Cryptocurrency Explained: Is It Simply FooL's Gold or Actually the Real Deal?

Cryptocurrency isn’t the black sheep it once was. It’s hit the mainstream, and it’s grabbing up more headlines and investors than ever before.

These days, about 1 in 7 Americans own some type of cryptocurrency. And a little more than half of them bought it for the first time in 2020.1

Those numbers are likely to climb this year. That’s because more than a quarter of folks say they plan to buy cryptocurrency in the next 12 months.2

With all the headlines, it’s hard to ignore all of the excitement.

And, yet, many also admit they still don’t know all that much about cryptocurrency.3

Do you know the basics?

How much do you really know about cryptocurrency?

Test your knowledge and check out the facts below to see if the cryptocraze lives up to all of the hype — and if it really makes sense for you to jump on the bandwagon.

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6 Things Most People Don't Know About Cryptocurrency

1

What Is Cryptocurrency?

It's digital or virtual currency created by encoding strings of data (crypto) into units of currency. The feds define it as "a medium of exchange that operates like a currency in some environments but does not have all the attributes of real currency."4

That means that, unlike the U.S. dollar, cryptocurrencies are not issued by the government. They aren't regulated by any central authority, and they don't have a physical form. They are digital, decentralized, and encrypted.

Think of them like virtual tokens or "credits" that you can only use in certain places — and that you can't necessarily cash out when you want to.

2

Top 3 Types of Cryptocurrency

Bitcoin (BTC), the first and biggest name in crypto, has dominated the market since its introduction in 2009. It's prized for its relative resilience and widespread acceptance in the crypto space. That's why some say it's the closest option investors have to getting a "blue-chip" cryptocurrency.5

Ethereum (ETH), second only to Bitcoin in market share, is distinctive in that it's a software platform where users can exchange a cryptocurrency known as "ether." Although many use the terms "Ethereum" and "ether" interchangeably, Ethereum can be used as a host for other cryptocurrencies. That means investors in Ethereum can benefit from wider uses of the platform, not just ether exchanges.5

Litecoin (LTC), created in 2011, was developed to be the "silver to Bitcoin's gold." Using some of Bitcoin's best features, Litecoin is a less complex cryptocurrency, meaning much shorter transaction confirmation times.

These popular options are just some of the 7,000+ cryptocurrencies that currently exist. Every week new cryptocurrencies are created, and they all have different use cases and goals.5,6

3

Should you invest in cryptocurrency?

That depends. Cryptocurrencies are attractive to folks who like to be on the cutting edge of technology. Certain ones are designed for fast, low-cost, confidential transactions with anyone who has internet access. And their limited supply and freedom from government control gives them hedge-like qualities against inflation and unstable governments. For some, that can make cryptocurrencies a worthwhile option. That doesn't mean it's right for you or that you should rush in, however. If you're considering jumping into cryptocurrency, you need to be aware of its volatility and risks.

4

Buyer Beware

Cryptocurrencies exist in a "Wild West"–type space. They aren't regulated, and they aren't protected by the FDIC or any government body. That makes them ripe for hackers and scammers, who have stolen at least $11 billion in cryptocurrencies since 2011.7 And over half of that has been taken since 2019.8

Sophisticated hackers can hijack accounts, fake new currency offerings, and use other schemes to defraud.9,10 But even simple scams can work with naïve investors or insecure accounts. When they do work, accounts can be drained in minutes, and that cryptocurrency will be lost forever.

5

What Is Blockchain?

Blockchain is the technology behind cryptocurrency. It's a network that chains chunks of data (blocks) together to create permanent, time-stamped records of every transaction. This database is stored in a decentralized cryptocurrency network, with peers verifying and recording each transaction. The public record of those transactions is called the blockchain.

This setup provides transparency and traceability. In fact, even though cryptocurrency owners can be anonymous, their digital currency is not. Any time it's exchanged, it can be tracked, and every historical transaction for cryptocurrency is on record.

Beyond that, the peer verification in blockchain makes reliable transactions possible without a financial institution as a middleman — and outside of government authority and oversight.

These distinctive features of blockchain may not just change the way some industries do business. Some experts say blockchain has the potential to create new economic and social foundations.11

Jan wants to give Tom one cryptocurrency coin.

The transaction represents a "block" of data.

The block is broadcasted to every computer in the cryptocurrency network.

The peers in the network validate the transaction using mathematical algorithms.

The block is permanently added to the chain, creating an accurate, transparent, and indelible record of the transaction.

The transaction is complete and the coin changes ownership.

6

Industries Ripe for Blockchain Disruption

Art & Collectibles

Blockchain has paved the way for collectible digital assets. Known as non-fungible tokens (NFTs), these virtual tokens can represent anything from sports cards and clips of games to digital artwork, video game memorabilia, and other rarities. Because each NFT is unique, they aren't interchangeable like other cryptocurrencies. Still, they are a blossoming space where multi-million-dollar transactions are already happening.12

Financial Services

Borders and banks don't matter for financial transactions that happen through blockchain technology. That's a game changer in developing countries where billions of people lack access to traditional banks. It also means faster, more transparent, and more efficient money transfers anywhere. Plus, blockchain has the potential to make bank records more secure while creating a real-time ledger and reducing operational costs.13

All of that is why some say that blockchain is poised to revolutionize the financial services industry in the same way the internet fundamentally changed media.14

Health Care

Patient records can be stored more securely, while remaining immediately accessible, through blockchain technology. That alone could save lives in an emergency. Beyond patient data, however, blockchain could solve other big problems in the health care industry, like managing drug supply chains, health care claims, data from research and clinical trials, and much more.15

Without any intrinsic value, digital currency is incredibly vulnerable to huge price swings. That means a sudden boom — or bust — could take any investor for a wild ride.

Financial Lesson:

Cryptocurrency Is Still a Gamble in the Digital Gold Rush Age

Cryptocurrency fever has ignited a digital gold rush.

More people than ever are excited about digital currency, and they’re diving into the crypto space for all sorts of reasons.3 Excitement, speculation, and the desire to be part of a new technology are just some reasons for the frenzy around cryptocurrency.

And it’s not just the little guys who want to stake their claims in the crypto space.

Publicly traded companies see digital currency as a way to hedge against inflation. That’s why some own billions in cryptocurrency.16

All of this has given digital currency strong staying power.

But it doesn’t change the risks or make this new asset class any less volatile. And it doesn’t mean it’s right for you.

Cryptocurrency is still highly speculative.

Without any intrinsic value, digital currency is incredibly vulnerable to huge price swings. That means a sudden boom — or bust — could take any investor for a wild ride.

Before jumping in, think about your objectives and your reasons for wanting to invest in cryptocurrency.

Are you afraid of missing out?

Are you prepared to withstand some big swings? Are you willing to lose it all?

These are just some of the questions you need to ask yourself to figure out if crypto truly makes sense for you.

The bottom line?

Cryptocurrency’s growing popularity and flashy headlines play to our emotions. The excitement and promises of big gains can push us to dive in before we really know the risks we’re taking on.

If you understand the basics, though, you can resist the temptation that comes with crypto fever, and you can set more realistic expectations when it comes to digital currency. You’ll also be setting yourself up to make better, more rational decisions in the face of any new “hot” financial trend.

Oscar Casas, CFP®, CRPC® Tranquility Path Investment Advisors, LLC

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