In just over a decade, cryptocurrencies have grown from digital novelties to trillion-dollar technologies with the potential to disrupt the global financial system. An increasing number of investors now hold bitcoin and hundreds of other cryptocurrencies as assets and use them to buy a swath of goods and services, such as software, digital real estate, and illegal drugs.
To their proponents, cryptocurrencies are a democratizing force, wresting the power of money creation and control from central banks and Wall Street. Critics, however, say that cryptocurrencies empower criminal groups, terrorist organizations, and rogue states while stoking inequality, suffering from drastic market volatility, and consuming vast amounts of electricity. Regulations vary considerably around the world, with some governments embracing cryptocurrencies and others banning or limiting their use. As of January 2024, 130 countries, including the United States, are considering introducing their own central bank digital currencies (CBDCs) to compete with the cryptocurrency boom.
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What are cryptocurrencies?
So called for their use of cryptography principles to mint virtual coins, cryptocurrencies are typically exchanged on decentralized computer networks between people with virtual wallets. These transactions are recorded publicly on distributed, tamper-proof ledgers known as blockchains. This open-source framework prevents coins from being duplicated and eliminates the need for a central authority such as a bank to validate transactions. Bitcoin, launched in 2009 by the pseudonymous software engineer Satoshi Nakamoto, is by far the most prominent cryptocurrency, and its market capitalization has peaked at more than $1 trillion. Numerous others, including Ethereum, the second-most popular, have proliferated in recent years.
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Cryptocurrency users send funds between digital wallet addresses. These transactions are then recorded into a sequence of numbers known as a “block” and confirmed across the network. Blockchains do not record real names or physical addresses, only the transfers between digital wallets, and thus confer a degree of anonymity on users. Some cryptocurrencies, such as Monero, claim to provide additional privacy. However, if the identity of a wallet owner becomes known, their transactions can be traced.
Bitcoin “miners” earn coins by solving complex math problems to organize these blocks, thereby validating transactions on the network; the process requires a system known as “proof of work.” Many cryptocurrencies use this method, but Ethereum and some others instead use a validation mechanism known as “proof of stake.” In bitcoin’s case, a transaction block is added to the chain every ten minutes, at which point new bitcoin is awarded. (The reward decreases steadily over time.) The total supply of bitcoin is capped at twenty-one million coins, but not all cryptocurrencies have such a constraint.
The prices of bitcoin and many other cryptocurrencies vary based on global supply and demand. However, the values of some cryptocurrencies are fixed because they are backed by other assets, thus earning them the name “stablecoins.” While these coins tend to claim a peg to a traditional currency, such as $1 per coin, many such currencies were knocked from their pegs during a spate of volatility in 2022.
Why are they popular?
Once dismissed as a fringe interest of tech evangelists, cryptocurrencies—particularly bitcoin—have skyrocketed to mainstream popularity and trillion dollar valuations. In November 2021, the price of bitcoin surged to more than $60,000 for the first time, though it has since fallen. As of mid-2023, an estimated 17 percent of U.S. adults polled by the Pew Research Center had invested in, traded, or used cryptocurrency.
Different currencies have different appeals, but the popularity of cryptocurrencies largely stems from their decentralized nature: They can be transferred relatively quickly and anonymously, even across borders, without the need for a bank that could block the transaction or charge a fee. Dissidents in authoritarian countries have raised funds in bitcoin to circumvent state controls, including to avoid U.S. sanctions on Russia.
Some analysts say that digital assets are primarily tools for investment. People buy cryptocurrencies “because of a speculative belief that these tokens are going to go up in the future, because a new future is being built on the blockchain,” says CFR Senior Fellow Sebastian Mallaby. Some bitcoin proponents view the cryptocurrency as a hedge against inflation because the supply is permanently fixed, unlike those of fiat currencies, which central banks can expand indefinitely. However, after bitcoin plummeted amid stock market volatility in 2022, many experts questioned this argument. The valuation of other cryptocurrencies can be harder to explain, though many are associated with a larger project within the digital asset industry. Some cryptocurrencies, such as Dogecoin, were created as jokes, but have retained value and garnered investment from high profile investors.
In countries with historically weak currencies, including several Latin American and African countries, bitcoin has become popular with populist leaders. In 2021, El Salvador made waves by becoming the first country to make bitcoin legal tender (residents can pay taxes and settle debts with it), though less than 15 percent of people had used it for that purpose in 2023, according to a poll by Central American University.
The price of bitcoin and other cryptocurrencies fluctuates wildly, and some analysts say this limits their usefulness as a means of transaction. (Most buyers and sellers don’t want to accept payment in something whose value can change dramatically from day to day.) Nevertheless, some businesses accept bitcoin.
Experts say stablecoins could be more effective than other cryptocurrencies as a form of payments. The value of stablecoins is, as their names implies, relatively stable, and they can be sent instantly without the transaction fees associated with credit cards or international remittance services such as Western Union. In addition, because stablecoins can be used by anyone with a smartphone, they represent an opportunity to bring millions of people who lack traditional bank accounts into the financial system. However, they have drawn increased scrutiny from regulators, especially after several stablecoins sunk below their $1 pegs during 2022’s market volatility.
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