Cryptocurrency – virtual or electronic currencies – has been in the financial news a lot lately. However, it remains a mystery to most people. Below is an overview of cryptocurrencies: how they work, what drives interest in them, and their associated risks.

What are cryptocurrencies, how do they work and are they a legitimate form of payment?

It is estimated that there are more than 5,000 cryptocurrencies in existence. Bitcoin is enviable as one of the most widely recognized, but other popular cryptocurrencies include Dogecoin, Ethereum and Litecoin.

Bitcoin was created in 2009 by an anonymous person(s) under the alias Satoshi Nakamoto. Like other cryptocurrencies, Bitcoin uses a peer-to-peer network to generate secure electronic transactions known as blockchain. Cryptocurrencies can be purchased or mined and are stored in a digital wallet.

Bitcoin and other cryptocurrencies are increasingly gaining acceptance worldwide as a form of payment, but they do not currently have legal tender status in the U.S.

What is driving interest in them?

Supporters with a longer-term view find cryptocurrencies appealing to facilitate efficient and inexpensive domestic and global transactions because there is no exchange rate, among other features. In addition, cryptocurrency supporters consider the decentralized nature of blockchain to be more secure than other payment systems.

Further, the value of cryptocurrencies is not influenced by governments or central banks, which can devalue currencies over time through monetary policy. In contrast to supporters with a longer-term view, speculators are interested in cryptocurrencies because of the high volatility they exhibit and their potential for dramatic appreciation as demand increases.

What are the risks associated with cryptocurrencies?

There are many risks associated with cryptocurrencies. Most notably, they are highly volatile. Their value may fluctuate dramatically in a single day, making their use as a currency challenging. Without government support, cryptocurrencies may find stability difficult to achieve.

Additionally, cryptocurrencies are unregulated, leading to greater potential for fraud or loss of value. Further, using virtual “wallets” for storing cryptocurrency means there is a risk of loss due to hacking. This risk is not unique to cryptocurrency. However, when added to the other risks, it becomes apparent that cryptocurrency will need to evolve significantly before wider adoption becomes a reality.

NOTE: This article is for informational purposes only and is not intended as an offer or solicitation concerning the purchase or sale of any security. Statements in this report are based on information available at the time this report was prepared. Bankers Trust Company and its affiliates cannot guarantee the accuracy of the information. This commentary contains no investment recommendations, and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.