What Is Cryptocurrency?
April 21, 2021
What Is Cryptocurrency?
April 21, 2021
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What Is Cryptocurrency?
We’ve all heard of bitcoin, but what IS it?
Bitcoin is the most well-known and highest-valued—and first—cryptocurrency. Cryptocurrency is decentralized digital currency that can be used to purchase goods and services or be traded or sold for a profit (or loss). A digital currency only exists electronically, meaning there is no physical manifestation of the coin—you can’t hold it in your hand. It has become increasingly popular in recent years. Using this digital currency removes some of the power of centralized banks, who currently manage the majority of the money supply. No central authority manages the crypto value or decides when to make more.
Many consider it the currency of the future, inferring that cryptocurrency will continue to increase in value as it becomes more mainstream. Currently, it’s not a widely accepted form of payment yet. One workaround is using a site like egifter.com to use Bitcoin as payment for gift cards to a variety of retailers. You can also sign up for a BitPay card, which functions like a debit card to exchanges cryptocurrency for dollars. Beware of the fees involved—both for registering for the card and to make withdrawals at ATMs.
Transactions are secured through an encrypted online ledger and can be exchanged through a global peer-to-peer network. Cryptocurrencies use blockchain technology—a decentralized system that some believe can be more secure than traditional payment methods—to manage and record transactions in a database. Transactions are recorded in “blocks” linked together on a “chain” to form a permanent history of all transactions. A network of peer-to-peer computers receive the transaction information and solve equations to validate it before clustering the information into blocks, which are then chained together to complete the transaction.
Some companies have created their own tokens to be traded specifically for that company’s products or services. According to coinmarketcap.com, there are currently 4,000 cryptocurrencies available as of March 2021—with more popping up all the time. The global market cap for crypto was $1.73 trillion as of March 2021. You can check the current price of cryptocurrencies here.
Why Use Cryptocurrency?
Cryptocurrencies have the potential to make funds transfer between two parties easier, cheaper, and more secure, thus eliminating the need for a third-party (like banks or credit card companies) to secure the transaction. Crypto transfers use public and private keys to secure the transactions. A user’s wallet (or account) uses a public key, and the private key is only known by the owner and is used to “sign” the transaction.
There is a certain level of privacy afforded to cryptocurrency users, making transactions more suited to fund illegal activities like money laundering and tax evasion—a significant concern for law enforcement, governments, and the crypto companies. On the flip side, Bitcoin has famously helped authorities identify and prosecute criminals using forensic analysis.
What Is a Market Cap?
The term market capitalization is a key concept in cryptocurrency, measuring the relative size or market value of the currency. To calculate market cap, multiply the current market price of a specific coin by the total number of coins in circulation. For example, if the trading value of one cryptocurrency unit is $15 and the supply in circulation is 75,000,000 units, the market cap is $1,125,000,000.
Market cap can be an indicator of both the growth potential of a coin and how safe it is to buy. Keep in mind that market cap doesn’t represent the total amount of money in the market, and it isn’t always indicative of how much money has actually been invested in the coin. Cryptocurrencies do not generate cash flow, which means that someone has to be willing to pay more than you did for the currency to generate a profit. The value of cryptocurrency is based on supply and demand—there’s usually little in supply and it’s high in demand, thus increasing the price. Unlike stocks and fiat currency, no government or institution is backing the cryptocurrencies’ values. Plus, a small fluctuation in price can significantly affect the market cap.
- For example, a cryptocurrency can have 10,000,000 coins available, but if only one person buys one coin for $1, the market cap is still $10,000,000—despite there being only one coin worth $1 sold.
- If demand increases, the price will likely rise, thus raising the market cap accordingly. Then, say the market cap reaches $100 million. This doesn’t mean there was in inflow of $90 million into the market. If everybody decided to sell, the price would fall dramatically, and the total amount investors could withdraw would be significantly less than the market cap.
Large cap cryptocurrencies (companies with a market cap of $10 billion or greater) are generally more safe and conservative investments. Mid cap cryptocurrencies are more volatile but have a greater growth potential in the crypto market. While small cap currencies MAY have great short-term growth potential, they are considered extremely volatile and a very risky investment.
We’ve witnessed the rapid increase and dramatic decrease in value of cryptocurrencies like Bitcoin, whose history includes many valleys and peaks. In early 2017, One Bitcoin’s value increased rapidly from around $2500 to over $13,000 by January 2018 before gradually falling to below $4000 by the beginning of 2019. In recent news, Bitcoin’s value almost doubled, rising rapidly from about $28,000 to $50,000 as of March 2021.
How to Invest in Cryptocurrency
You’ll need a “wallet,” an online app that can hold your currency, to buy cryptos. Cryptocurrency can be purchased on networks and exchanges, like Coinbase. Look carefully at the fees, especially if you’re purchasing a small amount of cryptocurrency, as the fees may far outweigh the coin cost. The investing app Robinhood has recently started allowing the purchase of several of the most popular cryptocurrencies without the fees of the other exchanges.
Putting all your figurative eggs (cryptocurrencies) into one basket (one security) can introduce you to more risk. Similar to the stock market, spreading your investments into many different funds is less risky than investing everything into one fund—however, cryptocurrencies are in short supply compared to the traditional stock market investments. Alternatively, you can invest in stock of the cryptocurrency companies, like Coinbase, at their initial public offering and beyond.
Is Cryptocurrency Secure?
Blockchain technology is relatively secure—but not immune as Coinbase and Ethereum Classic learned in 2019 when a hacker gained control of nearly half of the network to rewrite the transaction history. More so, other cryptocurrency elements may still be vulnerable to hacking—to the tune of nearly $2 billion since 2017. Now, for the good news: Illegal activity constituted 2.1% of all cryptocurrency transactions, but in 2020, criminal activity fell to 0.34% of all transactions, according to blockchain data firm Chain Analysis.
Also, we’ve all heard the story of the man at risk of losing $220 million in Bitcoin because he can’t find the password to his wallet, which is on a hard drive that allows 10 tries to input their password before encrypting the contents forever. According to The New York Times, Chain Analysis estimates around 20%—or $140 billion—appear to be in lost or stranded wallets. Bitcoin has no structure or ability to provide, store, or recover passwords. The private key (or password) is known only by the person who created the wallet. Moral of the story: Cryptocurrency and blockchain technology can be hacked, but it’s far more likely that you’ll forget your password. Might we recommend storing your password in multiple secure places, including a safety deposit box?
Remember, the cryptocurrency market is speculative and can be extremely volatile. Ultimately, determining if you should invest in Bitcoin or other cryptocurrencies is a personal choice that should be taken after careful consideration and education, perhaps with the help of an investment advisor or other financial professional. They can help you determine your appetite for risk and an investment strategy that reflects your risk tolerance.
Every strategy is dependent on a variety of different factors, so make sure you read the fine print.
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