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What Is Bitcoin? Investing in Cryptocurrency Explained

Brian Nelson
Bitcoin-Cryptocurrency-Blockchain, blockcahin

People who invested modestly in the cryptocurrency bitcoin back in 2009 and held fast to their investment are now enjoying millions of dollars as a reward. But this particular vein of investment opportunity comes with considerable risk.

Theoretically, cryptocurrency works just like any other currency in that it can be used to spend and buy goods. Currently, however, only specific merchants and companies accept cryptocurrencies for purchases, with others slow to join. Although the most well-known cryptocurrency is bitcoin, many other cryptocurrencies exist, including Ethereum, Litecoin and Ripple XRP.

Here’s what you need to know about investing in alternative currencies, including whether it’s the right type of investment for you.

What Is Cryptocurrency?

Cryptocurrency is a virtual currency built by using an encryption concept called blockchain to create money and verify transactions using that money. Cryptocurrencies are independent of any government or central bank, making them both anonymous and unregulated.

Because spending cryptocurrencies are still limited to specific instances, most people who know how to invest buy cryptocurrencies on a cryptocurrency exchange and then convert them back into a more spendable currency by selling them. Like all currencies, cryptocurrencies trade against other currencies, such as the dollar, to create a cryptocurrency market.

The rate at which one currency is exchanged for another fluctuates based on supply and demand. Demand has been high, so prices to buy bitcoin and other cryptocurrencies have been rising.

Cryptocurrency prices are still very volatile, however, and no one knows what the future holds for them. But cryptocurrencies can be exciting alternative investments if you can live with the volatility.

Cryptocurrency Exchanges

Buying bitcoins or other cryptocurrencies requires an account on an exchange that offers the currency you want to trade. Coinbase is one of the largest exchanges and offers the ability to trade bitcoin, Litecoin and Ethereum.

As with any exchange or brokerage, you need an account to hold your money and investments. In the world of cryptocurrencies, that account is known as a digital wallet. For example, you need a bitcoin wallet to buy, store and use bitcoins.

Unlike a brokerage account where you deposit funds, most cryptocurrency wallets work by attaching a bank account or credit card. When you buy currency, the money is withdrawn from the account or credit card. Likewise, when you sell, it is transferred back.

Related: Google, Apple, Bitcoin and 4 Other Digital Wallets Reviewed

Because cryptocurrencies are anonymous, transactions cannot be traced, which makes the funds an attractive target for account hackers. Using a reputable exchange and security measures like two-factor authentication can increase security.

Buying and Selling Cryptocurrencies

Once your account and wallet are set up, buying and selling cryptocurrencies is like buying or selling any other currency or stock type investment. Prices are displayed at the exchange’s website or at any service that publishes price quotes. For example, you can look up the bitcoin price under the symbol BTC-USD on most systems that publish stock quotes.

Cryptocurrency exchanges do transactions via credit card, debit card or bank account and usually charge a fee for each transaction. When purchasing bitcoins, you can enter an order to buy a certain dollar amount or a certain currency amount. You do not have to buy whole units; you can buy 2.382 bitcoins, for example.

Although the exact steps vary based on exchange, here are the general steps involved in buying cryptocurrencies:

  1. Set up a digital wallet or account.
  2. Connect a payment method, such as credit card or bank account to your wallet.
  3. Enter a buy order for a specified amount, either dollars or currency amount.
  4. The amount of the purchase is charged to your credit card as a purchase or moved from your bank account as an ACH or wire transfer, including any transaction fee.
  5. The transaction is added to the blockchain.
  6. The purchased cryptocurrency is added to your digital wallet.

To sell, the process is reversed.

Find Out: 7 Bitcoin Alternatives to Consider Investing in This Year

Time will tell if the cryptocurrencies continue to rise or if this is all a massive bubble, and there are many other questions still to be answered. Either way, investing in cryptocurrencies is simple enough for the average investor who is willing to take the risk.

This article originally appeared on GOBankingRates.com: What Is Bitcoin? Investing in Cryptocurrency Explained