There are literally hundreds of different cryptocurrencies available, and all have different values. Think of them as a type of unregulated digital money although most are not particularly easy to spend, and all carry a high level of risk. Here’s an overview of what you need to know.
Bitcoin and other cryptocurrencies
Bitcoin is probably the most well-known cryptocurrency but they come in many forms which include Ethereum, Ripple, Litecoin and Bitcoin Cash. These are all types of digital or virtual currency collectively known as cryptocurrencies.
However, the more established Bitcoin and other cryptocurrencies become in the future, the more retailers and businesses will be willing to accept it as a legitimate currency. Cryptocurrencies are facing increasing regulatory threats and with continually fluctuating prices they do come with a high level of risk for investors.
What are bitcoins and cryptocurrencies?
Bitcoin is just one type of cryptocurrency, a form of digital asset or money that can be exchanged in a similar way to normal currency. There’s no physical money attached to a cryptocurrency, so there are no coins or notes, only a digital record of the transaction. This digital record is often referred to as a blockchain.
A blockchain is a historical record of each transaction verified by each computer in the network. The verification is done after every transaction, for example when a cryptocurrency was sold and which account was credited. Each cryptocurrency has its own blockchain.
Cryptocurrencies are only a digital representation of value which isn’t issued or guaranteed by a central bank or public authority.
This means it doesn’t hold the same legal status as money.
They are generally not backed by any kind of tangible asset and are currently unregulated – meaning if something goes wrong, you won’t get any compensation.
So, if you’re looking to buy or invest in Bitcoin or other types of cryptocurrency, you’ll have limited legal protection and a high risk of losing some or all of your capital.
How are cryptocurrencies made?
Bitcoins and cryptocurrencies are created through a process called mining. Anyone can mine for most cryptocurrencies, but it is a difficult and time-consuming process.
Mining involves teams of computers solving mathematical problems. When the problem is solved, tokens for whichever cryptocurrency was being worked on are created, for example a bitcoin, and the computer that got the solution gets the new token.
Mining is also what gives cryptocurrencies their security. The mathematical problems that are being solved are connected to the blockchain, the record of every single token in a cryptocurrency. The latest mathematical problem doesn’t just create more tokens, it also checks the latest transactions at the same time.
How to use bitcoins and cryptocurrencies
Bitcoins and other cryptocurrencies can be exchanged for goods and services in the same way as British Pounds (£), American Dollars ($), the Euro (€) and the other currencies you’re used to.
To store and use your cryptocurrency you’ll usually need a specialised ‘wallet’ which will have its own unique digital address, allowing you to send and receive cryptocurrencies.
In addition to wallets you can also trade your currency on exchanges. Some of these will also allow you to convert your everyday currency - £, $, € and so on - into cryptocurrency, and to convert your holdings from one type of cryptocurrency to another.
Why do people buy bitcoins and cryptocurrencies?
There are many legitimate reasons to use cryptocurrency in place of everyday currencies like British Pounds – it’s secure, cheap and fast and offers genuine technical innovations that many believe will one day replace more traditional forms of exchange.
But because of the anonymity of the transactions, they are also frequently used by criminals seeking to avoid detection for unlawful activities.
However, people have been increasingly buying cryptocurrencies for the purposes of investment, hoping to make a lot of money quickly.
The instability of cryptocurrencies does means that it’s possible to make huge gains with small amounts of investments. But it’s also possible to make huge losses in a relatively short space of time.
The risks of Bitcoin and cryptocurrencies
Investing in cryptocurrencies can be very risky.
Firstly, to buy and store a cryptocurrency is quite technically demanding and it’s very easy for things to go wrong. The lack of regulation and central authority means that seeking compensation or making complaints is also very difficult.
Action Fraud statistics show that in June and July 2018 people lost more than £2 million to cryptocurrency scams – that’s over £10,000 per person.
Second, the cryptocurrency marketplace is a target for fraud, so extra caution is needed. Also, many exchanges have been subject to cyberattacks during which people who have left their holdings on these exchanges have lost them.
Lastly, the unstable nature of the currencies means that if you’re investing with the hope of making money, it’s very easy to lose some or all your original investment.
How to avoid cryptocurrency fraud
With the prices of cryptocurrencies increasing dramatically over the last few years, scammers are now actively targeting potential investors. The results often mean investors lose their original investment.
The most common cryptocurrency scams are:
You may see the investment opportunities of Bitcoin and other cryptocurrencies being marketed on social media and via email – these will send you to fake exchanges which can often disappear overnight.
Make sure websites are HTTPS secured - although this is no guarantee the site is genuine – but the most important thing is to do your research and seek out reviews of sites.
Wallets are primarily about storing your cryptocurrency and not buying or selling it. Fake wallets are scams for malware to infect your computer to steal your passwords and other personal information.
They are not easy to spot but sites like Bitcoin.com, for example, do recommend wallets for mobile and desktop users and provide a simple, secure way to send and receive bitcoin.
Phishing is when someone tries to trick you into thinking that a website or company is genuine. Scammers can contact you in a variety of ways including an email you have received containing a fake link, a brochure you have received in the post or through a fake advertisement. They will often encourage you to make a transaction, but this will be fake, meaning you’ll lose your cryptocurrency or investment as a result.
Alternatively, it could be an opportunity for scammers to place malware on your device to steal your personal details.
Ponzi scams usually involve making strong or unrealistic claims about the returns you are able to make by investing in cryptocurrencies. They often have referral programmes to encourage investors to sign up their friends and families.
In reality, most people will lose some of all of their investment in these types of schemes.
Warning on cryptocurrencies
Consumers have been warned of the possible risks from buying, trading or holding virtual currencies such as Bitcoins by a European financial regulator.
The European Banking Authority (EBA) has warned that some of the biggest risks facing consumers include:
- money may be stolen from your ‘digital wallet’
- the value of the virtual currency may change quickly reducing the value of your investment, and
- losing your money if the exchange platform collapses.
Virtual currencies are not regulated, so if something does go wrong you will not be able to claim compensation.
For more information on how to protect yourself, to check if a firm is authorised, find firms to avoid or to report a firm or scam, contact the Financial Conduct Authority (FCA) on their consumer helpline on 0800 111 6768
or visit the FCA websiteopens in new window