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Can you count on cryptocurrencies?

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They're in the news, and possibly in your inbox too. But what exactly are cryptocurrencies, and what are the potential risks?

Bitcoin is big news. In circulation since 2009, the very first cryptocurrency regularly hits the headlines when its value soars and drops.

However, its image is tarnished by suggestions of fraud - and by spam emails promising unfeasibly huge gains for investors.

What is Bitcoin?

Bitcoin is a digital payment system. Its key difference from traditional currencies is that it doesn't depend on a single, central bank or government.

Instead, it's run through a peer-to-peer network known as a blockchain - essentially an online ledger that tracks every Bitcoin transaction.

The network is decentralised across every computer that uses the currency. So no one has overall control.

By cutting out intermediaries, Bitcoin and other cryptocurrencies allow direct transactions between payer and payee.

What's the legal status?

Some countries have banned its use, but Bitcoin is entirely legal in the UK.

However, the anonymity of transactions means it is open to use for illegal purposes - from buying drugs to money laundering and the funding of terrorism. One study suggests about half of Bitcoin transactions are linked to illegal activity.1

In addition, many of the thousands of cryptocurrencies that have followed Bitcoin onto the market are known to be frauds.

For these reasons, Bank of England governor Mark Carney has called for regulation of cryptocurrencies.2 The EU has also warned that it's prepared to regulate if risks escalate.3

CryptoUK, a trade body for the sector, has supported regulation.4

What is Bitcoin used for?

Bitcoin is intended to be fast, reliable and secure. At present, Bitcoin transactions are also tax-free. Anyone can trade in the currency through online exchanges.

Some online traders accept Bitcoin payments. It can be used for certain purchases from Microsoft and Expedia, for example.5 So far, however, major online players such as Amazon and PayPal have resisted Bitcoin payment.

In rare cases, Bitcoin has also been used as remuneration. One Japanese company has offered staff the option of receiving part of their salaries in Bitcoin.6

What are the risks?

Though it is among the more stable cryptocurrencies, Bitcoin has still been highly volatile, presenting a risk for traders and investors.

The value has surged and fallen dramatically in response to market events. So investing in Bitcoin in anticipation of a currency appreciation is a huge gamble.

In addition, several of the exchanges on which cryptocurrencies are traded have collapsed, leaving users out of pocket.

What is the future of cryptocurrencies?

Bitcoin releases are slowing. That's because the ultimate number of Bitcoins was set by its founder at 21m when the currency was launched.

Some 17m have so far been `mined'. There is no consensus about how the value will change as the limit is reached.

Whatever the future of Bitcoin and its fellow cryptocurrencies, the technology on which they are based seems likely to be adopted more widely.

While he believes cryptocurrencies are `failing', Mark Carney says blockchain technology could ultimately make payments more efficient and transparent.2