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What Is Cryptocurrency? The Basics and Fundamentals (2021 Edition)

What is cryptocurrency?

Cryptocurrencies are digital currencies that can be exchanged for various goods or services, just like traditional currencies. They have no physical form and are not redeemable for another commodity (though some cryptocurrency tokens are pegged to other assets, like the U.S. dollar).

What makes cryptocurrencies unique is that they are powered by technology called the blockchain, which is a publicly viewable ledger of all transactions spread across computers around the world.

The use of blockchain technology makes cryptocurrencies more decentralized than traditional currencies, meaning that there is no single authority or institution who controls their supply.

Many cryptocurrencies use a proof-of-work (PoW) system, a concept that is central to crypto. PoWs are cryptographic mechanisms where the members of a network expend energy to solve unique puzzles in a way that allows peer-to-peer transactions to be verified without a third party present. 

There are over 2000 cryptocurrencies in circulation. As of writing the most valuable in order are Bitcoin, Ethereum, Cardano, Bitcoin Cash and Tether. The thousands of cryptocurrencies available are usually referred to as ‘tokens,’ and as of August 2021, the aggregate value of all the cryptocurrencies in existence reached over $2.2 trillion. Bitcoin, being the most popular, currently makes up about 46.5 per cent of that total value. 

What is the blockchain?

To understand cryptocurrency, it’s important to understand the blockchain. 

Blockchain, simply put, is a digital register of data. It stores a ledger of all transactions for a certain cryptocurrency token across a network of computers around the world. This allows people buying and selling cryptocurrency to verify transactions without needing a central authority (like a bank). 

The blockchain, therefore, enables a wide variety of applications that require trust (like transferring money to someone, for example) without the need for a central authority.

Benefits of the blockchain: 

Blockchain technology offers a number of benefits, including… 

  • More transparency: Everyone in the network can see exactly what is being bought and sold, and because every transaction has to be verified by each part of the chain, forgeries are virtually impossible.

  • Decentralized control: Blockchain allows for complex transactions at scale without a central authority needed to manage them. This has potentially positive implications from both a cost and privacy perspective.

  • Lower costs: Because no central authority or middle-man is required to process blockchain transactions, the costs for settling those transactions could in theory be much lower. For example, sending a cryptocurrency token to someone on the other side of the world can be much cheaper than sending money via Western Union.

Challenges with the blockchain: 

With all that said, there are still challenges people face when using blockchain technology:

  • Risk of loss: There have been many high-profile hacks of cryptocurrency exchanges that have resulted in people losing all their cryptocurrency stored on the exchange. While there are ways to securely store your cryptocurrency, these issues persist and have cost people billions of dollars.

  • Volatility: Cryptocurrency prices can be highly volatile, meaning that the value of people’s assets can steeply rise and fall in a short period of time. It’s not uncommon for the price of bitcoin, for example, to rise or fall 10% or more in a single week. In 2021, the price of bitcoin has risen as high as US$65,000 and experienced lows just under US$30,000.

  • Technical barriers: Cryptocurrency is still in its early days, so the process of transacting in crypto can be technically challenging for some users. Exchanges are constantly working to improve their user experience, but buying and selling cryptocurrency is, for many users, not yet as intuitive as trading stocks or maintaining a bank account.

  • Energy use: The network of computers that powers transactions on the blockchain mean that crypto’s environmental impact is immense. Specifically, the energy consumption largely comes from the mining of the coins themselves as well as the process of solving the proof of work algorithms to verify transactions. Earlier this year, the Bank of America said that Bitcoin miners’ energy consumption will soon match that of the largest countries in the world. Currently, China, Georgia and the U.S. are the biggest energy consumers.

Like all technologies, the blockchain creates new opportunities and challenges.

How do cryptocurrency transactions work?

Transactions involving cryptocurrency tokens can seem opaque, but the process is less complicated than it may first seem.

  1. To begin, someone starts a transaction. This could either be a request to sell, buy, or transfer a cryptocurrency token. These requests are processed through the blockchain that powers the cryptocurrency token in question. For example, Sally could request to purchase 1 bitcoin.

  2. The transaction is sent to the nodes in the blockchain network. Each node is a computer, and all the computers are connected to each via the internet.

  3. Nodes in the blockchain network validate that the transaction is legit: basically they solve equations to confirm that the transaction is valid and both the buyer and seller are doing what they say they’re doing. In Sally’s case, this would be providing the funds for 1 bitcoin while the seller provides the bitcoin.

  4. Once the transaction is verified, the transaction is bunched together with a bunch of other transactions. This grouping forms a new “block” of data.

  5. The “block” of data is added to the “chain” — hence the name blockchain — which forms a permanent record (or ledger) of all transactions.

  6. The transaction is complete, and in our example Sally would “receive” her 1 bitcoin — her “wallet” would show +1 bitcoin associated with it – and the seller of the bitcoin would get their funds in their wallet.

How did cryptocurrency get started?

Crypto as a fully realized concept (as much as anything virtual is fully realized) began with a white paper published in 2008 by the pseudonymous Satoshi Nakamoto, Bitcoin – A Peer to Peer Electronic Cash System. The paper described how the Bitcoin blockchain network would function.

Nakamoto, or the persons that made up the pseudonym, also purchased Bitcoin.org a few months prior. The following year, Nakamoto purchased the first block of 50 bitcoins, which is now referred to as the Genesis Block. In mid-2010, Nakamoto handed over control of Bitcoin’s source code and network key to software developer Gavin Andreson.

It took a few years for Bitcoin to take off in value, however. By 2011, ‘spin-off’ coins like Litecoin appeared while Bitcoin itself suffered through precipitous highs and dangerous lows. In 2012, Andreson founded the non-profit Bitcoin Foundation, meant to rehabilitate the crypto’s reputation amid its scandals.

While Nakamoto’s identity has never been fully uncovered — Elon Musk himself had to deny he was Nakamoto after a Medium post in 2017 from a former SpaceX intern — a statue of them was built in Budapest to recognize their achievements in cryptocurrency.

What is the cryptocurrency market?

You can buy or sell cryptocurrencies via exchanges. Despite being decentralized, crypto markets work similarly to other ‘real-world’ markets in a few ways. 

  • The value of the token can dramatically rise or fall based on its public perception or the influence of events around the globe. Their value can also change based on their supply, market capitalization, security breaches or ongoing regulatory updates. One famous instance of real world impact would be a one-word tweet at the end of August from Elon Musk in response to a Dogecoin update: “Important.” Within 24 hours, the coin rose by 1.52 per cent.

  • Like stocks and bonds you can speculate on the price without ever owning a currency. Meaning you can go long, or buy, if you think they’ll rise in value, or short sell if you think it won’t. This is done through a contract for difference, or CFD. You agree to exchange the difference in the price of a cryptocurrency from when you open your position to when you close it. Cryptos are traded all around the world, 24/7, and as such can have the prices rise or fall at any time.

Otherwise, you can buy cryptocurrencies like you would any other currency by setting up a digital wallet. Registering with an exchange also often involves a Know Your Customer (KYC) process, which is really just a form of verifying your identity to the exchange. If your coin increases in value, you can still profit should you choose to sell. 

It’s important to note that the only credit card company in Canada that currently allows you to purchase crypto is Koho. Otherwise, you can buy digital currencies via e-transfer, an electronic funds transfer, a bank wire or your debit card.

What’s the legal status of cryptocurrency in Canada?

In a word: complicated. While one large exchange, Binance, isn’t able to operate in Ontario, the Ontario Securities Commission has approved Wealthsimple and Coinberry to operate crypto exchanges on their platforms with a few select tokens, including Bitcoin, Ether and Litecoin. As of writing, Tether has been left off of that list, likely due to regulatory troubles the coin encountered in New York.

Canada did hop on crypto early, becoming the first government in the world to pass a law on digital currencies in 2014 when Parliament passed Bill C-31. The bill amended Canada’s Proceeds of Crime (Money Laundering) and Terrorist Financing Act to include digital currencies. As well, the world’s first publicly available Bitcoin ATM was opened in Vancouver in 2013, followed by one in Toronto.

In 2017, the Canadian Securities Administrators (CSA) launched a regulatory sandbox initiative for businesses offering innovative products, which includes “cryptocurrency or distributive ledger-based ventures.” The OSC’s LaunchPad initiative works similarly with fintech businesses to keep them aligned with regulatory practices.

Today, you can invest in digital assets like crypto when it comes to TFSAs and RRSPs. Canada also allows crypto exchange-traded funds. As far as taxes go, everything under the Income Tax Act also applies to crypto. Although, the Canadian Revenue Agency classifies crypto as a commodity and considers its transactions as a barter to prevent misreporting of taxes. It also means that, while you can use crypto to buy goods and services, it is not considered legal tender.

Any Canadian business that wants to deal in crypto has to first register with the Financial Transactions and Reports Analysis Centre of Canada (FTRACC) as a money services business.

Some of the available crypto exchanges in Canada are Coinberry, Coinbase, Coinsmart, Bitbuy, Kraken and Shakepay.