Cryptocurrencies
What cryptocurrencies are, how to invest in them, and some strategies for managing risk in this fast-moving market.
Crypto has been in the headlines for all the wrong reasons over the past decade or so. And, some might argue, rightly so. Compared to the heavily regulated world of stocks and currency trading, crypto has looked a lot like the wild west.
Major investors have lost millions, people have had their wallets stolen and lost all of their funds, high profile influencers have gone to prison and one crypto which was worth over $40 billion at one point ($LUNA) dramatically collapsed which sent shockwaves throughout the finance world.
It’s fair to say then, that crypto and crypto investors have had a rocky ride. But is it still worth investing in? I’ll leave that up to you to decide, but for educational purposes as always, this guide will get you up to speed with the basics.
Coming up:
- What is cryptocurrency?
- How is it different from investing in stocks or investing in other currencies?
- Does crypto have any utility?
- How to get started if you’re interested
- Terminology worth knowing
What is cryptocurrency?
Cryptocurrency is a form of digital or virtual currency that uses cryptographic techniques to secure transactions, control the creation of new units, and verify the transfer of assets. Countries like El Salvador have even gone as far as to adopt Bitcoin as legal tender alongside the US dollar.
When you invest in a cryptocurrency, you’re purchasing a number of ‘tokens’ which have a set value. The price of a token can fluctuate wildly and the price of one bitcoin has risen from less than a dollar to over $60,000 previously.
At the core of cryptocurrency is blockchain technology, which is a decentralized, distributed ledger that records all transactions across a network of computers (nodes).
Each block in the blockchain contains a list of transactions, a timestamp, and a cryptographic hash of the previous block, ensuring the integrity and chronological order of the blockchain.
Key Features of Blockchain:
- Decentralization: Unlike traditional financial systems that rely on a central authority, blockchain operates on a peer-to-peer network where all nodes have equal authority.
- Immutability: Once a transaction is recorded in a block and added to the blockchain, it cannot be altered or deleted. This ensures the integrity and transparency of the data.
- Consensus Mechanisms: To add a new block to the blockchain, the network must reach a consensus. Common consensus mechanisms include Proof of Work (PoW) and Proof of Stake (PoS).
Bitcoin was the OG cryptocurrency but since then, there are a ton of other cryptocurrencies available to invest in for investors too.
Not every cryptocurrency has its own blockchain
We’ve talked a bit about blockchains but it’s worth noting that not every cryptocurrency has its own blockchain and there are multiple different blockchains that are available for crypto developers to use. Some companies / developers might even decide to build their own blockchain.
Here’s a snapshot of the different categories of blockchains:
- Public Blockchains: These are open networks where anyone can participate without permission. Examples include Bitcoin and Ethereum.
- Private Blockchains: These are restricted networks where only authorized participants can join. They are often used within organizations for internal purposes.
- Hybrid Blockchains: These combine elements of both public and private blockchains, allowing for controlled access while maintaining some level of transparency.
- Consortium Blockchains: These are collaborative networks where multiple organizations share control. They are often used in industries where multiple stakeholders need to work together.
Some of the prominent blockchains include Bitcoin which is the first and most well-known blockchain, primarily used for peer-to-peer transactions. Ethereum is another, known for its smart contract functionality, enabling decentralized applications (dApps).Solana is recognized for its high throughput and low transaction costs. There are estimated to be well over 1,000 blockchains available but it’s the crypto issued on the blockchain that investors invest in.
For example, here’s a snapshot of the different cryptos that are issued on the Ethereum blockchain.
How is it different from investing in stocks or investing in other currencies?
Crypto is different to other types of investing in lots of ways which are worth knowing beforehand.
In crypto, trading markets are open 24 / 7 which is very different to the stock market which opens and closes at set times every weekday, for example.
If you’re completely new to crypto investing and you want to understand some of these differences, here’s an overview of some of the ones worth knowing:
Does crypto have any utility?
One of the most common criticisms of crypto is that it doesn’t really have much utility. As potential investors, it’s always reassuring to know that whatever you’re buying has some value; if you’re investing in Apple, you know it’s valuable because it’s a value creating, revenue generating business. It’s difficult to say the same for crypto, but is it right to say that all crypto has zero utility?
Well, it ultimately depends on the cryptocurrency.
Bitcoin has no utility aside from being legal tender in a few countries. It started off with a sales pitch to become a de factor replacement for standard currencies like the dollar but Bitcoin fans now say it’s value is more akin to “digital gold” i.e. that because of its scarcity, it is an asset of appreciating value that can be viewed as a store of value.
Bitcoin aside, there are plenty of cryptocurrencies which have been specifically designed with use cases in mind.
The VRA Verasity token is designed to prevent ad fraud. VeChain (VET) offers an enterprise blockchain solution for companies to track and manage supply chain logistics. Audius is a decentralized music streaming service that allows artists to publish their music directly to listeners. It uses blockchain technology to ensure artists are paid fairly and transparently, and it also enables fans to support artists by purchasing music as NFTs or streaming it through the platform.
But, despite these cryptocurrencies with use cases, adoption has on the whole been pretty slow.
How to get started if you’re interested
Cryptocurrency can be bought from exchanges like Coinbase which hosts most of the major cryptocurrencies. Given the controversy surrounding all of the other exchanges, Coinbase is probably the most reputable exchange and the fact that it’s publicly listed also adds to its legitimacy, too.
Other crypto exchanges include:
Binance - Binance is the largest cryptocurrency exchange by trading volume, offering a wide range of cryptocurrencies and trading pairs. It provides various services including spot trading, futures trading, and staking. Users can trade over 400 cryptocurrencies and access advanced trading features.
Kraken - Kraken is known for its security features and offers a wide range of cryptocurrencies for trading. It provides services such as futures trading and margin trading, making it suitable for both beginners and experienced traders.
OKX - OKX is a global cryptocurrency exchange that offers spot and derivatives trading. It supports a diverse range of cryptocurrencies and provides advanced trading tools, making it popular among professional traders.
How crypto is stored
When you buy crypto, you are free to then either store the crypto on the exchange you bought it from or store that cryptocurrency in your own wallet. This is known as “self-custody”.
A wallet can either be a physical wallet (which is like a hard drive) or a piece of software that is installed on a laptop or mobile. Crypto investors tend to say that a physical self custody wallet is the safest option because it is not connected to the web.
Here’s an example of a so-called ‘hard’ wallet which is physical:
Terminology worth knowing
Crypto can be difficult to get your head around but here’s some of the most useful concepts and terminologies to know when it comes to crypto:
- Blockchain: A decentralized digital ledger that records transactions across multiple computers. This technology underpins cryptocurrencies, ensuring transparency and security.
- Cryptocurrency: Digital or virtual currencies that use cryptography for security and operate independently of a central bank. Bitcoin and Ethereum are examples.
- Market Capitalization (Market Cap): The total value of a cryptocurrency, calculated by multiplying its current price by the total supply of coins.
- Bitcoin: The first and most widely recognized cryptocurrency, often referred to as digital gold. It serves as both a store of value and a medium of exchange.
- Ethereum: A blockchain platform that enables developers to build decentralized applications (dApps) and smart contracts. It uses Ether as its native currency.
- DeFi (Decentralized Finance): A movement aimed at creating a decentralized financial system using blockchain technology, offering services like lending and borrowing without traditional intermediaries.
- Staking: The process of participating in a proof-of-stake (PoS) blockchain by locking up a certain amount of cryptocurrency to support network operations, such as validating transactions. In return, stakers earn rewards. Different cryptos earn different rewards and you can think of it almost like earning a dividend from a stock.
- Cold storage: A method of storing cryptocurrencies offline to protect them from hacking and theft. It is often used for long-term storage.
- Consensus algorithm: The protocol used by blockchain networks to agree on the validity of transactions. Proof of Stake (PoS) and Proof of Work (PoW) are common examples.
- HODL: A term derived from a misspelling of "hold," it refers to the strategy of keeping cryptocurrencies for the long term, regardless of market volatility.
I hope this was a useful primer on crypto!
Jason
DISCLAIMER: None of this is financial advice. Finbrain is strictly for educational purposes.