What Are Cryptocurrencies?
Tuesday, May 17 2022
Cryptocurrency is growing in popularity. From Bitcoin to Ethereum and others, there are thousands of cryptocurrencies, which can make getting started in the crypto world overwhelming. What are cryptocurrencies, and why invest in cryptocurrency? This post explains more.
What Are Cryptocurrencies?
You’ve likely heard terms like crypto or Bitcoin. But if you’re like most people, you still question, “What are cryptocurrencies?”
Cryptocurrency, or crypto, is a virtual currency. There is no physical currency. Owning cryptocurrency represents ownership of a digital asset with zero intrinsic value. Most cryptocurrencies are created, distributed, traded, and stored using a decentralized ledger system known as a blockchain.
A massive amount of computing power verifies transactions via mining, creating a tamper-resistant record of transactions and tracking who owns what. Buyers and sellers connect through encryption keys instead of using names, tax I.D.s, or Social Security Numbers. Owners are anonymous.
Individual units of cryptocurrencies are called coins or tokens. The value of coins or tokens depends on the demand in the crypto market.
Like other currencies, you can use cryptocurrencies:
- In exchange for goods and services
- For investment
- To help complete complex financial transactions
The government issues fiat money, like the American (USD) or Canadian (CAD) dollar, meaning a central authority controls its value, interest rates, and how much is in circulation. Cryptocurrencies are made without using a third party or a central controlling authority. These traits make them immune to government interference or manipulation.
Cryptocurrency prices increase and decrease based on supply and demand. When comparing options, it’s necessary to understand what will drive demand for the coin higher.
There are more than 19,000 publicly traded cryptocurrencies, and the number continues to grow. Each cryptocurrency has distinct functions and specifications.
The most popular cryptocurrencies are:
- Bitcoin (BTC). Bitcoin is the original cryptocurrency. It’s the most widely known and traded crypto. An anonymous person using the pseudonym Satoshi Nakamoto created it in 2009.
- Ethereum (ETH). Ethereum is the second-largest cryptocurrency by volume. Launched in July 2014, Ether’s sub-units, Gwei and Wei, are named after Wei Dai, an early pioneer of cryptocurrencies. It’s commonly used to carry out financial transactions more complex than those supported by Bitcoin. You can use Ethereum to manage property and shares, for financial applications, and to develop games.
- Tether (USDT). Tether is the third-biggest cryptocurrency in the world by market value. The native coins are Tether tokens. It’s the world’s first stablecoin, meaning fiat currencies back it like U.S. dollars and the Euro. Because of this, the cryptocurrency is less volatile than the others, and investors favor it.
- Binance Coin (BNB). Established in 2017, Binance Coin is a popular payment option for merchants. You can use it in transactions or trade and exchange it for other forms of crypto on Binance Exchange.
- USD Coin (USDC). USDC was listed on Coinbase in October 2018. Like Tether, USD Coin is a stablecoin with a fixed value of $1 per coin. U.S. dollars held in reserve backs it. You can’t mine USD Coin. New coins are minted every time someone buys or converts currency and acquires USD Coin.
Why Invest in Cryptocurrency?
Now that you know what cryptocurrencies are, you may be wondering, “Why invest?” As cryptocurrency gains more attention and momentum, more investors consider it an investment avenue for their portfolios. It’s becoming a popular option for diversification because of its strong returns and as the number of crypto uses and applications increases.
Reasons to consider investing in cryptocurrency:
- Speed and Cost of Transaction. Because there are no third-party intermediaries, cryptocurrency transfers are faster than standard money transfers. A wire transfer takes at least 24 hours, stock trades settle in three days, and a crypto transaction is complete in minutes.
- Inflation Protection. The major cryptocurrencies have either limited or capped their circulation growth. The protocol established for Bitcoin dictates a cap of 21 million; almost 19 million have been mined so far. With no excess supply, the coins will eventually become scarce, increasing the demand and, in turn, increasing the price of the asset, theoretically hedging against inflation.
- Secure and Private. Unlike cash and credit cards, cryptocurrencies are digital and encrypted, and people can’t counterfeit them. Each cryptocurrency transaction is a unique exchange. You store crypto in a virtual wallet, which you can only access using a private key. Only someone with access to the key can sign transactions and access funds.
- Decentralized Banking. Cryptocurrencies aren’t linked to the currencies themselves but the infrastructure supporting them. People like that the network manages crypto and not one central authority. Banks and financial institutions are not necessary to enforce and police transactions between parties. The system eliminates the possibility of a single point of failure, such as a large bank.
- Financial Performance. The value of cryptocurrency doesn’t correlate with the price of stocks, bonds, or other asset classes. The value of a token is based on its rarity, the effort expended mining it, and its characteristics. Although crypto can be volatile at times, the long-term trend has been positive for early adopters.
Limitations of Cryptocurrency
Cryptocurrency has drawbacks to consider. The same reasons why some investors like it are why others hesitate.
Limitations of cryptocurrency include:
- Limited Regulation. The limited regulation of crypto means you don’t have the same protections as you do when investing in the heavily regulated stock market. It’s not under the supervision of the U.S. Federal Reserve or any other central bank. If your account gets hacked or your investment turns out to be a scam, there’s nothing you can do.
- High Volatility. All investing comes with risk, but cryptocurrency carries more. Cryptocurrency prices are significantly more volatile than the stock and bond markets. Price swings of 10% or more in just hours are common.
- Targets for Scams. Since crypto is digital technology, they are prone to cybersecurity breaches and may fall into the hands of hackers. Scammers took $14 billion worth of crypto in 2021. As interest grows in the currency, it attracts more sophisticated scammers looking for opportunities.
- High Energy Consumption. Crypto requires computers to solve complex math problems using an energy-intensive mining process. Digital transactions, like those powered by Visa, take less than a second and use 1/500,000 of the energy. As more people compete for crypto, thousands of computers will use more energy.
How To Invest
Once you’ve found a cryptocurrency you think will make a good investment, it’s time to start buying. Buying directly is the most common way to add crypto exposure to your portfolio.
Step 1: Choose an Exchange
An exchange is where buyers and sellers meet to trade cryptocurrencies. Crypto exchanges function similarly to online brokerage platforms. They provide you with the tools to buy and sell digital currencies and tokens.
Exchanges have relatively low fees. But they also tend to have complex interfaces with multiple trade types and advanced performance charts, making them intimidating for new investors. Read the fine print before you start. Review supported assets, fees, payment methods, and security.
Step 2: Establish an Account
After selecting the exchange, you can set up your account.
Step 3: Invest What You Can Afford to Lose
Cryptocurrencies are highly volatile. The value of tokens can diminish in hours due to the forces of supply and demand. Ensure you’re comfortable with your investment and risk.
Step 4: Start Purchasing
Exchanges allow you to purchase crypto with your debit card, bank transfers, or credit card. A single coin could be worth thousands of dollars. Most exchanges allow you to buy a fraction of a token. Keep in mind exchanges charge fees for every transaction.
Step 5: Store Your Currency
Your virtual wallet holds the codes for all your cryptocurrency. You can host your wallet on the cryptocurrency exchange or an independent wallet provider.
Where Can You Use Cryptocurrency?
Companies view accepting cryptocurrency as a way to set themselves apart. The number of institutions accepting cryptocurrencies grows daily as people and vendors get more comfortable with virtual money.
Insurance, consumer staples, luxury watches, and event tickets are among the items you can use crypto to buy. Overstock.com and Microsoft started accepting Bitcoin as early as 2014. Other retailers have accepted crypto, including Whole Foods, Nordstrom, Home Depot, Tesla, Etsy, Expedia, and PayPal.
Talk to FFCU to Learn More
Cryptocurrency may be a good way to diversify your portfolio if you accept the risk. Speak to an advisor at Focus Federal Credit Union to learn more about cryptocurrencies and why to invest in them.