Almost every investor has heard of cryptocurrency, or may know a little about it. This article will discuss what it is and how it impacts investors.
What Is Cryptocurrency?
Cryptocurrency, also known as "crypto," is a digital currency designed to act as a medium of exchange and a store of value but, because it's new, it's more commonly held as a speculative investment asset.
Cryptocurrency uses blockchain technology to record transactions in a ledger system. The most important aspect of this technology is that it can be viewed publicly but it can't be changed or controlled by any single entity, making cryptocurrency secure for online transactions and nearly impossible to counterfeit.
What Does Blockchain Mean?
A blockchain can be described as a digital ledger of transactions, which uses cryptography, a network of computers, and electricity to build blocks of data. This system of recording makes it difficult or impossible to change or manipulate the data.
How Many Cryptocurrencies Are There?
There are thousands of cryptocurrencies that are publicly traded today, as others continue to come on the market. Many of these cryptos are not well known and don't have much trading volume.
Examples of popular, more widely traded cryptocurrencies include:
Is Cryptocurrency Legal?
Cryptocurrency is legal in the U.S., as well as most developed market countries, such as the U.K., Germany, and Japan. Some countries have either banned it or restricted its use. For example, China has heavily restricted Bitcoin use but has not made it illegal to hold Bitcoins.
How Does a Cryptocurrency Gain Value?
As of Spring 2023, the value of all cryptocurrencies exceeds $1.25 trillion. Like other currencies, the value of cryptocurrency is primarily driven by the supply of the currency and its demand in the market. However, unlike traditional currencies, cryptocurrency is not issued by a central bank or backed by a government. For this reason, monetary policy, inflation, and economic growth do not influence the value of cryptocurrency.
Forces that may influence the value of a given cryptocurrency include:
- Supply and demand of the currency in the market
- The cost of production (mining or staking process)
- The supply and demand of competing cryptocurrencies
- The exchanges it trades on
- Any governing regulations or restrictions upon it
Pros & Cons of Investing in Cryptocurrency
There's no shortage of financial media coverage on the rapid growth and popularity of cryptocurrency. But like other types of financial assets, there are some significant risks and disadvantages that come along with the growth potential and benefits.
Pros of Cryptocurrency
- Anonymity: Cryptocurrency transactions are completely anonymous, which is a benefit for users wanting privacy.
- Transparency: Although transactions are anonymous, the data is recorded on an open ledger using blockchain technology. This means that data is transparent and publicly available at any time.
- Decentralization: Since cryptocurrency is not issued by a central bank or backed by a federal government, there is no interference from government or influence from monetary policy.
- Potential for quick gain: The popular cryptocurrency, Bitcoin, has had many short periods of significant gains, such as the first four months of 2021, where it more than doubled in price before falling again. Some of the top daily gains in crypto have surpassed 200% (coinmarketcap.com).
Cons of Cryptocurrency
- Price volatility: While quick gains are a big attraction to crypto for many interested investors, there is also potential for fast and extreme declines in value. An example is Bitcoin's 50% price drop in just two months from April to June 2021.
- Excessive cost to produce: Many cryptocurrency types require vast sums of electricity and other resources to mine. For example, according to Harvard Business Review, the energy required to mine Bitcoin represents the majority of costs associated with it.
- Regulatory restrictions: While cryptocurrencies are generally legal in many developed countries, the currency is not formally regulated by central governments. The risk of investing in cryptocurrency will be elevated until federal governments adopt and regulate it in the same way as fiat currencies, such as the U.S. dollar.
- Risk of losing coins: Many cryptocurrencies like Bitcoin require a private key to access the currency tokens that are stored in a digital "wallet." If you lose your key, or if your computer hardware fails, you lose your tokens, which are not recoverable in any other way.
Where To Buy & Trade Cryptocurrency
Although there are thousands of cryptocurrencies in existence today, there are only a handful of trading platforms that offer the option to buy or trade Bitcoin and other popular cryptos. Crypto trading platform examples include Robinhood. Another option is Coinbase (COIN), which is a popular exchange where users can buy, sell, transfer, and store digital currency.
Here are the basic steps to buy and trade cryptocurrency:
- Choose a trading platform or exchange.
- Create an exchange "wallet" to store your cryptocurrency.
- Add a payment method, such as a debit card, to fund your account.
- Buy your chosen cryptocurrency.
Is Cryptocurrency a Good Investment?
Individuals interested in cryptocurrency should be aware of its unique risks before buying. Determining whether or not cryptocurrency is a good investment will depend on its suitability for a given investor's investment goals and risk tolerance. For example, cryptocurrency does have potential for outsized gain but there's also the risk for significant decline or permanent loss in the principal amount invested.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.