FINANCIAL ADVICE CENTRE NEWS
Your Summer Newsletter 2021
Cryptocurrencies are in the news at the moment, so we thought we would explore what they are and what they mean for investors.
What is cryptocurrency?
A cryptocurrency is a digital currency that uses cryptography as a means of security.
Cryptography is the process of converting ordinary plain text into unintelligible text and vice-versa. It is a method of storing and transmitting data in a particular form so that only those for whom it is intended can read and process it.
Even though the general public has only stumbled upon cryptocurrencies over the past few years they date back more than a decade. Most cryptocurrencies operate without the need for a central authority such as a bank or government and operate instead through a distributed ledger to spread power among its community. A cryptocurrency has a set, defined monetary policy, whether it be a fixed limit of tokens or allowing the creation of new tokens based on predetermined rules.
When was Bitcoin created?
In October of 2008, a white paper by Satoshi Nakamoto was released. This paper described a decentralised network used to fuel a new cryptocurrency called Bitcoin. Over the next several years, more cryptocurrencies would be launched on the back of Bitcoin and ride the emerging cryptocurrency wave.
Cryptocurrencies go global
By 2014, there were already dozens of cryptocurrencies. Some of these, like Ethereum, would continue to grow and thrive over time, yet others would go bust as quickly as they came into existence. By 2017, cryptocurrencies were becoming the darling new niche of the financial world, hailed as a saviour from a “corrupt” financial system. They were bought and sold on new trading platforms. By the end of 2017, Bitcoin had skyrocketed in price from $900 to $20,000, and then to over $30,000 currently.
How does it work?
The distributed ledger that holds cryptocurrency transactions is known as a blockchain. A blockchain consists of blocks, which hold individual transaction information. This information is timestamped and posted to the ledger so that each transaction can be verified by other blockchain stakeholders and never be altered.
Let’s say you want to send your friend a small amount of Bitcoin. You create a transaction using your Bitcoin wallet and request to send Bitcoin to your friend’s wallet. After you make the transaction request, your transaction gets grouped with other transactions into a block on the Bitcoin blockchain. This block is verified by miners and posted to the blockchain, making the transaction complete.
Through this process, you can send cryptocurrency to anyone, anywhere around the world, with low transaction fees. Not only will the transaction usually be completed in a matter of seconds or minutes, it will only cost you a fraction of the fee you would have paid using a traditional money transfer service.
What is cryptocurrency used for?
One of the early appeals of cryptocurrency was that it offers you the opportunity to transfer large amounts of your wealth anonymously without any government or institutional interference. These days, cryptocurrency is used by some owners to take care of routine matters such as paying bills. Others use it as collateral to obtain online loans.
Still others put their digital currency to use by investing in business start-ups. The combination of innovative tech ventures and cryptocurrency seems like a natural fit. You can also use your digital currency to travel the world. Arrive at your destination in the luxury vehicle you purchased with your cryptocurrency or on the airline that readily accepted your Bitcoin.
What is cryptocurrency mining?
Cryptocurrency mining refers to the reward gained from verifying transactions on a blockchain. Blockchain transactions are encrypted when added to a block. Therefore, these transactions need to be verified for accuracy before the blockchain can continue adding transactions to the next block. This is where miners come in. Miners use their computing power to solve complex mathematical problems to verify transactions in a block on the blockchain. The first miner to solve the problem and verify all of the transactions in a block is rewarded with a fee for their services. This method of securing a blockchain is known as proof of work (POW).
Why do cryptocurrencies have value?
It seems strange to some people that cryptocurrencies have value when most of them are not official products of a sovereign nation. However, the misunderstanding goes hand in hand with a misunderstanding of the definition of currency. Simply put, currency is anything that buyers and sellers agree will serve as a form of exchange between them.
There are enough investors and traders of cryptocurrency to make it an attractive form of currency to people around the world.
What might the future hold for cryptocurrency?
First, cashless and mobile payments will continue to grow globally, helping in cryptocurrency adoption and usage. Cryptocurrencies, like Bitcoin, will see their technology advance and use cases grow, leading more and more merchants to accept cryptocurrencies as a form of payment.
The main issue with cryptocurrencies is their ease of use. Today, it still requires some level of technological understanding to utilise cryptocurrencies to their fullest potential. As more projects and developers work on user interface and design, cryptocurrency offerings will become easier to use for the average person with little to no technical knowledge. Once this happens, watch out, because there will be no limit to how high cryptocurrencies can grow.
Investing in cryptocurrencies
The technology behind cryptocurrencies, including Blockchain, are here to stay and proving to have many uses in the secure custody and transfer of assets.
However, cryptocurrencies themselves- rather than the infrastructure- are a different beast. As with all investments, it is worth exercising caution and remembering a few pointers:
• Do not invest more than you can afford to lose. This goes for any investment but especially for cryptocurrencies which have no intrinsic value. Ideally, your investment would come from disposable income rather than your savings.
• Consider your investment like gambling. There has been plenty of money made, but also plenty lost. Bitcoin investing is not a “skill” when something like a Tweet from Elon Musk can wipe 10% from the value.
• Expect volatility. The price of a Cryptocurrency largely depends on supply and demand, as there is no underlying asset. This means you can see huge fluctuations on the slightest whim. This volatility includes increases, as well as decreases, in value.
• Warren Buffet is famously critical of Bitcoin saying “It’s ingenious and blockchain is important, but Bitcoin has no unique value at all. It doesn’t produce anything. You can stare at it all day and no little Bitcoins come out or anything like that. It’s a delusion, basically.” However, Mr Buffet has been wrong before and there are plenty of opposing views.
If you are interested and feel that cryptocurrency is the future, then a modest investment is understandable. However, the market is very high risk, highly volatile, unregulated and not well-understood and it is essential that you understand this before you part with any of your hard-earned money.
Financial Advice Centre is not able to provide advice or recommend our clients invest in cryptocurrencies.