The cryptocurrency space could be really intimidating and scary for a beginner. If you are a first-time investor and are feeling FOMO this guide will give you the basic knowledge you require to make an informed decision.
What does cryptocurrency mean?
In the simplest of words, cryptocurrency is a digital currency. It is mainly used by individuals and very few businesses. One will not be able to physically hold it unless they cash it in for a physical token. They are available to be purchased on various platforms. These platforms act like an exchange, similar to a stock exchange. Individuals can buy and sell their tokens online with the same ease.
Another very complex method of acquiring tokens is through mining. A person could use their personal computer and solve complex mathematical equations to get a small amount of tokens. the more someone mines the tougher these equations get. Now, this is a very simple explanation of cryptocurrency mining, but in reality, there are various ways one could go about it and this is a good place to start.
Legality and Usage
Money has three primary functions – 1) medium of exchange, 2) unit of account and 3) store of value. Let’s see if cryptocurrency meets these criteria.
- Medium of exchange – cryptocurrencies are widely accepted by people and maybe among some businesses as well. They can be transferred via a digital wallet in order to purchase a good or service.
- Unit of account – NFTs or Non- Fungible Tokens are digital assets that are unique and not interchangeable. They could be photos, videos, audio, or any kind of digital content. This asset is primarily exchanged using cryptocurrencies. Cryptocurrencies give each asset a value which signifies the market value of that asset.
- Store of value – $1 will let me buy a bar of chocolate today and tomorrow. The value of the dollar, barring inflation, has not changed drastically in the short term. It allows me to buy the same good, quantity, and quality. On the other hand, cryptocurrencies change value drastically within 24 hours. It reacts to the slightest change in market feelings. Thus, it is not an ideal store of value.
Cryptos act like money, they can be used in a transaction and give value to commodities but their value itself may erode quickly.
On a spectrum of legality, ranging from fiat money to monopoly money, cryptocurrency is somewhere in between. It is not backed by any government implying that if it were stored in a bank and they go out of business, the government is not obliged to step in and retrieve them. But unlike Monopoly money, their value changes. It may change due to supply and demand or due to financial and economic events. So even though cryptocurrencies are not backed by any government they are widely popular and new ones are coming every other day.
How do they work?
Cryptocurrencies use blockchain technology that allows their users to anonymously transact without going through a bank. Thus they are seen as a secure medium for exchange. These transactions cannot be faked or reversed and they tend to be low fees. This blockchain technology facilitates peer-to-peer transactions making the middle man irrelevant.
Their supply is controlled by the users’ activities – mainly the miners – and highly complex protocols built into their governing codes. These miners serve as record-keepers and ensure the smooth functioning and stability of the cryptocurrency. They are rewarded with brand new tokens and variable existing tokens as operational fees. The other primary method they are created through is code.
There are primarily two ways to create your own cryptocurrency. The first option is to create a coin. This is comparatively a more time-consuming and difficult process. The process of creation itself is easy, copy the code of Bitcoin and add a new variable. But the real cumbersome part is to understand the code and how to change it. One would require professional-level coding skills for this. Additionally, the coin needs to be maintained, supported, and promoted. The advantage of this option is that there is complete control over the blockchain.
The second option is less time-consuming and cheap. The first step is to choose an existing blockchain that is popular and can be trusted. The fork cryptocurrency¹ is created on top of it, in this way the token created runs on a secure network, protected from fraudulent attacks. Some of the blockchains that offer the means for creating a token are – Ethereum, NEO, and EOS. These three are the most popular ones which are easy to use.
Then comes the tedious task of Initial Coin Offering or Security Token Offering. Usually, after publishing a white paper, detailing how the system would work, the company would ask people to purchase their coin in return for another coin or fiat. An important difference between an IPO and ICO is that an IPO grants you an ownership stake in the company when you buy a share. When you buy a coin from a company you do not own a part of the company.
There are a number of exchange platforms devoted to cryptocurrencies but here we will mention the top few and give a general idea of how it works. The best overall is coinbase, it is widely known and accepted in the U.S. It is a user-friendly platform that removes the barriers to enter into the crypto market. They additionally provide insured custodial wallets, which means your tokens are insured against data breaches and hacking.
If you are a new investor, Cashapp is a good place to begin. It behaves like any digital wallet and offers smooth peer to peer money transfer. It also allows you to withdraw Bitcoin, the only crypto on the app at the moment, and invest in stocks and ETFs.
If you have been in the market for a while and want to have a range of cryptocurrencies including altcoins, Binance is the ideal platform. Known for their lower fees and advanced charting they dominate the global exchange market.
The coins listed here are those with high market capitalization and huge user activity.
- Bitcoin – the story started with the most widely used cryptocurrency, Bitcoin. It has a supply limit of 21 million Bitcoin. It is increasingly becoming an accepted means of payment. The USP of Bitcoin when it launched was its lower transaction cost and decentralized architecture.
- Ethereum – launched in 2015, it is the second most popular cryptocurrency and usually the second most valuable. A notable improvement in Bitcoin’s basic architecture is smart contracts. This disallows parties to back out from their agreements and provide refunds should one party violate. The goal behind Ethereum is to create an umbrella of decentralized financial products available to everyone in the world.
- Binance Coin – it operates as a payment method for the fees related with trading on the Binance exchange.
- Tether – it was one of the first and most popular “stablecoin”. These types of cryptocurrencies peg their value to a reference point, usually another currency in order to reduce volatility. Tether is pegged against the US dollar. The stable nature of this cryptocurrency attracts cautious investors.
Total Market Capitalization
a) Total Market Capitalization of the entire Cryptocurrency market to date
Percentage of Total Market Capitalization (Dominance)
b) Market capitalization categorized by cryptocurrency
Source : coinmarketcap.com
Expert & Global Opinion
The biggest and most popular critic against cryptocurrency is Warren Buffet. He has always stayed away from them and claims that he always will. He referred to Bitcoin as a gambling device that has not produced anything, connected to numerous frauds. Investors like Mark Cuban and editor of Fintech newsletter, James Ledbetter, consider cryptocurrencies as highly volatile. There are huge gains but also huge losses, hence they advise investing that amount that you can afford to lose.
On the other hand, some look at it as a long-term investment, going up in the span of five to ten years. Anthony Pompliano, the co-founder of cryptocurrency hedge fund Morgan Creek Digital Assets, supports holding them for long terms. Due to their limited supply, Anthony believes that the demand will increase leading to an increase in price. Experts say the recent bull market is due to institutional investors exposing their balance sheets to cryptocurrency. Some of the notable financial companies that have invested in them are Paypal and Fidelity. This creates confidence among retail investors and pushes the demand further.
Moving on to nations that are crypto-friendly, we have Malta, Singapore, Japan, Switzerland, Estonia, and some parts of the United States (not an exhaustive list). Malta, a tiny European island nation, was the first nation to accept blockchain technology. Their government has passed three bills in July 2018, providing a framework for blockchain technology. The prime minister even made a very strong statement, “crypto is the inevitable future of money”. Some of the biggest crypto exchanges have set shops in Malta. Their economic minister wants Malta to be known as “The Blockchain Island”.
Japan is one of the few countries known for its most progressive cryptocurrency regulations in the world. They account for 10% of total global traffic to crypto exchanges. In 2017, they made a big move and recognized these assets as legal tender and laid out tax guidelines. They have also established an association in order to allow self-governance. The twenty organizations part of it have the authority to formulate regulations and standards for the cryptocurrency exchanges in Japan.
As seen above, there are mixed opinions on cryptocurrencies, some think they are just a speculative vehicle whereas others see them as the future of digital currency. Due to its peer-to-peer technology at no transaction cost, it could be seen as a potential global currency, one not influenced by any government but its users. As an investor, you need to decide your investment purpose and risk appetite. There are various coins on the market, each different from the other with their own USP. Select the one that caters to your needs. Once you decide which specific cryptocurrency you want to invest in, it is recommended to read its white paper to get a holistic understanding of its technology and vision.
¹ Miners in a blockchain set the rules that move the memory in the network. Fork means to change those rules; a diversion to the protocol