Cryptocurrency 101: Here’s What You Need to Know
investing-my-money | Read Time: 4 minutes
By Balaj Singh, CFA®, CAIA® | Published: February 2022
The topic of cryptocurrency is discussed by pundits on the news, influencers on social media, and people trying to make small talk. You would think with how much cryptocurrency gets mentioned we would all be experts by now. But it feels like when you try to ask someone what cryptocurrency is or why they own it – they can’t seem to give you a straight answer. The conversation either becomes technical with new jargon you haven’t heard of before or half-baked responses with generic buzzwords. Whichever kind of crypto “expert” you ask though, their conclusion ends up being cryptocurrency is “the future.”
While cryptocurrencies are an innovation that society is starting to embrace, it’s still a nuanced topic with concepts that are not given enough attention. For cryptocurrency to go mainstream one day and be recognized as more than a speculative investment, it’s essential that we are all on the same page about the basics of what it is.
What is cryptocurrency?
Cryptocurrency, often called “crypto,” is meant to be a medium of exchange just like the dollar. Crypto is digital currency that is decentralized and based on cryptography. Let’s expand on two concepts introduced in this definition of crypto: decentralized and cryptography.
A cryptocurrency isn’t issued by a central authority like a government or bank, the way the dollar and other legal tender are. Instead, cryptocurrencies are decentralized. They are created, exchanged, and overseen by a distributed peer-to-peer network. A peer-to-peer network means that everyone on the network is equal. There is no middleman, and everyone gets access to the crypto’s ledger.
Cryptography refers to the mathematical technique used to secure each unit of cryptocurrency to ensure it can’t be copied. It is a method of encryption and decryption to secure communication to make sure any validated record cannot be reversed or changed.
These are the crucial elements of what makes a cryptocurrency different than the dollar, but what’s the appeal? What advantages does cryptocurrency have over the dollar?
The technology behind cryptocurrency is complex but these are some of the reasons that it is popular:
- There are usually no restrictions on the amount of funds you can transfer.
- The market is open 24/7.
- In some scenarios it can be cheaper to use cryptocurrencies to transfer money versus traditional banks.
Banks have been trying to compete with the disruption of crypto but are still lagging in some areas. Nonetheless, even with the popularity of crypto, how many bank customers in the U.S. are using cryptocurrency as a medium of exchange consistently? Intuition would tell you not a lot of people and you would be right. The US dollar is not volatile in value like most cryptocurrencies are but that’s not the case for all legal tender in the world. It’s important to recognize that cryptocurrency is a global asset that can be utilized anywhere with an internet connection.
Who owns cryptocurrency?
Although it can appear that the only people who own cryptocurrency are folks trying to make a quick buck, in emerging markets crypto is being used practically in a broader sense. Around one third of the people in Nigeria own cryptocurrency as a means of exchange, according to one global consumer survey.1 Nigerians often use their phones to send money to each other or to pay for goods and services. Recently, businesses have been adding crypto plugins to their phone payment options, adding another way in which Nigerians can use cryptocurrency in their everyday lives.
Even though the crypto economy is still not as prevalent in the U.S., blue chip companies are trying to implement an infrastructure to accept payments in cryptocurrencies. Household names like Microsoft, Whole Foods Market and Home Depot are slowly starting to participate in the crypto economy.
Can I buy Crypto… Should I Buy Crypto?
Investing in cryptocurrency has become easier over the years with the development of major crypto exchanges. However, there are thousands of cryptocurrencies available, each having its own risks and considerations. Before deciding whether you should buy crypto, it is important to do your own independent research.
1 Buchholz, Katharina, and Felix Richter. “Infographic: How Common Is Crypto?” Statista Infographics, 17 Mar. 2021, https://www.statista.com/chart/18345/crypto-currency-adoption/.
About the Author – Balaj Singh
Balaj Singh, CFA®, CAIA® is a Research Analyst on West Capital Management’s Research Team and supports West Capital Management’s Investment Committee. Balaj is responsible for investment due diligence on managers and strategies, portfolio construction, and performance reporting. Prior to joining West Capital Management, Balaj was a Senior Stock Operations Associate at Broadridge Financial Solutions, Inc. and a Client Service Analyst at Hamilton Lane Advisors. Balaj graduated from Rutgers University with a Bachelor of Science in Finance and Accounting with a Minor in Economics. Balaj has earned the CFA® Designation and the CAIA® Designation.
This communication is provided by West Capital Management (“WCM” or the “Firm”) for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. No portion of this commentary is to be construed as a solicitation to buy or sell a security nor a recommendation to purchase crypto currencies or the provision of personalized investment, tax or legal advice. Certain information contained in this report is derived from sources that WCM believes to be reliable; however, the Firm does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages.
Because crypto assets are a new technological innovation with a limited history, they are a highly speculative asset. Future regulatory actions or policies may limit the ability to sell, exchange or use a crypto asset. The price of a crypto asset may be impacted by the transactions of a small number of holders of such crypto asset. Crypto assets may decline in popularity, acceptance or use, which may impact their price.
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value, but it does not have legal tender status. Virtual currencies are sometimes exchanged for U.S. dollars or other currencies around the world, but they are not currently backed nor supported by any government or central bank. Their value is completely derived by market forces of supply and demand, and they are more volatile than traditional fiat currencies. Profits and losses related to this volatility are amplified in margined futures contracts.
Purchasing virtual currencies on the cash market – spending dollars to purchase Bitcoin for your personal wallet, for example – comes with a number of risks, including:
- most cash markets are not regulated or supervised by a government agency;
- platforms in the cash market may lack critical system safeguards, including customer protections;
- volatile cash market price swings or flash crashes;
- cash market manipulation;
- cyber risks, such as hacking customer wallets; and/or
- platforms selling from their own accounts and putting customers at an unfair disadvantage.
It’s also important to note that market changes that affect the cash market price of a virtual currency may ultimately affect the price of virtual currency futures and options.
If you are considering the purchase of a digital coin or token, it is important to weigh factors that could impact its current or longer-term value, including:
- The potential for forks in open-source applications that could split away market participants, increase the number of digital coins, or make your coins obsolete.
- Decreasing mining or validation costs (if price is tied to those factors).
- Acceptance of other currencies, coins, or tokens for offered goods and services.
- The link between the value of a digital coin or token and the offered product or service.
- Adoption of the digital coin or token as a broad medium of exchange or store of value.
- Future competitors or technological changes that could disrupt the underlying business.
- Future demand or uses for an application, network, product, or service.
- Liquidity in the market for a specific digital coin or token.
- Changes to the underlying technology that could devalue your digital coins or tokens.
- Risk of theft from hacking.
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