have been used for criminal activity. The seizure rate for crypto: 27%, according to [Uniswap Legal Chief Salman] Banaei," Consensus magazine deputy managing director Daniel Kuhn wrote in April 2023.  

Disadvantages of cryptocurrency

As a result of this move to decentralize finance, countries such as the U.S. have looked to regulate cryptocurrencies further. In early June 2023, the U.S. Securities and Exchange Commission (SEC) sued Binance and Coinbase Global (COIN), the world's two largest cryptocurrency exchanges. 

The SEC's lawsuit against Binance accused the company of knowingly operating an unregistered exchange, as well as offering and selling unregistered securities. The complaint against Binance included 12 cryptocurrencies, such as Solana and Polygon. 

The separate SEC lawsuit against Coinbase claims that it, too, operated an unregistered exchange, offering and selling unregistered securities.  

"We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions," the SEC said in a statement.  

If you are new to cryptocurrency, it is crucial to understand that the industry remains in transition. There remain many regulatory challenges from agencies such as the SEC. 

This makes any investment – including in diversified crypto ETFs – potentially volatile and possessing above-average risk. 

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Will Ashworth
Contributing Writer, Kiplinger.com

Will has written professionally for investment and finance publications in both the U.S. and Canada since 2004. A native of Toronto, Canada, his sole objective is to help people become better and more informed investors. Fascinated by how companies make money, he's a keen student of business history. Married and now living in Halifax, Nova Scotia, he's also got an interest in equity and debt crowdfunding.