The field of cryptocurrencies is one that is in constant flux and evolution. It was only a few years ago that cryptocurrencies were seen by arguably the majority as a risky asset class and a fringe concept that only a handful of people were in. Now, some cryptocurrencies have become exceptionally valuable, and many of us are aware of the success story of Bitcoin at the very least.
Cryptocurrency has become quite a controversial topic among financial advisors and observers as well. Some feel that cryptocurrency is the future of finance and the economy. In contrast, others assert that it has no real value and is, therefore, a hazardous waste of money to invest in or purchase. Such criticisms haven’t stopped cryptocurrencies from continuing to grow both in value in prominence, however.
This trend has caused many to become more interested in cryptocurrency and investigating whether or not it might be possible for them to invest in cryptocurrencies or get somehow involved otherwise. There are conflicting reports and accounts in terms of whether or not investing in cryptocurrency is especially risky or something that more and more people should take seriously as their prominence continues to grow. This article goes into some depth on the various investment options available for cryptocurrencies, as well as some of the potential risks involved.
What Is Cryptocurrency?
You may be wondering what exactly defines a cryptocurrency. In simple terms, a cryptocurrency is a currency based on and traded exclusively via the internet. It is controlled neither by central authorities, nor banks. Cryptocurrencies are exchanged or purchased directly via two consenting parties. The identities of these parties are concealed to the public, but all transactions are recorded. Fees charged when trading cryptocurrencies are usually very low, making it much cheaper to exchange in this way than it might be when working with a bank and regular currency.
Cryptocurrency is sent between two users through something known as a blockchain. A blockchain is a database, which many different computers make up a network of. When a cryptocurrency is being traded, for example, both parties in the transaction make up a block each, and the chain is used to send the currency. It is very, very difficult to falsify information with the blockchain or change a block once it has been created. This is one of the reasons that the proponents of cryptocurrency claim it to be a very safe and secure method of trading currency.
Bitcoin was the first cryptocurrency to emerge that received significant support and interest from mainstream culture. It was allegedly invented by Satoshi Nakamoto, who took it upon himself to create a decentralized, digital currency that could be sent between two people. In reality, it is not known who Nakamoto is, and many have claimed to be Satoshi Nakamoto, especially after Bitcoin’s rise to substantial prominence in widespread awareness.
In any case, cryptocurrencies are generally traded between two anonymous people, and cryptocurrency transactions are irreversible. This is one of the potential downsides to cryptocurrency; the lack of regulation and authority means that you are entirely responsible for your use of the currency. Given how valuable Bitcoin especially has become, it is a substantial amount of financial responsibility and potentially also risky to own or trade Bitcoin.
The value of cryptocurrencies vary, but most cryptocurrencies deliberately limit the number of tokens (the equivalent of cash) that they produce to prevent saturation or loss of value of the currency. It is estimated that the total number of Bitcoin tokens is going to have been provided by the year 2140. The supply of Bitcoin decreases over time too.
Due to their independence from the monetary system, cryptocurrencies are entirely free from the influence or effects of politics. They cannot be controlled in any sense by the central banking system. This is undoubtedly an advantage in many respects. If you buy cryptocurrency, you do not need to worry about inflation or deflation being implemented by the banking system. However, there are many risks associated with cryptocurrencies that do not generally apply to standard currency.
Cryptocurrency and Risk
Cryptocurrencies are very new and have not yet been taken up by the majority of people in any substantial way. This makes them potentially very risky as an asset class, though some people have certainly successfully invested in cryptocurrency. One of the primary issues with cryptocurrency as an investment class is their short history. It’s tough to predict how cryptocurrencies are going to behave as a result.
As a result of this, many financial advisors describe investing in cryptocurrency as ‘speculation,’ as opposed to investment. This is because investing is best described as a practice where you put part of your money towards something that is reasonably reliably going to give you some return that is greater than the amount of money you contributed. With cryptocurrencies, this is simply not known yet. However, speculation isn’t that unusual as a form of investment and is often a small part of the portfolio of many successful investors.
Cryptocurrencies, in general, are constantly changing, and startups are continually developing new cryptocurrencies. Their value is also very volatile. As such, some say that investing in cryptocurrency is essentially like gambling because there is simply no way of knowing how their value is going to change. The fact that cryptocurrencies are not backed by anything else means that their value can change to vast degrees within brief periods. Conventional currencies are backed by commodities or gold, which ideally stabilizes their value to some degree.
In any case, investing should be understood as a balance between risk and reward, and cryptocurrency investing is certainly no exception in this case. Generally speaking, the higher the risk of a potential investment, the greater the return may be. It is, therefore, essential to balance risk and reward when you invest and do so in such a way that it feels appropriate to you. The level of risk that feels appropriate can vary a lot from person to person and should depend mostly on your profile as an investor.
One aspect of your investment profile should be your level of risk tolerance. Different people have different personalities, as well as differences in terms of the assets available to them, and they are, therefore, going to choose to invest in different ways. Somebody who intends to invest primarily to gradually supplement their income throughout their career to retire more comfortably is likely not very suited to investing in such a risky asset class as cryptocurrency.
If you are unsure of the level of risk you are willing to tolerate with your investments, then you should think about any future financial goals that you might have. For example, if your primary aim financially is to purchase a house or pay for a mortgage within a particular timeframe, then you may want to use your investment funds more wisely and put them towards more dependable asset classes. This can help you to ensure that you are investing in such a way that is likely to show you returns, which you can subsequently put towards a new house.
On the other hand, if you have substantial disposable income and have already developed a portfolio, then you may want to consider investing in cryptocurrencies as a form of speculation, and they can make up a small part of your portfolio. In this way, you are going to minimize the risk associated with investing in cryptocurrency by limiting how much you spend on them. You can then sell on the cryptocurrency if it becomes profitable to do so or put it towards other means.
Investing in Cryptocurrency
The fact that cryptocurrency is risky doesn’t mean that you can’t or shouldn’t invest in it. It can be very profitable if done correctly, as long as you accept that there is potentially a very high chance that you aren’t going to see any return or profit on your investment. If you wish to invest in cryptocurrency anyway, then you should ensure that you have a minimum of a few months’ expenses saved up. This is true of beginning any type of investing. We recommend this so that you are financially secure in case of an emergency or if you lose your job, for example.
Primarily, people invest in cryptocurrency by buying and then storing it. All you essentially need to do so is a place where you can buy the cryptocurrency and then store it yourself. Many people use cryptocurrency ‘exchanges,’ which lets you buy a quantity of cryptocurrency with regular currency. Coinbase is one of the most popular cryptocurrency exchanges currently, and you can use Coinbase to purchase several different cryptocurrencies, like Ethereum and Bitcoin.
Another advantage of Coinbase is that it gives you a place to store your cryptocurrency. This place is usually known as a ‘wallet,’ and a wallet is one of the most common ways to store cryptocurrency in general. When you use a cryptocurrency wallet, you have both a public and a private key. These ‘keys’ are unique to your wallet and are a chain of numbers and letters that can be used as a way to send cryptocurrency to you. The blockchain records them during transactions as a way of marking you and the other cryptocurrency user who took part in the deal.
Wallets can come in different types. A digital wallet is the most common way to store cryptocurrency and is a form of software. In a sense, printing your transactions on a piece of paper is also a form of a wallet. You can also store your cryptocurrency on some type of hardware, like a USB stick. This gives some users an added sense of security, as they can take their cryptocurrency around with them (or leave it at home). However, one, of course, does risk being able to lose their cryptocurrency by storing it this way instead of online.
When a new cryptocurrency is started, it generally raises its funds through an Initial Coin Offering (ICO). This is a practice that lets the currency find its feet, and it is quite a similar process to crowdfunding. When an ICO is being run, investors receive several tokens that are considered to be equivalent to their investment. These tokens are generally deposited into the wallet of the investor.
Whether or not you should invest in an ICO varies a lot, depending on the company behind it. ICOs and new cryptocurrencies are generally the product of startups explicitly founded to develop a new cryptocurrency. Unfortunately, the lack of central control or governance over cryptocurrencies means that scam ICOs are relatively common, so it is crucial to do as much research as you possibly can into the company before you consider investing in an ICO.
Attitudes Towards Cryptocurrencies
As has been previously mentioned, there is a broad spectrum of attitudes towards cryptocurrency on the whole amongst financial advisors and experts. Warren Buffett is a particularly well-known investor, for example. He is also very critical of Bitcoin in particular. Buffet has gone so far as to describe Bitcoin as being a ‘gambling device’ and that he feels it is too easily used for fraud.
However, on the other hand, cryptocurrencies are becoming more and more widely accepted among younger people especially. Millennials have perhaps embraced them more than any other generation, and a survey from Bankrate has shown that people who are part of Generation Y were more than three times more likely than Generation Xers to invest in digital currencies.
Cryptocurrencies are illegal in many parts of the world, due in some part to the lack of regulation or governance over them. They are banned in China, India, and Russia, for example. In other countries, cryptocurrencies are legal, and financial regulators are trying to keep up with the rapid developments within the field of cryptocurrency, as well as figure out how it might be possible for cryptocurrencies to be regulated in general. Such regulation would primarily be intended to protect investors in cryptocurrencies from scams.
Which Cryptocurrencies Are There?
As of the time of writing this article, there are a handful of cryptocurrencies that are currently the most dominant and valuable. Bitcoin is undoubtedly the best-known of the cryptocurrencies in the mainstream, and it is still the most popular as well. Part of the reason a range of people so enthusiastically adopted Bitcoin was that it was engineered to maintain privacy and decentralization. At the time of writing, there are over seven million active users of Bitcoin.
Developed in 2015, Ethereum is a newer and also reasonably popular cryptocurrency that also uses blockchain technology to facilitate transactions between two users. One aspect of Ethereum that differentiates it from other cryptocurrencies is the use of contracts. Some critics of Bitcoin, in particular, argue that it is too easy for users of Bitcoin to scam one another due in part to the fact that there is no need for any type of commitment within Bitcoin to fulfilling some part of an agreement. The transaction simply takes place in the form of an exchange.
Ethereum’s contract system attempts to address this to ensure compliance on the part of one or both parties with some type of agreement. It is a paperless form of contract with terms included that can also eliminate the need for a middleman. These contracts are computer-generated and are ultimately intended to try to enforce that the proposed transaction takes place with a basis in the originally agreed terms.
Litecoin is another competitor to Bitcoin that is gaining both in popularity and prominence. One significant advantage of Litecoin is the speed with which its transactions are processed. The average Bitcoin transaction takes around ten minutes to be complete. Litecoin transactions are much faster and take, on average, just over two minutes. It also uses blockchain technology, making it quite reliable and safe (relative to other cryptocurrencies). There is also more Litecoin currency available than there are Bitcoins.
Monero is another cryptocurrency focused on purchasing or paying for goods and services. The unique thing about Monero is that it is even more geared towards prioritizing the privacy of its users. Transactions made with Monero are only temporarily stored or recorded, unlike with Bitcoin, where they are permanently recorded with the blockchain (though using only the keys of the users). There is currently a limited number of retailers that accept Monero as a cryptocurrency at present, and the currency was launched in 2014.
The premise of Monero may sound somewhat strange, especially given how Bitcoin already offers much higher protection of the privacy of its users compared to transactions made online with regular currency. However, many users of Monero feel that it is a suitable way for them to avoid their purchases or spending habits to be tracked by advertising companies to use through targeted advertising. Some users also live in countries with quite controlling or restrictive governments, and Monero allows them to make purchases that may be risky otherwise.
How Are Cryptocurrency Prices Determined?
Cryptocurrency prices rise and fall depending on many factors. Something interesting about cryptocurrency is that many of the currencies tend to fluctuate following the same patterns. As such, if one currency experiences a drop in value, then it is reasonable to expect the other currencies to do the same shortly after. A significant factor in the value of cryptocurrencies is how much attention the currency receives from the media. If a particular currency receives substantial media attention, then it is likely that many new people are going to become users of the currency, and it thereby becomes much more valuable.
Another major factor is support or interest from the financial sector. Any substantial investment in a cryptocurrency is likely going to see its value increase dramatically. For example, the Ethereum cryptocurrency has a so-called Ethereum Enterprise Alliance, which is like a committee for the currency. When the Alliance gained several new prominent members, the currency saw a sharp increase in its value.
Other factors can vary from currency to currency. For example, the cryptocurrency NEO is based in China and was affected substantially by legislation in China that moved to regulate cryptocurrencies. The Chinese central bank eventually banned ICOs altogether, and this had a tremendous impact on the cryptocurrency market in the country. As such, if you want to ensure that you benefit as much as possible from investing in cryptocurrencies, you need to follow carefully with developments within the currencies that you invest in at the very least, as well as the market as a whole if you can.
Cryptocurrencies are currently changing and evolving, which makes them an exciting asset class to follow the development of. However, it can also make it very risky to invest in cryptocurrencies, as there are no guarantees to their values, which can plummet or skyrocket almost at the drop of a hat. Cryptocurrencies certainly have their advantages, especially when it comes to ensuring the privacy of their users. However, this can lead to scams and deceptive behavior if you are not careful when using cryptocurrencies.
The success story of Bitcoin made cryptocurrency investment very alluring for many. More recently, several other cryptocurrencies have made their mark on the world of finance. Bitcoin arguably has paved the way to a much warmer reception of new cryptocurrencies among investors and the general public at large. Still, it is essential to be aware of just how risky it can potentially be to invest in cryptocurrencies.
If you do choose to invest in cryptocurrencies as an asset class, it is wisest to ensure that they only make up a small portion of your portfolio. This is the best way to minimize any risk that is associated with investing in a class like cryptocurrencies. It’s also vital that you follow as closely with developments within the currency or currencies that you choose to invest in as possible to have the best possible understanding of any changes you might be able to expect regarding those currencies.