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What is Cryptocurrency?
Bitcoin, Ethereum, Cardano, Tether and others – these are just several types of Cryptocurrencies. While some of these digital currencies have been around for 12 years, there's still a lot of ambiguity and misinformation. There have been attempts to make Cryptocurrencies legal tender in some nations. While others have banned it completely. Let's take a closer look at what Crypto was, what it is now and what it might become.
Why are they called Cryptocurrencies?
The first coin factory is thought to have existed around 640 BC. It produced bronze coins. This was physical currency that could be exchanged for goods and services. Cryptocurrencies are 100% virtual i.e., they are digital assets with no physical form. They're called Cryptocurrencies because they are secured by Cryptography – a method of storing and transmitting data securely. And unlike traditional currency, Cryptocurrencies are decentralized – they are not issued by governments or banks. When you buy or sell Crypto, the transaction is saved in a digital spreadsheet called the ledger that everyone has access to.
How Cryptocurrencies work
With Bitcoin, each transaction is recorded in a ledger known as the blockchain. The blockchain is made up of a list of records called blocks. Each block holds within it a cryptographic hash of the previous block, a timestamp, and transaction data. When you purchase a Bitcoin, that purchase is recorded in a block, which is replicated across many computers. Recording a transaction across multiple devices increases data security exponentially.
Types of Cryptocurrencies
Bitcoin was the first Crypto to achieve prominence. The Cryptocurrencies that came after Bitcoin are known as Altcoins. Ethereum (ETH) is currently the biggest Altcoin on the market. It has a market cap of $156 billion. Besides Altcoins, there are also Cryptocurrencies that feature low volatility which are called Stablecoins. They attempt to peg their market value to stable external reference points such as commodities or currencies. USD Coin is a Stablecoin that has its price pegged to the U.S. dollar.
Are Cryptocurrencies safe?
While Cryptocurrencies have their benefits they also have a few inherent risks.
Volatility
Whether it’s Bitcoin, Cardano, or Ethereum, the fact is that all Cryptos are volatile. Unlike gold or silver, no one really knows what they are worth. Their prices are speculative and are tied to the news cycle. If a company agrees to accept a certain Cryptocurrency as payment, its value rises. But the opposite can also happen. Speculation and hype can cause massive price swings. These fluctuations in price can make Crypto a risky investment.
Vulnerability
Cryptocurrencies are unregulated. There is no designated authority to keep this asset class in check. This means that, if you are the victim of a hack, there isn't an official body you can turn to for help.
Over the years, a number of scams and hacks have cost investors billions. As government regulations are yet to be put in place, Crypto markets carry less certainty with them, and hence, greater risk than the stock market. This has also caused many Crypto lenders such as Celsius and FTX to file for bankruptcy.
Criminality
The anonymous nature of Cryptocurrency has made it a powerful tool for financing crime. Criminal organizations suddenly have access to a new means of laundering money and committing fraud. The untraceable nature of Cryptocurrency transactions may have created a new generation of cybercriminals.
Cryptocurrency Mining
Cryptocurrencies can be purchased from a Cryptocurrency exchange such as crypto.com or they can be mined. Bitcoins and other Cryptos can be mined using powerful computers called mining rigs. Currently, you can even mine some Cryptos on your phone. Essentially, you are dedicating your device's computing power to mining. Large scale Crypto mining has received some criticism as it is estimated to be responsible for 0.1% of world greenhouse gas emissions.
What are Crypto ETFs?
A Cryptocurrency exchange traded fund (ETF) is essentially a fund that is comprised of one or more Cryptocurrencies. While traditional ETFs track an index or a basket of assets, a Crypto ETF tracks the price of one or more Cryptocurrencies. And just like traditional ETFs, the price of Cryptocurrency ETFs fluctuates on a daily basis.
You can buy and sell Crypto ETFs with a TD Direct Investing account, find out more here.
Cryptocurrencies vs traditional asset classes
The speculative nature and volatility of Bitcoin and other Cryptocurrencies make them a risky proposition. Traditional fundamental analysis cannot be applied to Crypto as they are neither a traditional currency nor commodity. They are shrouded in secrecy with no real methodology to assess their value. Add to this the complexity of the underlying technology and unfamiliar terminology, which results in a steep learning curve for novice investors.
Stocks vs Crypto
While stocks and Cryptocurrencies both offer the potential for returns, they have quite a few dissimilarities. Stocks are a share of ownership – they allow you to own a part of a company. Cryptocurrencies, on the other hand, have no intrinsic value. To buy and sell stocks and securities you need to open an account with a brokerage, which means disclosing personal information to fulfill the account opening process. To buy and sell Crypto, you generally don't need to disclose any personal information. The downside to this is the fact that you are responsible for the security of the Crypto you own. Stocks are also highly regulated while Cryptocurrencies are not. This means that there are no safeguards if something goes wrong with your Crypto investment.
Mutual Funds vs Cryptocurrency
A mutual fund is an investment vehicle that consists of a portfolio of stocks, bonds, or other securities. Their value is derived from their underlying assets. Meanwhile, Cryptocurrencies derive their value from speculation. Mutual funds are governed and regulated by laws while Cryptocurrencies are not.
ETFs vs Crypto
ETFs or exchange-traded funds help investors diversify their portfolios by providing access to an entire asset class. ETFs are traded on exchanges just like traditional stocks. They are considered to be low-risk investments as they are low-cost and offer genuine diversification. While ETFs are simple to buy and sell, Cryptocurrencies have a more involved process for investing. Cryptos are also vulnerable to hacks and cyber attacks while ETFs offer some protection as investors don't directly own the asset.
You can learn more about some other traditionally regulated investment types here.
Cryptocurrency Frequently Asked Questions
How are Cryptocurrency transactions recorded?
Cryptocurrencies are secured by cryptography and are recorded on a distributed digital ledger called a blockchain. In Canada, Cryptocurrency transactions often have tax implications.
Are blockchain and cryptocurrencies the same?
While Cryptocurrencies are a medium of exchange like the dollar, the blockchain is the underlying technology. It is a cryptographic medium used for saving data on decentralized networks.
Is it legal for me to purchase Cryptocurrency in Canada?
In Canada, Cryptocurrencies are legal to purchase but are not considered legal tender. The Investment Industry Regulatory Organization of Canada (IIROC) requires that all Cryptocurrency trading platforms register with provincial regulators.
On a final note
While Cryptocurrencies may be a tremendous technical achievement, volatility, absence of regulation and lack of inherent value continue to be a challenge.
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