Cryptocurrency basics

Before you consider purchasing a cryptocurrency, make sure you understand how they work and the risks associated with them.

Cryptocurrencies explained

Cryptocurrencies, such as Bitcoin, Ether and Litecoin, are digital mediums of exchange that use cryptographyCryptography The conversion of information into a secret code, using complex math equations, so that it can be sent to another party securely. Cryptography is used to secure and create cryptocurrency and facilitate cryptocurrency transactions.+ read full definition as a method to help ensure the security and data integrity of the system. Different cryptocurrencies can be used in different ways. For example, some may be used as a way to purchase goods or conduct business online.

Cryptocurrencies are not issued or backed by a central bank or monetary authority and in many cases cryptocurrencies have not been subject to traditional financial sectorSector A part of the economy where businesses provide the same or related products or services. May also refer to a group.+ read full definition regulations. However, this may change as governments and regulators around the world consider new rules to oversee the use and sale of cryptocurrencies. Some cryptocurrencies, particularly those offered in initial coin offerings (ICOs) and initial token offerings (ITOs), may be subject to securities regulation. Learn more about cryptocurrency offerings.

How cryptocurrencies work

In some ways, sending and receiving cryptocurrencies is a lot like sending email. To start receiving email, you create an email address that you can shareShare A piece of ownership in a company. A share does not give you direct control over the company’s daily operations. But it does let you get a share of profits if the company pays dividends.+ read full definition with other people. To send an email from that address, you need to know both your address and a password, which only you know and which you don’t share with other people. Similarly, to acquire cryptocurrencies, you are assigned an address (often called a “public key”) that you can share with others. When you obtain an address, you also receive a password (called a “private key”) that you can use to send cryptocurrencyCryptocurrency Digital currency that is not regulated by the government. Cryptocurrencies are risky, vulnerable to hacking and are often used to support illegal activities. They are decentralized, meaning that no one owns or controls their networks, instead using peer-to-peer structures with hundreds of computers working together to process transactions.+ read full definition from your address, and which you do not share with other people.

Of course, cryptocurrencies don’t function exactly like email. There are a number of differences:

  • Unlike with email, where you get to pick your address and password, the public and private keys are assigned to you. Each key contains a string of letters and numbers. Your keys are linked together using an algorithm, which allows the system to confirm your public and private keys link up to the same accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition.
  • You do not provide any personal information to set up public and private keys. This makes your transactions difficult to trace back to you. It also means, if your private key is lost or stolen, you cannot regain access to your cryptocurrency by validating your identity.
  • While records of your emails are usually stored on a central server maintained by your email service provider, records of your cryptocurrency transactions are distributed publicly across hundreds, possibly even thousands, of computer systems around the world. These records are called a “blockchain,” a type of “distributed ledger.” Maintaining duplicate records on multiple systems is believed to make tampering more difficult.

Cryptocurrency transactions do not happen instantaneously. Because records are kept on multiple systems, it takes time for these systems to validate transactions and agree to add them to the blockchain (i.e., their ledgers). Cryptocurrency “miners” typically solve complex math problems to validate and properly record transactions. Anyone with a computer and an internet connection can try to participate in “mining”. Miners are typically paid transactionTransaction The process where one person or party buys goods or services from another for money. Examples include taking money out of an account, buying something with a credit card or taking out a loan.+ read full definition fees and may also receive rewards (usually in the form of newly-issued cryptocurrency). These rewards are intended to encourage people to build and maintain the complex “mining systems” necessary to create cryptocurrency and to keep cryptocurrency transactions running.

Cryptocurrency users (users) often pay a fee for sending cryptocurrency to another user. Fees vary depending on the cryptocurrency used, and generally these fees are not regulated. High demand for cryptocurrency may result in higher fees for users.

Purchasing cryptocurrencies

Cryptocurrencies often are purchased through online cryptocurrency trading platforms (commonly called cryptocurrency “exchanges”), which allow users to buy, sell or exchange cryptocurrencies for other cryptocurrencies or conventional money (like dollars), often for a fee.

Cryptocurrency trading platforms operate around the world. These platforms may be especially susceptible to fraud and market manipulation. In addition, the same cryptocurrency may tradeTrade The process where one person or party buys an investment from another.+ read full definition for significantly different prices on different platforms.

These platforms are also subject to significant operational risks: because they hold the private keys for their users’ cryptocurrency, they are often the target of cyberattacks intended to gain access to these keys and steal users’ cryptocurrency. Cyberattacks may also be intended to disrupt trading on these platforms. Users may experience problems placing and executing trades over a platform, due to technical problems on that platform or because the platform has temporarily halted trading in one or more cryptocurrencies. In addition, there is no guarantee that a platform will have sufficient cash on hand to meet users’ withdrawal requests. These platforms typically place limits on the amount of cash that a user can withdraw in a single day.

Some companies offer cryptocurrencies for sale at a physical kiosk, often branded as an “ATM,” which lets you insert cash in exchange for a cryptocurrency. If you already have a public key, the kiosk can send your cryptocurrency to that public key; otherwise, the kiosk often can assign you new public and private keys and then print these keys off for you on a slip of paper. Before purchasing cryptocurrencies at a kiosk, make sure you understand the fees you are being charged. Keep any private keys you receive secure, and do not share them with anyone.

Cryptocurrency risks

Before you consider purchasing any type of cryptocurrency, understand the risks, including:

  • High volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition – Cryptocurrencies are prone to large swings in market valueMarket value The value of an investment on the statement date. The market value tells you what your investment is worth as at a certain date. Example: If you had 100 units and the price was $2 on the statement date, their market value would be $200.+ read full definition, gaining or losing hundreds or even thousands of dollars over the course of a day. This makes holding cryptocurrencies risky; any cryptocurrencies you own could stand to lose some or all of their market value at any time.
  • Lack of oversight – Regulation and oversight are intended to protect the interests of users. In the absence of regulation and oversight, a user may be left with few remedies if they lose money as a result of a cryptocurrency transaction. The “terms and conditions” or other contracts an individual typically agrees to when signing up for a cryptocurrency trading platform or other service are usually drafted by the service provider, and may be not be in the best interest of the user. Carefully review the terms and conditions associated with any cryptocurrency trading platform or other party that you use to purchase or sell cryptocurrencies. News articles and online forums may help you learn more about the reputation of a cryptocurrency trading platform or other service and the quality of its services. However, it is crucial to read third party information with a skeptical eye. Similar to any unverified source, positive reviews might be drafted by employees, or other people paid by a service provider. Also, information could be outdated or inaccurate by the time you come upon it.
  • Risk of fraud – Some fraudsters have tried to capitalize on market interest in cryptocurrencies by creating new scams, or rebranding existing scams such as Ponzi schemes. They are looking for people who are seeking opportunities to get in “on the ground floor” with cryptocurrencies. If you are ever approached about a cryptocurrency investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition, consider whether it fits the signs of investment fraud. Learn how certain transactions involving cryptocurrencies are regulated in Ontario. When in doubt, contact your provincial or territorial securities regulatorSecurities regulator A government agency that enforces the securities act in jurisdiction it has authority over. This act is made up of laws that establish rules for issuing and trading securities. The Ontario Securities Commission is the securities regulator for Ontario.+ read full definition, such as the Inquiries and Contact Centre of the Ontario Securities Commission.

Cryptocurrencies may also be subject to other risks. Learn more about types of investment risk.

Caution

Before you consider purchasing a cryptocurrency, make sure you understand how they work. The Ontario Securities CommissionOntario Securities Commission An independent Crown corporation that is responsible for regulating the capital markets in Ontario. Its mandate is to provide protection to investors from unfair, improper or fraudulent practices and to foster confidence in fair and efficient capital markets.+ read full definition’s Inquiries and Contact Centre is available to answer your questions. You can also get unbiased responses to your investing questions at Re: Investing.

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