Contrary to traditional money, which is issued and stored by governments and bank, cryptocurrencies are digital assets which fluctuate constantly in value. Some, like bitcoin, have limited supply that helps create demand while non-fungible tokens allow users to program unique smart contracts using non-fungible assets.
Numerous wealth advisors recommend their clients invest in cryptocurrency as part of a diversified portfolio. Here’s everything you should know.
What is it?
Cryptocurrency is a form of digital money that utilizes encryption to secure transactions. Perhaps the best-known example is Bitcoin, created in 2009. Cryptocurrency does not belong to a central authority like a government or bank and instead lives inside digital wallets similar to software programs used to store files on computers. A decentralized system monitors transactions within cryptocurrency blockchain records which are kept by powerful computers running special hardware processes called mining that validate transactions by adding records onto this ledger.
Due to their highly unpredictable market, cryptocurrency investors typically treat cryptocurrencies more as investments than as means of payment; however, there are a few businesses who accept cryptocurrency payments, and some people store large amounts as stores of value.
A cryptocurrency’s value is determined by supply and demand as well as acceptance as a means of payment. Other factors, including speculation and investor trust can impact its price as well.
Coins and tokens are two forms of cryptocurrency. Coins are virtual, digital currencies that feature their own blockchain while tokens build upon existing coins to represent both currency and ownership rights of other assets – examples include Bitcoin, Litecoin and Ethereum. Non-fungible tokens cannot be replaced like trading cards can.
There is no set limit to the number of cryptocurrencies that can be created; thousands have emerged since Bitcoin’s meteoric rise in 2017. Some of the more prominent cryptos include Bitcoin, Ethereum, Litecoin and Monero; their market capitalization value is frequently reported by news outlets.
How does it work?
Cryptocurrency is a digital form of currency that uses encryption to verify transactions and create new currency units. Unlike its traditional counterpart, cryptocurrency doesn’t fall under government oversight or management; rather, its production and validation takes place through a decentralized computer network known as blockchain. Mining involves adding transactions onto this public and secure ledger in an ongoing process called mining requiring special hardware and software.
Transferring cryptocurrency is recorded on an open ledger for all to see, with transactions encrypted with advanced coding and timestamped to reduce hacker interference in altering or deleting them. Owners store their coins in virtual wallets that may require another password or authentication code sent directly to their phone for security.
Although cryptocurrency can have real-world uses, such as paying for goods at certain merchants, most people purchase them primarily as an investment vehicle. This speculative activity has caused price swings as investors trade in and out.
Initial Coin Offering (ICO), also known as initial public offering (IPO), allows cryptocurrency creators to raise funds quickly while also building brand recognition for their new coin. An ICO allows potential investors to buy shares of the newly launched cryptocurrency for cash or another cryptocurrency. An ICO helps quickly raise funds while increasing brand recognition for the new coin.
There are various cryptocurrencies designed for specific uses; each was developed for its own specific function. Bitcoin, for instance, is perhaps best-known and used primarily for online purchases and transactions. Others, like Ethereum and Dogecoin were created specifically to poke fun at the absurdity surrounding Bitcoin.
Some cryptocurrencies may serve specific functions, while others do not; investors must carefully assess their risks before investing. Billionaire Warren Buffett has warned investors against them, calling Bitcoin “probably rat poison squared”. Although Buffett is certainly one of many investors to express caution over investments they choose to pursue; having a reliable advisor by your side can help.
Why is it popular?
Cryptocurrency markets have seen tremendous activity over the past several years, as more people purchase coins with hopes that their value will appreciate. Unfortunately, much of this speculation can be explained away as mere profiteering by those hoping to sell at higher prices than initially planned – while these currencies might provide payment methods, it’s difficult to argue they provide any real-world utility beyond payment systems.
Most cryptocurrencies are exchanged via decentralized computer networks between individuals holding digital wallets, with transactions recorded on distributed, tamper-proof ledgers known as blockchains. This open system eliminates the need for central banks to validate currency while protecting users from spending coins they don’t own or undoing previous transactions, enabling quick, low-cost transfers compared with traditional banking networks – with Bitcoin being just one example amongst thousands.
Cryptocurrencies have quickly gained in popularity due to their promise as an international form of money that can be quickly and without incurring transaction fees sent anywhere around the globe. Furthermore, their supporters point out their fixed number of coins which helps protect against inflation or other forms of monetary manipulation. But using cryptocurrency has its drawbacks; hackers may target it and prices can become unstable quickly.
Concerns have also been expressed over the amount of electricity necessary to run the computer network that tracks transactions and generates coins, particularly Bitcoin which uses approximately 27 megawatts a day, equivalent to that used by Denmark or another small nation. Such high useage has drawn backlash among some who see it as frivolous use given climate change concerns.
Though cryptocurrency payments do have their drawbacks, an increasing number of businesses accept cryptocurrency payments for goods and services. Online luxury retailer Bitdials accepts Bitcoin payments for Rolex watches sold at Bitdials while Premier Shield Insurance in the US accepts it as premium payments for home and car insurance policies sold there.
What are the risks?
Cryptocurrencies are highly risky investments that often fluctuate in value and are vulnerable to hacking or other security risks, often costing investors significant sums of money in losses. Many investors have taken risks investing in cryptocurrencies only to be disappointed by them later.
Price of cryptocurrency investments are determined by supply and demand; as more people buy one, its price goes up; if less people want it, its price falls. This creates an unpredictable cycle where investors buy as they anticipate an increase in price before selling when the opposite happens – this makes cryptocurrency investments risky so it is essential that investors fully understand any associated risks before proceeding with an investment decision.
Cryptocurrencies present another risk due to being unsupported by any central authority, leaving them without regulation like traditional currencies are, making identity verification of anyone buying or selling one difficult and leading many people to speculate that these digital tokens could be used for illegal activities such as money laundering and tax evasion.
Since cryptocurrencies are unregulated by any central authority, their value can fluctuate wildly and become risky investments. Therefore, it’s crucial that investors understand their risk before proceeding with an investment decision.
Due to their relative youth, cryptocurrencies have yet to establish themselves as reliable stores of value. To qualify as such an asset, currency must be widely accepted with stable purchasing power – two criteria which cryptocurrencies lack. Also, their price history makes them less likely as potential future stores of value.
Given their lack of central control, cryptocurrencies are vulnerable to hacking and security risks. Cryptocurrency users must store their coins in digital wallets which are vulnerable to theft and loss; these wallets can either be stored on exchanges (which carry regulatory risks) or privately hosted computers (called cold wallets). Should your wallet go missing, all investments within will also vanish into thin air.
