Cryptocurrencies: What Are They?

In only a few years' time, the cryptocurrency industry has exploded. From the now-ubiquitous tales of "bitcoin millionaires" to the increasing number of companies jumping into the crypto arena, it's hard to ignore the news—or the feeling that not owning cryptocurrency means missing out. The price of one bitcoin has ranged from $1,000 in early 2017 to more than $68,000 in November 2021, before falling back to around $16,000 by late 2022—but with intense volatility, including periodic drawdowns of more than 50% along the way.

Bitcoin is a virtual, digital, or "crypto" currency—so called because of the cryptography, or unchangeable coding techniques, involved in the blockchain code on which they exist. The intent of bitcoin is to allow online payments to be made directly from one party to another through a worldwide payment system, without the need for a central third-party intermediary like a bank. Bitcoin is not issued by any central bank or government and is still not considered legal tender (meaning a national currency established by statute) in most countries. Like physical gold, bitcoin's value stems from a combination of its perceived scarcity and the perception that it can be a store of value, an anonymous means of payment, or a hedge against inflation, though none of these characteristics have yet to establish a long-term track record.

Blockchain, the underlying technology that supports cryptocurrencies, is an open-source, public record-keeping system operating on a decentralized computer network (i.e., the internet) that records transactions between parties in a verifiable and permanent way. Blockchain provides accountability because the records are intended to be immutable, which presents potential applications for many businesses. While blockchain has often been associated with cryptocurrencies, it has many potential uses beyond payments, including smart contracts, supply chain management, and financial services. Note that ownership of bitcoin or other cryptocurrencies is not an investment in blockchain, the technology, or its current or future uses.

Fiat currencies like U.S. dollars and euros are forms of money issued by governments to serve as legal tender. Cryptocurrencies like bitcoin, on the other hand, are "non-fiat," non-governmental forms of "digital cash" to be used for electronic payments. The idea of "digital cash" isn't new—it started with credit cards, PayPal, Venmo, and others to satisfy the need for easy, traceable electronic payments. But those payments are tied to fiat currencies managed by central banks, whereas cryptocurrencies are managed by technology, specifically cryptology. Proponents believe the value of a cryptocurrency is based on the quality of the cryptology, the number of cryptocurrency units created, and the technology that limits the creation of additional units. Like any traded item—think baseball cards—the value often depends on supply and demand: The fewer units available, the higher the price potential buyers are willing to pay.

Like many new technologies or products, bitcoin attracted adherents interested in innovation and the perceived absence of governmental control. Traders saw it as an alternative to traditional investments like stocks, bonds, and cash, and trading momentum led to a rising, if highly volatile, price. All this attracted media attention, which has driven mainstream awareness and ultimately increasing acceptance and a market to trade it. While companies as varied as PayPal, Microsoft, Starbucks, and AT&T accept bitcoin as a form of payment, such transactions typically involve a third-party processor; thus, its use in everyday commerce remains far outside the mainstream.¹

Bitcoin was created based on a paper written in 2008 by a "founder" who goes by the pseudonym Satoshi Nakamoto, but no person or agency currently regulates it to ensure that it maintains value and liquidity and works as a means of payment. It's governed by consensus of a private digital community according to guidelines based on the community, cryptology, and a network of computers. While individual countries may allow bitcoin to be used as a means of payment, regulate the terms under which its citizens can trade or mine bitcoin, and authorize the operation of cryptocurrency exchanges, they don't regulate/control the existence or value of bitcoin itself or the blockchain code on which it operates. Bitcoin is promoted by the Bitcoin Foundation, but the foundation also does not control or manage bitcoin's trading or value. The number of bitcoins in circulation is limited by and managed by the original computer code and traded through one of several digital, decentralized exchanges.

No one knows for sure, but despite more than 85 million owners total as of June 2023, just 9.11% of account owners controlled more than 98% of the total bitcoin in circulation.¹

No. Bitcoin was the first cryptocurrency and is the best known, most widely held, and—with about 48% of the total cryptocurrency market cap.² However, as of June 2023, there were more than 25,000 digital currencies in the marketplace, of which more than 40 had a market capitalization exceeding $1 billion. Some more popular cryptocurrencies include BNB, USD Coin, Cardano, Tether, Ethereum, Polkadot, and XRP.

Federal Reserve Chair Jerome Powell and SEC Chair Gary Gensler both have stated that they don't intend to outlaw cryptocurrencies, but by mid-2023, both the SEC and the CFTC had initiated formal charges against Binance and Coinbase, two of the largest crypto exchanges, for operating unlicensed broker dealers, exchanges, and clearing agencies, as well as violating numerous federal securities laws intended to protect investors.  

Cryptocurrencies are not going away any time soon. China launched a digital yuan in 2021, and it's estimated that at least 100 different countries around the world (including the United States) are exploring the idea of launching their own proprietary Central Bank Digital Currency. In April 2023, European lawmakers approved the world's first comprehensive package of rules aimed at regulating cryptocurrencies, and in June 2023, the U.S. House Financial Services Committee and the House Agriculture Committee released a joint bill that creates a broad regulatory framework for cryptocurrency. This bill is expected to be taken up by Congress in 2024.

Schwab continues to monitor cryptocurrencies as regulations and technology evolve. While some traders have made money on the change in price of bitcoin or other cryptocurrencies (and others have lost money), we suggest most investors continue to treat them as a speculative asset primarily for trading with money outside a traditional long-term portfolio.