Understanding Crypto Fundamentals
Cryptocurrency is a complicated technology, but it’s also accessible. It can be understood by anyone, regardless of your background.
At this point, it’s highly likely you’ve at least heard the many buzzwords associated with cryptocurrency. Blockchain, Bitcoin, or Ethereum ring a bell? But how many times has someone also said, “You should definitely invest in crypto” and then done a poor job of describing what any of it actually means?
I’m all for movements and trends that create engagement within the investing space, but most of us require more before we feel comfortable taking action. My hunch is that some of the qualities that help make an investor successful—being thoughtful and disciplined, for example—can also be our Achilles heel when it comes to crypto and other speculative investments.
And while I’m not suggesting that we set our principles aside and immediately add crypto to our portfolio, (heck, only 15% of women are actually investing in it and we’re the better investors, aren’t we?), understanding the fundamentals should help unlock the door to the possibility. At the very least, I hope it prepares you for the next time crypto is inevitably brought up in conversation.
So let’s master the three main areas, eh? What it actually is. Considerations for investing. And how to do so, if you so wish.
Section 1: So, what’s crypto, anyway?
First things first, it’s important to understand a few key definitions. Only then can we piece them together to try and make sense of it all. Three key terms:
- Cryptocurrency “Crypto”: a form of payment for goods and services that can only be exchanged virtually (digital currency). It’s also decentralized, meaning the transaction doesn’t have to be made through an official financial institution, such as a bank.
- Blockchain: the technology behind crypto that enables virtual records of all digital transactions to be created and stored securely across computers. This helps verify ownership and prevents fraud.
- Bitcoin: one of the MANY types of cryptocurrencies that exist.
Tied together, crypto is basically a decentralized form of currency that relies on blockchain technology to facilitate secure and strictly digital transactions. Bitcoin, while by far the most popular cryptocurrency, is really just one of many that exist. Bitcoin can be acquired and used to exchange goods and services and/or as an investment opportunity.
Still confused? Analogy time.
It’s kind of like when you go to a carnival and you use tickets instead of cash. The ticket is your Bitcoin (or another crypto, like Ether) and it carries a perceived value that can be exchanged for something else: Say, a ferris wheel ride. Your primary motivation for having the tickets could be purely transactional, like paying for the fun night at the carnival. But what happens if you wind up with leftover tickets at the end of the night, either intentionally or unintentionally?
By not timely exchanging those tickets for other goods and services, it’s expected that their value could change. Over time, the same leftover tickets could potentially buy you 2x the ferris wheel rides, for example, or the same ride could require more tickets than before.
To tie it back to cryptocurrency, what continues to attract investors is the idea that the value of cryptocurrency could increase over time.
Section 2: To invest or not to invest?
The considerations associated with investing in the digital currency space are unique and complex.
Does one invest in a single cryptocurrency? A mixture of the 1,000+ possible currencies? Or, is it actually the technology behind cryptocurrency that has the most potential? And exactly how much exposure should one have? If you were hoping for a straightforward answer, I'm sorry to disappoint.
Take Bitcoin, for example.
Satoshi Nakamoto created Bitcoin in 2009, in response to the financial crisis of 2008. His primary intention was for Bitcoin to act as an alternative to your traditional, bank-controlled currency. Fast forward to today and Bitcoin is still far from being a convenient, 1:1 replacement for cash. Instead, retail investors are flocking to it for its growth potential, betting its value will continue going up.
And even though Bitcoin is far and away the single largest cryptocurrency—and the fastest ever asset class to reach a $1T market cap thanks to a $500B surge in 2021 alone—its historical price fluctuations and inherent volatility often make it too risky to be trusted as a standalone investment.
Bitcoin’s extreme price fluctuations in April should be a caution sign to all investors. After cracking $60,000, a 15% flash crash had Bitcoin’s price as low as $50,900, and as of end of month April, it was still down about 8%. And if you’re looking for a sound reason as to why the crash happened...good luck. There is no true consensus.
So, even if you believe in the technology and conclude crypto’s here to stay, one thing is certain: Right now, this is not a stable asset class and buying Bitcoin is absolutely not the same as holding a regulated currency, like U.S. dollars.
That said, even if stability and a disciplined investment approach is important to you, there could still be room for crypto in your strategy. Like anything else, having some exposure is reasonable.
You just want to be sure it’s in balance with your broader strategy, explicitly categorized as “play money”, and not being counted towards any specific goal or future need. Until there’s an easier way to actually exchange your crypto for goods and services (at a steady price), you should be buying it primarily for its growth potential.
Section 3: I think I’m ready to buy.
So, you’re ready to join the club. You’ve decided that based on your financial goals and strategy, you’re willing to invest some of your excess cash in crypto. Great. Like the many currencies and tangent technologies, there are several platforms to choose from, possibly even through one of your existing accounts.
Unless you have the ability to easily track and monitor your crypto, keeping it separate from your established portfolio may help you better maintain your core strategy moving forward.
As you evaluate your options, here are some additional considerations to keep in mind.
- Safety and security: Use a centralized exchange, or one that’s required to register and follow standard “know your customer” rules (at least when you’re first starting out).
- Cost: Depending on the platform, there can be trade specific fees, ongoing management fees, and additional costs to send your currency to someone else.
- General platform functionality: Do you want to be able to simply buy and sell currency? Or do you also want to be able to exchange your currency for additional goods and services and send it to other people? Since this asset class is so volatile, what is your chosen platform’s track record of uptime? Nobody wants their platform to be down while they are trying to make a trade.
Companies like Coinbase are often touted as good enough options for beginners and have seemingly avoided the fraud and funny business that other exchanges have fallen victim to. They also have a lot of resources and tools you can access as you get your feet wet. Consider using them as a jumping off point for further exploration.
Be an informed crypto investor.
So, while this asset class is relatively new and is constantly evolving, it’s important to get familiar with the basics.
It’s clear that cryptocurrencies aren’t going anywhere, and the sooner you have the tools to understand what cryptocurrency is—and the consideration related to investing in it—the more empowered you’ll feel participating in the ongoing conversation, and ultimately investing (responsibly), if you so choose.