Cryptocurrency is growing more mainstream, making it more difficult for investors to ignore it. You might be unsure what to make of bitcoin and whether it should be included in your investment portfolio. However, even the most fundamental concept might be daunting if you are unfamiliar with digital currency or blockchain technology.
Here’s our primer on cryptocurrency and why it’s causing such a stir these days.
What is Cryptocurrency?
Cryptocurrency is a sort of digital and decentralized currency. Cryptocurrencies may be used to buy and sell items, and their ability to store and grow value has piqued investors’ interest.
Today, there are tens of thousands of different cryptocurrencies to choose from. Bitcoin, which was founded in 2009, is the most popular — and the first. Ethereum, XRP, and Bitcoin Cash are three famous cryptocurrencies. Each of these currencies has a distinct function, with some meant for use as a substitute for cash and others for private, direct transactions.
Because cryptocurrencies are entirely digital, there is no tangible coin or bill associated with the one you own. Owners instead store cryptocurrencies in a digital wallet and trade them on an internet exchange. Your wallet could be stored online (some major exchanges, such as Coinbase, Binance, have in-app wallets) or offline on a physical device like a USB drive.
Cryptocurrency’s core tenet is decentralization. Unlike traditional currencies–often called “fiat currencies”–, which are backed by a central bank — the US dollar, for example, is backed by the US government’s “full faith and credit” – cryptocurrencies are maintained and valued by their users.
A decentralized ledger is used to record cryptocurrency transactions. A blockchain is a name for this type of ledger. Every time someone buys or sells cryptocurrency, the transaction is recorded on the blockchain, which is a public database of all transactions that is accessible to other cryptocurrency holders. Anyone can join and participate in the blockchain, but the data on individual transactions — and the persons involved — is encrypted (the basis for the term cryptocurrency). A digital validation mechanism is used to check and prevent fraud for each transaction uploaded to the blockchain.
What Can Cryptocurrency Be Used For?
While bitcoin has elements of both currency and investments, experts are divided on whether it is obviously one or the other.
You can buy things using cryptocurrency, as the name implies. Your purchasing power, however, is limited because cryptocurrency is still not generally accepted by stores and other businesses.
According to Roger Aliaga-Daz, principal and senior economist of Vanguard Investment Strategy Group, crypto’s function as a currency is limited due to its lack of widespread adoption and volatility.
Crypto is a sort of alternative investment for many people. You can buy and trade cryptocurrencies in the same way that you can buy and trade stock in public corporations in the hopes that it will appreciate in value over time, allowing you to cash out for a profit at a later date. Some people invest in cryptocurrency not because they believe it will become a popular currency, but because they believe in the blockchain technology that underpins it.
However, defining cryptocurrency as an investment is also difficult. It doesn’t fit the shape of a traditional stock or bond, and while cryptocurrencies have some similarities to commodities like gold, such as the ability to be bought and sold for cash as well as derivatives based on predicted future value, they have no inherent physical worth or utility.
Cryptocurrency rises and falls on an unpredictable demand cycle since there is no clear track record to gauge long-term worth. Individual investors face a similar challenge since “you never know where supply and demand will end up,” Aliaga-Daz explains.
There are considerable hazards connected with a mostly unregulated market, similar to forex — foreign exchange — trading, and your best chance is to get informed ahead and don’t spend any money you can’t afford to lose. Regulators are still figuring out how to categorize cryptocurrencies for trading, payments, anti-fraud, taxation, and other purposes. Clear legislation could help us comprehend how to utilize cryptocurrencies and where they might go in the future, but we aren’t there yet.
Former SEC Chairman Jay Clayton recently told CNBC that “where digital assets reside, at the end of the day… will be dictated in part by legislation, both domestic and international.”
What Cryptocurrency Terms Should You Be Aware Of?
Blockchain: A blockchain is a sort of database in which the digital transaction records of a cryptocurrency are stored in groups or blocks. As extensions of the previous block, new blocks are continually formed, establishing a chain. Within the database, these blockchains layer on top of each other, recording an ever-increasing quantity of data on a cryptocurrency’s transactions.
Decentralized: The term decentralized refers to the fact that cryptocurrency is not backed by a central bank or other financial organization.
Distributed Ledger Technology (DLT): A decentralized digital record created by distributed ledger technology (DLT). There is no central authority, unlike traditional databases; the record is saved in several locations at the same time, and once a transaction is logged, it is permanent. Although blockchain is a sort of distributed ledger technology, it may be used for a variety of reasons other than bitcoin trading.
Bitcoin: Bitcoin was the first cryptocurrency, and it remains the most widely used today.
Altcoins: Any cryptocurrency that isn’t Bitcoin is referred to as an altcoin. Ethereum, Dogecoin, and Litcoin are some of the most popular altcoins today. Each of these cryptocurrencies has its own set of features and uses.
Exchange: A cryptocurrency exchange is a site where you may purchase and trade cryptocurrency.
Wallet: A wallet is a digital wallet that allows you to keep track of your cryptocurrency holdings. Digital wallets are available on several exchanges.
Is Cryptocurrency Safe?
Due to the decentralized — and public — nature of distributed ledger technology and the encryption process that every transaction goes through, the blockchain technology that underpins bitcoin is inherently safe.
However, this does not involve that it is fully secure in the same sense that most people regard the US dollar or other established currencies. Because Bitcoin is not backed by any government, it lacks the same safeguards as many traditional currencies around the world.
“If a virtual currency company fails – and many have,” the Consumer Financial Protection Bureau said in a 2014 notice regarding cryptocurrency, “the government would not pay the loss,” unlike money saved in a bank insured by the Federal Deposit Insurance Corporation (FDIC) (its most recent guidance).
Consumers should be aware of more particular hazards, such as unpredictable currency rates, potentially excessive fees on exchange platforms, and the danger of fraud, according to the CFPB. Due to the decentralized nature of blockchain and the lack of governmental regulation, it can be extremely difficult to reclaim your cash if they are lost or stolen.
Furthermore, just because Bitcoin is secure does not imply that it is safe. While investors’ trust in cryptocurrency’s value has fueled part of its current appeal, such value is still dependent on guesswork. Those that invest in cryptocurrency will be taking on one of the riskiest ventures they will ever undertake.
Daniel Johnson, a financial advisor and founder of RE|Focus Financial Planning in Asheville, North Carolina, says, “I believe everyone should have a diverse portfolio.” Any investment you make should be measure dcarefully about the rest of your portfolio and the general market. It’s imprudent to put all of your money into crypto, just as you wouldn’t put all of your money into one company.
What Does Cryptocurrency’s Future Hold?
In recent years, the value of Bitcoin and other cryptocurrencies has surged. In 2021, Bitcoin’s price has more than doubled, while Ethereum’s worth has more than quadrupled.
However, whether or whether that growth is sustainable, as well as what it means in the long run, remains to be seen. Dr. Richard Smith, executive director of the Foundation for the Study of Cycles, a nonprofit organization dedicated to studying recurring patterns throughout economies and cultures, says, “This crypto, blockchain technology, the public interest in it right now is being driven by a kind of speculative fever.”
Despite this, a growing number of large, powerful players are seeing crypto’s potential.
“Every single day, more large, powerful entities are continually approving the concept that it could be worth something, that it could be a store of value,” Johnson says, pointing to established financial institutions holding digital currencies and large corporations adding them to their corporate balance sheets. “As adoption and acceptance rise, so does the belief that it’s genuinely worth something.”
Finally, the future of cryptocurrencies — their value, security, and long-term viability — remains uncertain. However, according to the experts we spoke with, owning some cryptocurrency could increase in value over time. Experts emphasize the necessity of understanding the particular volatility and risk characteristics of cryptocurrency before investing, regardless of your purpose or interest.
“I believe it is critical to keep your eyes open,” Johnson says. “Don’t develop FOMO when you’re sick because it’s highly explosive. No one should invest money they can’t afford to lose, and this is advice I provide to anyone considering any type of investment.”