A Complete Introduction to Cryptocurrency

By now you have probably heard of a growing phenomenon called cryptocurrency. This new type of investment asset is loved by some, hated by others, and confusing to many. Here we’ll explain what cryptocurrency is, discuss a bit about its history, and explore the risks and benefits of investing in this new form of currency.

 

What Is Cryptocurrency?

Cryptocurrency is a digital currency that uses a special form of cryptography called blockchain to allow for unbrokered, direct transactions between individuals or businesses. These blocks of data serve as an open source, decentralized record, which consists of "blocks" of transaction data, including the history and value of the coins. Each coin represents a single unit of cryptocurrency – rather than a fiat, or government-backed, currency, such as the US dollar, or a physical commodity such as gold, silver, or oil. To put it in simpler terms, cryptocurrency is a new type of money that only exists in a digital format. It’s protected by an advanced encryption technology to ensure that all transactions are secure and properly logged.

 

How Cryptocurrency Works

The blocks of data are organized into a comprehensive ledger through a process called mining, sometimes referred to as crypto mining. Miners work diligently to verify transactions through encryption and, once verified, they add blockchain units to the ledger. This open source ledger format, combined with blockchain technology, creates a method for verifying transaction data and cryptocurrency ownership. In addition, creating these blocks produces a predetermined amount of coins, and the amount will continually decrease the more coins are generated, which is what leads to cryptocurrency’s rarity and value.

 

History of Cryptocurrency

Cryptocurrency was originally created in 2009 when an unknown author using the pseudonym, Satoshi Nakamoto, published a research paper entitled: Bitcoin: A Peer-to-Peer Electronic Cash. This introduced the world to the concept of Bitcoin, but it wasn’t until nearly two years later that an actual crypto market started to take shape. As Bitcoin grew in popularity, alternative cryptocurrencies, commonly known as “altcoins,” began to appear.

Today, there are a number of cryptocurrencies which have formed a sizeable speculative market. After experiencing years of steady growth, there was a remarkable spike at the end of 2017, only to be followed by a major correction in 2018 caused by investor panic over a software update to the Bitcoin ledger. Cryptocurrency has since rebounded as the software update did not create any long-term issues within the ledger. Since then, the crypto market has regularly posted strong gains and today is becoming more widely accepted. Several large, consumer-facing businesses, including Microsoft and Whole Foods, now allow Bitcoin to be used as a form of payment, and Visa and MasterCard both support crypto transactions to some extent. Some banks and credit unions are even dipping their toes into the crypto market. With the crypto market growing so quickly, let’s take a look at who is participating in it.

 

Who Buys Cryptocurrency?

By late 2020, approximately 7% of the U.S. population had invested in cryptocurrency. That number is only expected to grow, with some forecasts predicting that it will double by the end of 2021. Cryptocurrency has found a range of investors, from everyday people to celebrities to wealthy entrepreneurs like Elon Musk. In fact, Musk’s electric vehicle company, Tesla, recently invested $1.5B in Bitcoin. Because cryptocurrency is globally available and requires no minimum holding amount to open an account or transact an exchange, it is accessible to anyone with internet access – regardless of their location. This widespread accessibility is a key reason so many people are jumping on the crypto bandwagon. Let’s take a look at what else makes this such a popular investment.

 

What Draws Investors to Cryptocurrency?

Cryptocurrency is appealing for several reasons. Like gold, silver, and other commodities, cryptocurrency is finite, so it has worked as an effective hedge against price instability and inflation in currency markets. In a diverse portfolio, crypto can be strategically positioned to mitigate these risks while maintaining exposure in a high growth market.

Unlike other assets, cryptocurrency is decentralized. Geo-political fears have less of an impact on pricing, because there are no concerns about access to a limited supply of a physical commodity. For instance, the U.S. experienced a period of staggering inflation in the 1970s that was tied directly to a major oil shortage. Such concerns may influence your likelihood of investing in things like, gold, silver, oil, or even coffee, but with cryptocurrency, these are non-issues.

 

Should You Consider Investing in Cryptocurrency?

Before making any investments, you should always evaluate your tolerance for risk and your financial goals. Determining if cryptocurrency is right for you can be challenging with all the buzz surrounding the topic, but it is certainly worth consideration. If the past decade or so has been any indicator, crypto can be a tremendously impactful addition to your portfolio.

 

What Are the Benefits of Investing in Cryptocurrency?

There are many reasons you may want to invest in cryptocurrency. Let’s take a deeper look at why you might be tempted to enter this innovative new market.

Domestic Currency Instability

Currency, especially the US dollar, continues to experience incredible devaluation caused by inflation. This is only likely to increase as the Federal Reserve prints more physical money to ensure payments for quantitative easing, stimulus packages, and other programs. As the value of the dollar drops, more money will have to be printed to meet the increasing cost demands associated with inflationary changes. These conditions introduce a great deal of instability to the long-term value of the dollar and can be observed in the cumulative inflation over the past 50 years. During this time, the value of the dollar has dropped by over 560%, meaning that if you held cash over that timeframe you have actually lost a significant amount of purchasing power. Crypto provides an alternative currency that is not impacted by inflation, because the number of coins has already been permanently limited.

International Availability and Liquidity

Not only does investing in a finite asset offer a hedge against inflation, but also more and more businesses and even individuals are accepting direct payment using cryptocurrency. There are several digital wallets that make it possible for users to make crypto transactions as well. Cryptocurrency is not subject to exchange rates, so there is no reason to trade your U.S. Dollars for Euros or other fiat currency when traveling or doing business abroad. Cryptocurrency is immediately available and immediately payable anytime, anywhere. As cryptocurrency gains traction with more major retailers, you can expect this to trickle down to other storefronts.

High Potential for Growth

As with any investments, the goal of putting money into the crypto market is to make it work for you by growing over time. Cryptocurrency offers exciting potential for extreme growth, especially considering that it is still in its relative infancy. Getting in on a growing trend early means that you are likely to see some fluctuation, but as it becomes more widely adopted as a standard form of payment, the shares you own will grow in value.

 

How Can I Get into the Crypto Market?

Purchasing cryptocurrency is actually quite simple, and anyone with an internet connection can do it. Although the price of an entire Bitcoin might be beyond your means or more than you would care to invest, you can invest in more manageable fractions of a single coin.

Crypto Exchanges

If you aren’t sure where to start, begin by looking at the available trading platforms. First, compare the cost of access, the security, and the reliability of these various platforms. Each should disclose whether they are legally registered within your state, as well as be able to address any questions you may have. Doing your research can help you avoid certain legal risks when investing in cryptocurrency. As of today, here are the three most popular crypto exchange markets:

1. Coinbase
2. Binance
3. Cash App

Researching Crypto Value

Because cryptocurrency trades off-market, their values change 24 hours a day, 7 days a week. There is no open or close, and the value is purely speculative. Make sure that you know the current rates of the cryptocurrency you are interested in. Search for the most up-to-date information on current trends and changes, so you are making an informed decision and purchasing at your right price.

Know Your Limits

Before jumping into any investment, it is essential to understand the risks you are taking and determine your own tolerance for that risk. Take the time to understand what your goals are with this investment and how it fits into your total portfolio. Don’t just think about the potential upside; also measure the risk you are willing to take. Then you can make an informed decision about how much to invest and which cryptocurrency meets your needs.

 

The Risks of Investing in Cryptocurrency

Like all investments, cryptocurrency comes with its own set of unique risks. The act of trading crypto is safe, because the digital ledger is public (though the owner remains anonymous) and requires multiple security verifications. This protects crypto markets against hackers and other cyberattacks. The process of verification from the entire network also serves as a form of accountability, so you do not have to worry about purchasing forged coins. The biggest safety concern is generally theft, which is only possible if another party gains access to your password. Here’s a more in-depth look at some of the risks associated with cryptocurrency.

Fraud Risk

As a global and open-source technology, there are currently few regulations to protect investors. This is, in part, by design, as the goal behind cryptocurrency is to eliminate all parties not directly involved with transactions. It becomes challenging, however, to determine which cryptocurrency offerings are legitimate and which are not. There have been cases of fraudulent Initial Coin Offerings (ICOs), in which investors put their money into fake cryptocurrencies. However, investors can avoid these kind of costly mistakes with some simple research.

Exit Risk

Global risk expert, Dante Alighieri Disparte, has expressed concern that crypto has a “wide entrance and a narrow exit.” In other words, it's easy to invest in cryptocurrency, but it can be difficult to exit during times of price instability and leave many investors with no way out apart from catastrophic loss. Because cryptocurrencies are not correlated to any traditional economy, changes in market behaviors or trends can cause panic among investors. If too many people unload their crypto assets at one time, there may not always be enough buyers ready to purchase.

Manipulation Risk

Because cryptocurrency is a global asset and not strictly regulated by any specific government, there are some taxation risks that you should be aware of before investing. The IRS, for example, could choose to treat crypto as an owned property, and therefore obligate any growth to capital gains tax. There is also much ambivalence surrounding the purchase of crypto through foreign markets. Which countries have the right to tax these purchases is still up for debate and will likely shift over time.

Forgetting Your Password

One risk crypto investors face is losing their password. Although cryptocurrency provides a great deal of safety in preventing anyone without your unique password from accessing your digital coins, there is no way to retrieve your investment if you lose your password. A young man in California made international headlines in early 2021 when a story broke about his being unable to access his Bitcoin portfolio – worth roughly $220M at the time.

 

The Main Thing to Remember

Determining what best meets your needs can be challenging in the ever-changing landscape of cryptocurrency, but it’s important to remember that anything you invest in crypto should fit into a broader portfolio. That’s where it can help to speak with a professional.

The advisors from the First Service Wealth Management team are here to help you develop a unique investment strategy that matches your specific goals and accounts for your personal tolerance for risk. They will help you with your due diligence and make every effort to understand and accommodate your wishes for your account. Having the insight of an experienced professional can help you feel comfortable while navigating any investment scenario. Complete the form below to request a free consultation!¹¹¹