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Cryptocurrency 101: The Risk vs. Reward
It seems like every day we hear about how much a certain cryptocurrency’s value is skyrocketing, how a millionaire was made with cryptocurrency, or how the number of people using cryptocurrency wallets is exponentially increasing.
Created in 2009, Bitcoin was the first cryptocurrency, and arguably is still the most recognizable name in the game. Ten years later, there are almost 3,000 different digital currencies in the cryptocurrency market, and for many, this new type of investment holds the answer to their financial future.
Unfortunately, there are a lot of scams out there related to the crypto market. And similar to the stock market, there is also a lot of uncertainty. Your first line of defense? Learning more about it.
What is cryptocurrency?
Most traditional forms of currency are centralized. U.S. dollars, for example, are regulated by the Federal Reserve, the central bank of the United States. It sets monetary policy, provides payment services (including ensuring there is enough money in circulation), and regulates banks. Through these duties, the Federal Reserve provides a level of financial stability to the United States.
Unlike U.S. dollars, most cryptocurrency is decentralized, which means there is no single government or financial entity that regulates them. At its most basic, cryptocurrency is digital currency (or money). So instead of requiring people to carry around paper money, such as U.S. dollar bills, cryptocurrency allows for transactions that are all based online. Additionally, instead of storing money in a bank like you do with U.S. dollars, you store cryptocurrency in a digital wallet.
Cryptocurrency advocates generally believe that centralized currency has a potential fatal flaw: A mistake made by the one high authority can negatively impact the entire system. That’s why cryptocurrencies were designed as a decentralized alternative to government currencies. Cryptocurrencies use technology, frequently one called blockchain, to ensure a level of decentralization, transparency, and security.
How do people make money from cryptocurrency?
There are several ways people make money from cryptocurrency, but we’ll just go over a few of the most common ones. We can't tell you anything about the payout value or whether they are good ways to make passive income, but we can provide general information about how certain people are using this type of digital money.
First, you can invest in cryptocurrency by buying it with U.S. dollars (hopefully at a lower price) and hope its value increases. There are crypto exchanges that help facilitate these transactions. Of course, like any investment, there are risks associated with this. The cryptocurrency might not increase in value, and it could even decrease over a period of time, causing you to lose money.
Other people earn their cryptocurrency by mining. Someone who mines cryptocurrency uses their computer to validate blocks of cryptocurrency transactions. This is part of the blockchain technology we mentioned earlier.
Cryptocurrencies use a public ledger to record all transactions, kind of like your bank statement records the transactions of your bank account.
However, cryptocurrency transactions can’t be validated unless the network (made up of miners) solve the complex mathematical problems established by the cryptocurrency’s protocol. Solving the math problems “unlocks” the cryptocurrency and makes it available. Miners get a fraction of the currency they unlock, and that’s how they earn money online. Some cryptocurrencies require sophisticated (and expensive) computers to solve their math problems, while others can be solved with a standard computer. Others join a mining network for a fee, which allows them to work with other miners and share profits.
Other people earn cryptocurrency by completing microtasks, which are frequently called “bounties.” Sometimes, startups will offer cryptocurrency in exchange for real work, such as writing promotional copy, creating a video review — whatever the startup needs. There are websites that list bounties and airdrops, a similar type of task-based work. Many crypto enthusiasts believe that its best to get in on the ground floor with new cryptocurrencies, and you can usually find this type of work on these websites.
So what is the problem?
Well, you’ve probably already noticed by now that cryptocurrency doesn’t come for free, and it’s not always straightforward, at least not for people who don’t have a background in the type of technology that cryptocurrency uses. Cryptocurrency is not infallible either, despite what some crypto-enthusiasts may have you believe.
2019 alone saw several major cryptocurrency scams, resulting in more than $4.26 billion that had been stolen from crypto users, exchanges, and investors. These scams include, but are not limited to:
- A $40 million hacking of one of the world’s biggest cryptocurrency exchanges
- A three-year phishing scam resulting in more than $100 million in stolen cryptocurrency.
The takeaway here is that both supposedly secure institutions, such as large exchanges, and individuals are being targeted by crypto thieves and scammers.
The U.S. Federal Trade Commission offers some words of warning about cryptocurrency on its website. Remember:
- Cryptocurrency is not backed by a government. While this is the appeal for many, it also means that your cryptocurrency does not have the same protections as the money in your FDIC-insured bank account. If your cryptocurrency is stolen, for example, or the crypto business you are working with shutters and you lose all your money, there is very little you can do to recoup losses. Likewise, the transactions you make with cryptocurrency don’t have the same protections as U.S. dollars.
- The value of cryptocurrency changes all the time. We mentioned this above as a risk for investing in cryptocurrency. Cryptocurrency value can fluctuate from hour to hour. The value of Bitcoin, for example, fluctuated wildly in 2019, and dropped 8% in one day that June. When a cryptocurrency’s value drops, there is no guarantee that it will return to its higher price.
- Scams abound. Some reports will have you believe that cryptocurrency is the silver bullet of your financial woes, but just like with any get-rich-quick scheme, if it sounds too good to be true, it probably is. Scammers frequently offer investment or business opportunities related to cryptocurrency that promise (1) you’ll make money, (2) you’ll make money fast, and/or (3) you’ll get free money. These are all red flags. If someone promises you a way to make a lot of money in a short amount of time, always proceed with caution.
The Dangers of Borrowing Cryptocurrency
There is another potentially dangerous game in town, and it’s called borrowing cryptocurrency. This is a newly created field, and the risks associated with cryptocurrency multiple when you add in a loan element.
Risks increase even further when you don’t understand the underlying technology of cryptocurrency. Cryptocurrency loans can also be straight-up scams, along with fake cryptocurrencies, fake cryptocurrency websites and mobile apps, and email phishing scams.
Reporting Cryptocurrency Scams
If you or someone you know has been the victim of a cryptocurrency scam, there are three ways to report it:
- Send a complaint to the FTC.
- Report it to the Commodity Futures Trading Commission (CFTC).
- Report it to the US Securities and Exchange Commission (SEC).