In recent years, cryptocurrency has become a transformative, intriguing, and immensely popular asset class.
If you're a new investor eager to explore the world of cryptocurrencies, it's important to understand its basics, benefits, and risks. Here is a primer.
What is cryptocurrency?
Cryptocurrency is a digital asset that uses cryptography for secure transactions, independent of any central authority such as banks or governments. The best-known cryptocurrency is Bitcoin, but today there are thousands of other digital assets available, each with their own unique characteristics and purposes.
Starting in the 1990s, many people tried to create digital currency systems, but they all failed. Satoshi Nakamoto, the pseudonym given to an unknown inventor or group of inventors, was the first to succeed. In 2008, Nakamoto created Bitcoin as a peer-to-peer e-commerce network. Since then, the world has seen an explosion of similar digital assets, which are often called cryptocurrencies because they can be used to buy things, just like traditional currencies like the dollar.
Bitcoin is still the most dominant player in the cryptocurrency market. As of mid-May 2023, Bitcoin had the largest share of the market capitalization with over $500 billion of the global cryptocurrency market capitalization of approximately $1.20 trillion.
The practice of using digital assets, or cryptography, to purchase goods and services was established as early as 2012 by the open source content management system WordPress. Other companies, such as Overstock and Expedia, soon followed suit. Now many others, like AT&T, Microsoft, and PayPal, make it easy for customers to spend their digital assets by accepting them as a form of payment.
However, it is not difficult to understand why some merchants do not accept cryptocurrency as payment. These assets can be surprisingly volatile, and values โโcan drop significantly even in one day. For example, consider some recent values โโfor Bitcoin.
In dollars, the price of a Bitcoin rose from about six cents in 2010 to an all-time high of $67,567 on November 8, 2021. The price then plummeted rapidly, falling 30 percent by the end of 2021, just seven weeks. after. Investors quickly shifted their focus to safer assets, and volatility has continued.
Benefits of cryptocurrencies
Decentralization: Some cryptocurrencies operate on decentralized networks, eliminating the need for intermediaries such as banks. This allows for peer-to-peer transactions, eliminating some of the fees and delays associated with traditional financial systems. It also means that transaction data is not stored in a single location, but is hosted on millions of computers simultaneously and is accessible to anyone on the Internet.
Hypothetically, this means that the data cannot be controlled by a single entity and does not have a single point of failure. However, in practice, most people keep their digital assets on one of the major platforms, like Coinbase, where things are very centralized. To take full advantage of decentralization, you need to store your digital assets in a hardware wallet.
Security: Cryptocurrencies use advanced cryptographic techniques to protect transactions and user identities. This improves security and reduces the risk of fraud or identity theft.
Global accessibility: Cryptocurrencies allow anyone with an internet connection to participate in the global financial system. They also provide financial services to the unbanked population, fostering financial inclusion and empowerment.
Potential for high returns: The cryptocurrency market has seen significant growth, resulting in substantial returns for early investors. However, it is important to note that this potential for high returns comes with increased volatility.
cryptocurrency risks
Market Volatility โ These assets can be highly volatile, with prices fluctuating rapidly. While this volatility can lead to significant gains, it also presents considerable risk of loss. Investors must be prepared for price swings and potential market downturns.
Regulatory uncertainty: Digital assets operate in a regulatory gray area in many countries. Governments around the world are still formulating regulations to govern this nascent industry. Changes in regulations can affect market sentiment and the value of cryptocurrencies.
Security Concerns: While digital asset technology is typically secure, the surrounding infrastructure, such as cryptocurrency exchanges and digital wallets, can be vulnerable to hackers and cyberattacks. Investors should adopt strict security practices and choose reputable platforms to mitigate these risks.
Lack of Fundamental Value โ Unlike most traditional investments, cryptocurrencies do not derive their value from underlying assets or earnings. Instead, its value is driven by market sentiment and speculation. This speculative nature can lead to unpredictable price movements.
Before purchasing any digital asset, please do your research to fully understand the risks associated with the purchase. If you choose to continue, it's a good idea to only invest what you can afford to lose. And remember that when you sell these assets, you will make a profit or loss and may owe the appropriate income tax.
Of course, when we invest in cryptocurrencies, we expect to make a profit. But due to the nature of the asset class, we must be prepared for a loss. Going forward, mainstream views on digital assets may change, but for now, they are still considered speculative. As an investor, it is important to treat them as such.
Teri Parker is Vice President of CAPTRUST Financial Advisors. She has practiced in the field of financial planning and investment management since 2000. Please contact her by email at Teri.parker@captrustadvisors.com.
