Introduction to Cryptocurrency
As you think about the various elements of prosperity and building wealth, having stewardship over things (ownership) that have value is fundamental to being prosperous.
Cryptocurrency is a digital representation of value, and it serves the same purpose as traditional money, including serving as a store of value and a medium for exchanging value.
As fiat currencies (ones that are not backed by anything of intrinsic value, like gold or silver) such the US dollar and the Euro continue to demonstrate weaknesses in terms of being able to maintain value (inflation is always a threat to the ability of a fiat currency’s purchasing power), other alternatives for preserving wealth and savings have become more attractive. Cryptocurrency is one of the most popular alternatives to cash savings for people who are nervous about whether the money they’ve saved will be worth what they expect it to be as they put it aside for their savings and retirement objectives.
Cryptocurrency is also quickly becoming more popular as a method for paying for things. In fact, many major and smaller retail stores now accept Bitcoin and other forms of crypto, including:
- Overstock.com The first major retailer to accept Bitcoin, beginning in 2014.
- Home Depot: Home Depot gift cards can be purchased using Bitcoin through a Home Depot gift card provider.
- Namecheap: The domain registrar started accepting Bitcoin in 2013.
- Starbucks and Quiznos: Using a third-party app called Bakkt, fast food restaurants Starbucks and Quiznos are now accepting Bitcoin for payment.
- Many Online Retailers: Crypto.com has a payment module that is being used by an increasing number of online retailers to accept over 30 different cryptocurrencies, including Cronos, Ethereum, Bitcoin, Polkadot, DogeCoin.
The short answer to whether the US dollar will maintain its value over the long-term is simply: NO! If you want to know the details about why that is, you may be interested in learning about the difference between money and currency to see why all fiat currencies ultimately fail, becoming worth $0 at some point.
Over the past decade, cryptocurrency has increasingly made its way into public discussions about money and payment systems. Compared to traditional forms of currency, the concepts associated with cryptocurrency require some technical understanding, more technical understanding than most people have. That lack of technical depth among the population, the fact that cryptocurrency is such a relatively new way of holding and exchanging money, the very publicly visible volatility of Bitcoin (the original cryptocurrency) and the natural hesitation most people have with regard to understanding what factors can increase or decrease the value of any particular cryptocurrency have made it so that widespread adoption of this new digital form of currency for buying, selling, and saving money is still not a reality.
However, it does appear clear that cryptocurrency will continue to be more of a part of the worldwide economy. Over the coming months and years, you are very likely to see more merchants accepting Bitcoin and other forms of cryptocurrency, and you will likely see the transition accelerate from the cash and fiat currency based payment methods to cryptocurrency for several reasons, some of which I will explain here.
With that background, I am going to introduce you to cryptocurrency and explain as much as I can in laymen’s terms how you should approach cryptocurrency as a part of your financial plan.
What is Cryptocurrency?
Cryptocurrency is a digital version of currency that is represented by a cryptographically secured (i.e. made secure through encryption mechanisms) network of computer nodes that run crypto software. Cryptocurrency is not dependent upon a bank, a government institution, or any kind of central authority in order to validate its value or approve of transactions on the network. Instead, with cryptocurrency, the functions that would normally be handled by a central governing authority (such as approving transactions) are handled intrinsically by the network and the logic written in the software.
Advantages of Cryptocurrency Over Fiat Currencies
In the just over a decade that cryptocurrency has been around, it has already demonstrated several benefits compared to traditional currencies:
- Protection against inflation: Cryptocurrencies typically have limited supply, and more cannot simply be printed as with fiat currencies. This protects against inflation
- Faster transaction speed: Whereas transactions at traditional banks (such as check deposits, electronic funds transfers, wire transfers, etc.) can take a day up to as much as a week, many cryptocurrency transactions are completed within a few minutes.
- Lower transaction cost: One of the primary aims of cryptocurrency is to lower the costs of holding and exchanging money. Transaction fees are generally lower when exchanging crypto.
- Security: There are security benefits for using cryptocurrency, namely that people can’t sign your name to a check or steal money from you using the common methods. However, if someone gets access to your private key (which is your handle to your cryptocurrency wallet and funds) or you lose it, you’re out of luck.
- Privacy: Transactions made with cryptocurrency are done using your private key, but no information about you is transmitted as it is when writing checks and with other means of sending and receiving money.
Among other risks of using cryptocurrency, two that stand out are:
- Volatility in value
- Vulnerable access to crypto through private key
I’ll discuss these in more detail below.
As a new form of storing money or value, cryptocurrency is highly volatile. Because of how quickly the crypto industry is moving, with several new cryptocurrencies being created pretty much every day, it is clear that the cryptocurrency world in general is in flux. To a person who invests money in an unproven cryptocurrency that tanks in value, the risk of the US dollar going into hyperinflation doesn’t seem like a bad alternative.
With any investment that has such high volatility and risk, it is imperative that you do not invest in cryptocurrency unless the following criteria are met:
- You are using money that you can afford to lose, at least in the near term. as with any other risky investment, cryptocurrency should only be purchased with money that you won’t need anytime soon. Otherwise, there is a high likelihood that you will take a loss on your investment.
- You understand whichever cryptocurrency you decide to invest in well enough that you can make informed decisions. There are so many cryptocurrencies (almost 20,000 of them as of March, 2022) in existence that you’ll need to understand how to determine which ones seem to have legitimate potential for solid returns.
The chart below shows the historical price of Bitcoin through March, 2002. While those who bought Bitcoin and held on to it over the years have seen their investment multiplied as much as nearly 12,000%, later investors, who may have bought at a peak and weren't able to hold on to it during one of its downturns, have suffered great losses.
Many of the advantages of using cryptocurrency for investment and general banking purposes also have flip sides. I just mentioned the potential for loss of value associated with cryptocurrency. That potential downside is for most crypto coins you can invest in at least as big as the risk of inflation of a fiat currency.
A second major risk associated with cryptocurrency is the idea that a private key – a large, randomly generated number represented (for “simplicity”) as a string of alphanumeric characters – is the sole gateway to the money you’re storing in your crypto wallet. With everything people have to keep up with in life, including passwords, account numbers, kids, schedules, etc., there is a high likelihood that any person could lose his or her private key.
This kind of unreliable handle to someone’s store of money feels vulnerable. In contrast, access to money you have in a bank account can be obtained through several verification processes that provide redundancy. People don’t tend to feel like they’d lose access to their savings if they misplace any particular code or alphanumeric string.
Learning About Cryptocurrency
Since cryptocurrency is still in its infancy in terms of how prevalent its use is among the general populace, those who use cryptocurrency are either early adopters (people who tend to jump into new technology as a natural element of their personalities) or investors, those who purchase cryptocurrency with the intention of experiencing an increase in value of their investment and with the expectation that they can sooner or later sell that investment for a profit.
At some point in the future, it is likely that cryptocurrency will replace the faulty fiat money systems that have existed for several decades, but that ultimately (because of principles of economics) will disappear. When cryptocurrency becomes the norm for money exchange, it may not be so necessary to become educated on the fundamental principles of this form of trading.
However, since cryptocurrency still has a way to go in terms of widespread adoption, it’s important for those who are investing to become familiar with the concepts that are associated with cryptocurrency so that you can intelligently filter out ones that don’t hold up to
Concepts Associated with Cryptocurrency
- Encryption: Most cryptocurrency uses digital encryption for communication of transactions across the crypto network.
- Blockchain: This is a public, distributed ledger used to show a history of the transactions that have created the most current state of ownership of cryptocurrency. The blockchain is updated as new transactions occur.
- Peer to Peer Network: This is a system of computers running software that form the technological foundation for each cryptocurrency.
- Wallets: Cryptocurrency is kept in virtual wallets that use public and private keys to manage transactions.
How Blockchain Works
How to Buy Cryptocurrency
Opportunities to buy and sell cryptocurrency are becoming more and more accessible by the day. Buying cryptocurrency involves going to one of the exchanges that offer the cryptocurrency you’re interested in purchasing, setting up an account (which usually involves providing government issued identification), funding your account via a bank account or some other payment method, and then purchasing the cryptocurrency you want.
Choosing a crypto exchange to use is not entirely straight forward, as there are several conditions that would need to be met in order for you to successfully use the exchange to buy (and possibly, later, sell) the cryptocurrency or cryptocurrencies you’re interested in. Each of the crypto exchanges don’t support anywhere close to all of the cryptocurrencies available to purchase. Also there
Choosing a Crypto Exchange
Here are some questions to ask when determining which crypto exchange will meet your needs.
- Does is support buying/selling the crypto you’re interested in?
- What fiat currencies (USD, EUR, CNY, etc.) does it support?
- Does it support the payment method(s) you want to use to buy cryptocurrency with your fiat money?
- Is the exchange available in your geographic location?
- What governmental regulations in your area prohibit you from using any particular crypto exchange?
- What is the fee structure for transactions through the exchange?
Here are some of the most popular crypto exchanges:
Binance is the world’s largest cryptocurrency exchange. It was founded in 2017. Binance supports almost 50 fiat currencies, including USD, CAD, EUR, and many others.
Binance has encountered many legal issues in the US, Canada, and elsewhere where it has operated.
People in the US must use Binance.us instead of Binance.com because of legal restrictions in the United States over Binance.com.
If you attempt to use Binance.com from a US-based IP address, you’ll get this error message.
FTX is rated the second highest rated (behind Binance) cryptocurrency exchange by CoinMarketCap.
Similar to Binance, those located in the United States must use a separate version of the FTX.com global exchange, FTX.us, to trade crypto through the FTX exchange.
FTX currently supports 10 different fiat currencies, including USD, EUR, and GBP.
Coinbase is another popular cryptocurrency exchange, likely the most popular in the United States. Coinbase supports only three fiat currencies: USD, EUR, and GBP.
Coinbase is the #3-rated cryptocurrency exchange by CoinMarketCap.
In addition to these three popular crypto exchanges, there are hundreds of other exchanges that you could could shop among to get started with investing, trading, and cryptocurrency.
How To Set Up an Account on an Exchange
To set up an account with a cryptocurrency exchange, you’ll need to provide some identification (a passport or driver’s license is standard), and you’ll need to deposit an initial amount of fiat currency, which is normally done by connecting your new crypto exchange account with a form of payment, such as a credit card or a checking account.