A cryptocurrency is a type of digital currency that’s not tied to any type of central authority, such as a specific bank or government. Cryptocurrency shouldn’t affect your credit.
The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.
Cryptocurrency is a popular concept right now, but not everyone understands what it is, how it works and how it fits into the rest of your finances. If you’re considering diving into crypto, you might wonder whether cryptocurrency affects your credit score. The quick answer is no, using crypto shouldn’t affect your credit.
Still, if you’re going to explore cryptocurrency, you should have a general understanding of it before you start investing much. This guide walks you through everything you need to know about what cryptocurrency is and how it impacts your finances.
What is cryptocurrency?
A cryptocurrency, also commonly known as crypto, is a type of digital currency secured by cryptography and exchanged through a computer network and stored digitally. This type of currency was created as a form of payment that’s not tied to any type of central authority, such as a specific bank or government.
Some of the most popular cryptocurrencies right now are Bitcoin, Ethereum, Tether, Binance Coin and USD Coin.
Cryptocurrency has gained popularity because it comes with several advantages, including:
Of course, there’s also been a lot of criticism of cryptocurrency due to some of its drawbacks. The most well-known downsides to cryptocurrency are:
- Many people use cryptocurrency to perform illegal transactions as it can be impossible to trace ownership
- Cryptocurrencies have a reputation for taking considerable swings in the market, rapidly increasing and decreasing in value, which makes them a high-risk investment
- It’s also risky to hold cryptocurrency, as you can lose your digital wallet and then lose that money forever. One man in London accidentally threw out his hard drive with the garbage—today, the amount of Bitcoin on that hard drive would be worth $280 million
- There’s a risk that someone could hack your computer and steal your digital wallet (although the same risk holds true now with online banking and your “regular” money)
Cryptocurrency is taxable. The U.S. government considers your digital wallet the same as other assets, like gold and stocks, and it will be taxed at the same rate.
How does cryptocurrency work?
Cryptocurrency is a digital coin based on blockchain technology and secured by cryptography. Blockchain is a type of distributed ledger that offers a way for cryptocurrencies to record and transfer information securely. To put in another way, the blockchain is like a ledger keeping track of cryptocurrency transactions across authorized users.
Blockchain technology wouldn’t be possible or effective without the privacy and security offered by cryptography. Cryptography helps encrypt cryptocurrencies so unauthorized users can’t access them.
These elements work together to create what cryptocurrency promises: a secured, anonymous digital coin that can be easily transferred between authorized users without monitoring from a central system like a government.
Cryptocurrency and your credit
Cryptocurrency can’t affect your credit unless you purchase it with credit. Most financial experts discourage buying cryptocurrency with credit, so hopefully you don’t run into this issue. Since cryptocurrencies are so volatile, if you purchase them on credit cards, you run the risk of going into debt and incurring high credit card interest and transaction fees.
Imagine you buy $10,000 in cryptocurrency on your card and the next week, that particular digital coin takes a drastic dip. Now that $10,000 is worth $100, while you still have to pay off your credit card at a 22 percent APR—not a situation anyone would want to be in. Due to this volatility, some credit card companies don’t allow crypto purchases.
How to buy cryptocurrency
If you decide to purchase cryptocurrency, you can follow these steps:
1. Buy through a traditional broker or centralized exchange
First, you always want to purchase your cryptocurrency safely to avoid being scammed. The two safest sources are through a traditional broker or a centralized exchange.
Many traditional brokers that help individuals buy and sell financial assets like stocks, bonds and EFTs also help purchase cryptocurrency. However, these brokers typically only offer a few crypto coins to choose from.
The other option is purchasing through a cryptocurrency exchange that allows you to buy multiple kinds of cryptocurrencies, wallet storage and other features. This is the preferred option for beginners as it’s much easier to set up an account with a cryptocurrency exchange than a broker, and it comes with more options.
Still, when deciding between the two, it’s best to look at the cryptocurrencies on offer, the fees, your storage and withdrawal options and the security features.
2. Decide how to pay
You can purchase cryptocurrency with fiat currency (government-issued currencies like the U.S. or Canadian dollar) via debit or bank transfer, credit or another crypto.
As we’ve already mentioned, purchasing with credit is quite risky and isn’t recommended unless you can immediately pay that credit card off.
You may have to check with your broker or centralized exchange to see what kinds of payment methods they accept and if the charges vary depending on the payment type.
3. Purchase your cryptocurrency of choice
There are more than 1,500 types of cryptocurrencies available for purchase. Your next step will be to decide which cryptocurrency is best for you. You should do your research and decide what aligns with your investment goals.
While you’re purchasing your cryptocurrency, you’ll need to figure out where you’ll store it. There are different ways to store crypto safely, including hot wallets and cold wallets.
Hot wallets are a type of cryptocurrency storage that uses online software to protect the private key that holds your assets. Cold wallets (or hardware wallets) are offline electronic devices that store your private keys—like a hardware disc. Hot wallets often don’t charge fees, while cold wallets do.
What can you buy with cryptocurrency?
The list of things you can buy with crypto is growing but still limited. Currently, some things you can use it for include:
- Products and services from tech companies and some e-commerce websites. Some examples include AT&T, Shopify, Home Depot, Overstock, Microsoft and Rakuten
- Cars at some car dealerships
- Some luxury good stores (watches, jewelry, etc.)
- Some insurance companies
- News media subscriptions
- Donations to some charities and nonprofits
Should you buy cryptocurrency?
Whether or not you should buy cryptocurrency is a personal decision. Remember that cryptocurrency is somewhat shielded from rising inflation rates and allows you to make anonymous purchases. But it also comes with risks like the volatile cryptocurrency market and the possibility your digital wallet could be lost or stolen.
Overall, crypto is a riskier investment than other options, so it’s recommended that cryptocurrency not make up too much of your investment portfolio. Most financial experts recommend that crypto make up between 2 and 5 percent of your portfolio and that you’re comfortable losing this money.
Famous personal finance adviser and expert Suze Orman says about Bitcoin, “I think it should be a part of your portfolio as long as you can afford to lose that money and you’re going to keep it for a seriously long period of time.”
If you do want to invest, do your research first:
- Find out what kind of security your brokerage or centralized exchange has
- Compare fees before choosing where you buy
- Find out if there are fees to buy or sell
- Understand that volatility will happen and it’s best to be able to hold out rather than panic sell
- Know how to store your digital wallet safely
- Diversify your investments and don’t keep too large a share in crypto
You may hear many stories about overnight crypto millionaires, but don’t assume that’ll happen to you. This is a risky investment that can potentially offer high rewards but can also come with significant losses. It can be fun to play around with cryptocurrency investments when you’re not risking your life savings, but it’s important to have other investments in places with a higher chance of return—such as property investment or index fund stocks.
Learn more about what kinds of things do and don’t affect your credit by getting in touch with the consultants at Lexington Law today.
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