It’s about time we talk about cryptocurrency. Throughout 2020 and into 2021, no other financial topic has dominated the news cycle like crypto. And yet, despite all of this media coverage, most people still aren’t sure what crypto is and if they should be investing in it.
Don’t worry if you’re out of the loop. In this article, I’ve put together an introduction to crypto to help you understand this nebulous digital currency. Here’s what you need to know to consider if crypto is a sound investment option for you.
What is cryptocurrency?
Cryptocurrency is the native asset of a blockchain network that can be traded, utilized as a medium of exchange, and used as a store of value. It’s easiest to think of cryptocurrency as a completely digital form of currency. One of its defining features is that cryptocurrency is decentralized, meaning that the currency is not overseen or regulated by any government, agency, or organization. Instead, it uses blockchain technology to power transactions over a network of computers.
Like any form of payment, people can use cryptocurrency to buy goods and services, but today, many people invest in cryptocurrencies as they would in stocks. And for today’s investors, there are tons of options. As of April 2021, there were more than 6,700 unique cryptocurrencies available on the market. The most popular and most well-known cryptocurrencies are Bitcoin and Ethereum. You also could explore other elements of this market such as non-fungible tokens (NFTs). NFTs are used to buy proprietary and unique digital files such as photos, videos, audio files, etc.
What is blockchain?
Cryptocurrencies came to exist thanks to a new technology called blockchain. Most investors don’t need to understand all of the ins and outs of this technology. Let’s face it, it’s a complex concept that’s abstract in nature, which makes it difficult for most people to wrap their heads around. Here are three, high-level concepts that you should know that will help you understand blockchain.
- Blockchain is a digital ledger
- Defining blockchain starts with its role as an accounting tool. It merely keeps track of who owns what. It uses a peer-to-peer network, meaning a random computer somewhere in the world connects to another computer to record transactions — no online platform or database is required.
- Blockchain is a technology, not a currency
- Blockchain is the technology that cryptocurrencies use as a platform. It itself is not a cryptocurrency. While it is foundational to the invention of cryptocurrency, blockchain technology has many other applications as well, thanks to its secure and decentralized nature.
- Blockchain is very secure
- One of the biggest benefits of blockchain technology is its advanced security. Blockchain issues digital “keys” to every “block” that contains transactional data. It’s virtually impossible to corrupt a transaction without the proper key. What’s more, the system is self-policing, as others in the peer-to-peer network are incentivized to verify new blocks before they are added to the chain.
Many proponents of cryptocurrency say that crypto is the currency of the future. They point to the digital nature of cryptocurrency and its ability to remove central banks from the equation. Many people like that it transports transactions
from behind closed doors to out in the open, reducing the chance for corruption or malfeasance to occur while reducing the power of banks. Additionally, crypto advocates argue that this new digital form of payment is a key part of reducing the risks associated with inflation.
Onto the bad news — cryptocurrency, as an investment, is highly volatile. It’s known to have intense price swings, which could hurt you in the end. Some financial advisors recommend against investing in cryptocurrency at all. One reason for this is that cryptocurrencies don’t generate cash flow, which means that in order to make money from your investment, someone down the line must pay a higher price than you did. This is referred to as the greater fool theory of investment.
Another challenge cryptocurrencies face is the unknown acceptance as a form of payment or store of value. To have financial viability, a cryptocurrency must have relatively high adoption rates. This means another party must be willing to accept your cryptocurrency in exchange for goods, services, or perhaps, a fiat currency. If you cannot use it, then what good is it to own it?
On top of other factors that may push or pull your opinion about cryptocurrency, a larger conversation is taking place about the environmental sustainability of cryptocurrency. Bitcoin and other cryptocurrencies require large amounts of energy to function. The largest energy consumption comes from “mining” or the complex mathematical computations that must occur in order to verify crypto transactions. These computations become more complex as cryptocurrency matures, which in turn creates a bigger energy draw.
More and more people are starting to mine cryptocurrency as the price increases, sometimes devoting entire rooms or warehouses of computers to the sole task of mining. According to the BBC, Bitcoin uses 121.36 terawatt-hours (TWh) a year, which is more electricity consumed than the entire country of Argentina.
The world of cryptocurrency is a fascinating one, no doubt about it. While the technology behind crypto is an important breakthrough in digital security, the concept of cryptocurrency as an investment is a trickier one to endorse. Due to the highly volatile nature of bitcoin in general, I would advise proceeding with caution.
Don’t invest your entire portfolio in crypto. Instead, test the waters with smaller increments that you would be ok with losing. Because for the most part, crypto is a lot like many other get-rich-quick schemes. You could make some money fast, but in most cases, you’re most likely to lose it all.
If you’d like to explore crypto other investment options further, don’t hesitate to contact me. I’m always happy to be an informal sounding board for your financial plan.