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Published April 4, 2022

What Is Cryptocurrency and How Does It Work?

Cryptocurrency is a digital asset supported by a decentralized technology known as blockchain. Cryptocurrencies are unregulated and their values are highly volatile.

Cryptocurrency (also referred to as crypto, crypto assets, digital currency and altcoin) is a form of digital or virtual currency. Unlike traditional currencies, cryptocurrency is not a tangible form of money, meaning it doesn’t come in physical bills or coins.

Over the last few years, cryptocurrencies have gone from being esoteric concepts largely ignored by traditional financial institutions to some of the most talked-about, controversial and coveted assets in the world.

What is cryptocurrency?

Cryptocurrency is made possible by a ledger technology called blockchain that relies on advanced computer algorithms to track transactions.

One of the most well-known cryptocurrencies is Bitcoin, which was introduced in 2009. Since then, cryptocurrencies have become incredibly popular. By some estimates, there are over 10,000 digital currencies in circulation worldwide.

In Canada, traditional units of currency are known as dollars. In contrast, individual units of cryptocurrencies are often referred to as coins or tokens.

Unlike traditional currency, which is approved by a nation as legal tender and regulated by a national government and centralized bank, cryptocurrency is largely unregulated and there is no single overarching financial entity that oversees its use. As such, crypto is not considered legal tender in Canada.

Cryptocurrencies are designed for several different purposes:

  • To be exchanged for goods and services, much like traditional currency.
  • To store value, like a share of stock or other investment.
  • To facilitate computer networks that handle complex financial transactions.

Why are cryptocurrencies popular?

Reasons for crypto’s growing popularity include its decentralized, unregulated nature; a unique and arcane creation process; and the fact that transactions can’t be traced. The constant headlines cryptocurrency seems to command in the news — mostly due to volatile value fluctuations — also add to its allure, even if those stories are often about the unpredictable nature of crypto as an investment.

If you were to name the single moment when digital currency went from outlier to mainstream news item, you would likely go back to 2017, when the value of a single bitcoin went from $3,000 to $20,000 in six months. A year later, the value had plummeted back down to around $4,000. As of the time of this writing, the pendulum had swung back the other way, with a bitcoin trading at over $55,000. The rollercoaster-like ride and high-risk status of the the investment are features that attract some to crypto, while serving as a warning to others.

» MORE: Scams to watch out for in Canada

What cryptocurrencies are available in Canada?

Some of the most widely traded digital currencies in Canada include Bitcoin, Ethereum, XRP, Litecoin, Ripple, EOS, Chainlink, Polkadot, Uniswap, Polygon and Dogecoin.

Canadians can access digital currencies via a number of crypto trading platforms, like Binance, Bitbuy, Coinbase, Crypto.com and Kraken. Binance, for example, is the largest crypto exchange in the world and sells over 350 different varieties of cryptocurrency. Note: As of June 2021, Binance ceased operations in Ontario due to regulatory pressure from the Ontario Securities Commission.

» MORE: How do online-only banks work?

How to buy cryptocurrency in Canada

In Canada, the main way to buy and sell digital assets is by using an online crypto exchange. These exchanges operate much like a traditional brokerage trading platform, though with a crypto exchange you may have the option to buy digital currencies with your own traditional currency (Canadian dollars) or any existing crypto assets you own.

While some platforms hold your assets for you in their own proprietary “wallet” specially designed to store digital currency, you may have the option of moving your crypto assets into your own, non-hosted wallet (i.e., one that’s not overseen by a crypto platform). More experienced digital traders usually like to have absolute control over their own assets and so will often opt to house crypto into their own wallet.

  • Online wallets (also called hot wallets) are stored in the cloud and accessed via your computer or mobile device.
  • Offline wallets (also called cold wallets) are not connected to the internet. Instead, they are like flash drives on which your digital assets are stored.

Online wallets are less secure than hardware/offline wallets because they’re connected to the internet and can therefore potentially be hacked. However, it’s much easier to lose a hardware wallet. All wallets feature advanced software that is specially encrypted and protected by a personal identification number (PIN) that you’ll need to access your crypto. If you lose your PIN or a hardware wallet, you lose your crypto — that’s one of the dangers of investing in a non-regulated, decentralized currency.

Be aware that not all crypto trading platforms allow you to actually store digital assets off of the platform in your own wallet, so check the details before you sign up.

» MORE: Are you ready for a digital wallet?

Is it safe to invest in cryptocurrency?

Cryptocurrency is one of the most volatile investments in the world. While you could certainly see huge gains, you’re just as likely to experience massive drops in value. Because digital currency is fairly new and unregulated, performance is difficult to predict, making it tough for beginner investors.

For those looking to experience the excitement of trading in digital assets but who also want to minimize risk, investing in a cryptocurrency exchange traded fund (ETF) could be the answer.

Canada has numerous cryptocurrency ETFs available, including several that focus solely on Bitcoin and even a carbon-neutral crypto ETF. Another advantage is that crypto ETFs can be held in registered accounts (like RRSPs and TFSAs), whereas individual cryptocurrencies can’t.

» MORE: How to invest in a TFSA

What can I do with my cryptocurrency?

Cryptocurrency is not a widely accepted form of payment in Canada. Because the value of any kind of digital currency is erratic, many merchants are reluctant to accept it in exchange for goods and services.

One way to spend your cryptocurrency in Canada is to buy gift cards at Coincards.ca. This platform allows you to exchange cryptocurrency for gift cards from a wide array of retailers like Starbucks, Amazon.ca and Air Canada. The site also offers prepaid Visa and Mastercards.

A crypto rewards credit card can be another way to both earn and spend digital currencies. With a crypto rewards card, you have the option to earn digital currencies — rather than points or miles — in exchange for typical spending. Certain crypto rewards cards also act like their own exchange, allowing you to buy goods and services with your digital currency.

Taxes and cryptocurrency

In 2021, the Canada Revenue Agency (CRA) introduced a guide detailing the tax implications of owning and trading in cryptocurrency. The CRA announced that it will treat cryptocurrency like a commodity for purposes of the Income Tax Act. Any income generated from transactions involving digital currency will be treated as either business income or as a capital gain, depending on the taxpayer’s circumstances.

About the Author

Sandra MacGregor

Sandra MacGregor has been writing about personal finance, investing and credit cards for over a decade. Her work has appeared in a variety of publications like the New York Times, the UK Telegraph, the Washington Post, Forbes.com and the Toronto Star. You can follow her on Twitter at @MacgregorWrites.

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