Cryptocurrency Explained: How It Works, Risks And Taxes

Key takeaways

Cryptocurrency is digital money recorded on a shared public ledger, with no bank in the middle.
Prices are very volatile, and most crypto markets are not regulated or insured the way bank deposits are.
Scams often ask for payment in crypto. Real businesses and government agencies don’t.
The IRS treats crypto as property, so selling or spending it can create a tax bill.

This article is general information, not investment, tax or legal advice. We don’t recommend buying any cryptocurrency. Talk to a qualified professional about your own situation.

What is cryptocurrency?

Cryptocurrency is digital money that exists only electronically. There are no coins or banknotes. Most cryptocurrencies aren’t controlled by a bank or government. Instead, a network of computers records and checks every transaction.

Bitcoin was the first, and thousands of others now exist. Some are used as payment, some as investments, and some power software projects. Their values can differ enormously, and most go down in value or disappear over time.

How it works

Blockchain. Most cryptocurrencies use a blockchain: a public ledger, copied across many computers, that records every transaction in groups called blocks. Once a block is added, it is very hard to change.
Transactions. When you send crypto, the transaction is broadcast to the network. Computers (called miners or validators, depending on the system) check it and add it to the ledger.
Wallets. Your crypto isn’t “in” a wallet. The wallet holds the private keys that prove it’s yours. Lose the keys, or have them stolen, and you can lose the crypto. Wallets can be apps, devices or paper.
Exchanges. Most people buy crypto through an exchange, a company that matches buyers and sellers. Exchanges are businesses, and some have failed or been hacked.

The main risks

Prices swing widely. The Commodity Futures Trading Commission (CFTC) says virtual currencies “are more volatile than traditional fiat currencies.” Large swings can happen in days.

Little protection. The CFTC says “most cash markets are not regulated or supervised by a government agency,” and that platforms may lack key customer protections. Crypto is also not covered like a bank deposit. The Securities and Exchange Commission (SEC) has warned that crypto held with companies offering interest-bearing crypto accounts is not insured by the FDIC or NCUA, and that SIPC, which protects brokerage customers, does not generally cover the loss of most crypto assets.

Hacks and theft. The CFTC notes that crypto is “commonly targeted by hackers and criminals,” and that there is “no assurance of recourse if your virtual currency is stolen.”

Borrowed money makes it worse. Trading with leverage (borrowed money) can magnify losses. The CFTC warns people may “lose more than their initial investments.”

Transfers can’t be undone. The FTC says crypto transfers are generally not reversible. If you send it to a scammer, getting it back is rarely possible.

Scams to know

The Federal Trade Commission (FTC) describes familiar scams that now demand crypto. Watch for:

Anyone who demands payment in crypto. The FTC says, “Only scammers demand payment in cryptocurrency.” Legitimate businesses and government agencies don’t.
Guaranteed profits. “Only scammers will guarantee profits or big returns.” Endorsements and testimonials are easily faked.
Celebrity or “investment manager” offers that reach you by social media, text or email.
Romance and investment mixed together. The FTC’s advice is blunt: never mix online dating and investment advice.
Vague answers about how the investment works and where your money goes.
Upfront fees to get a job, paid in crypto.
Blackmail threats that demand crypto. Don’t pay, and report it to the FBI.

If you’ve been scammed, report it to ReportFraud.ftc.gov. You can also report to the CFTC, SEC, the FBI’s Internet Crime Complaint Center (ic3.gov), and the exchange you used. Recovery is often not possible, so prevention matters most.

How crypto is taxed in the US

The IRS says that for US tax purposes, “digital assets are considered property, not currency.” In general:

Taxable events: selling crypto for dollars, trading one crypto for another, spending it on goods or services, and receiving it as payment, a reward, mining or staking income, or certain airdrops.
Not taxable by itself: buying crypto with dollars, holding it, or moving it between wallets you own.
Gains and losses: if you held the asset for personal or investment purposes, your gain or loss is usually a capital one. It’s short-term if you held it a year or less, and long-term if longer.
The Form 1040 question: every year the return asks whether you received, sold, exchanged or otherwise disposed of a digital asset. You must answer yes or no.
Records: keep records of what you bought, when, what you paid, and what you sold or spent. You report transactions whether or not they produce a gain or loss.
Broker reporting: brokers report to the IRS on Form 1099-DA, starting with transactions in 2025, and cost basis reporting starts for certain transactions in 2026.

The IRS also warns that it doesn’t send letters asking you to register digital assets through a QR code. Treat those as scams.

A tax professional can tell you how this applies to you.

Questions to ask before you buy anything

Can I afford to lose all of it? Don’t use money you need for bills, emergencies or retirement.
Do I understand what I’m buying and how it’s meant to make money?
Who is selling it, and are they a registered, established company?
Am I being rushed, or promised a guaranteed return? If yes, stop.
How will I store it safely, and how will I keep records for taxes?

Frequently asked questions

Is cryptocurrency legal in the US?

Owning it is legal, but it is regulated by several agencies and rules change. Check current rules before you trade.

Is crypto insured like a bank account?

Generally no. See the SEC and CFTC warnings above.

Which crypto should I buy?

We don’t recommend specific coins. Anyone who promises one will “go up” is guessing or selling something.

Do I owe tax if I only hold it?

Holding alone isn’t a taxable event, but selling, spending or trading it can be.

Sources

Money note: this article is for general information and is not financial advice.