Key points
- Cryptocurrency has burst onto the scene in the past decade.
- Investors in the space need to be vigilant, as this asset class is very volatile.
- Large losses were realized in 2022.
What is cryptocurrency?
A cryptocurrency is a digital currency that functions via encryption algorithms, a technical method of securing data on a system called the blockchain, which we explain below.
Cryptocurrencies commonly run without the backing of a central party, such as a government or central bank, but rather exist in a decentralized manner.
Cryptocurrency vs. physical money comparison
Bitcoin was launched in 2009 and was seen as a technological breakthrough in the area of digital cash. In the years since, thousands of cryptocurrencies have launched.
The sector has attracted mass speculation, with the market cap of all coins rising as high as $3 trillion during the 2021 bull market before collapsing during the 2022 “crypto winter.” Today, the total market is worth a mere fraction, at around $1 trillion, with most of the market dominated by ethereum and bitcoin.
What is a blockchain?
Blockchain is the technology on which cryptocurrencies run. Whenever you hear the term blockchain, you can visualize a public ledger or database. This database is updated in real time and records every transaction using that cryptocurrency.
For example, the bitcoin blockchain can be seen here. It lives on the internet in plain sight for all to see, with every transaction in the history of bitcoin recorded on it.
“A blockchain is a decentralized database where data is sectioned into blocks, which are connected with one another into a linear sequence through cryptographic techniques,” says Till Wendler, founder of Web3 company peaq.
“This decentralization is ensured by strong cryptographic mechanisms that enable trustless interactions between network participants,” Wendler adds.
As crypto has evolved over the past decade or so, different forms of blockchain technology have been developed in conjunction with different cryptocurrencies. In the case of bitcoin, the blockchain is maintained by a group of volunteers, known as miners, who solve complex mathematical puzzles with powerful computers.
The back end of this technology is very technical and beyond the scope of this piece.
Cryptocurrency examples
Of the thousands of cryptocurrencies in existence, the vast majority aren’t worth much. Some experts even argue all cryptocurrencies are nothing more than speculative toys programmed to eventually hit zero.
Below are some of the most well-known coins in the space.
Bitcoin
The coin that kicked it all off, bitcoin has a first-mover advantage and operates differently from most cryptocurrencies. It runs on a proof-of-work blockchain, meaning it theoretically is more decentralized than other cryptos. But that comes at the cost of a mammoth energy consumption bill, something detractors criticize concerning climate change.
Some liken bitcoin to a digital form of gold and hope it can one day be a store of value where citizens can park their wealth outside the control of third parties like governments and central banks.
Right now, it remains incredibly volatile. Bitcoin hit an all-time high above $68,700 in November 2021 before a precipitous fall throughout 2022. Bitcoin’s price also took a massive hit last year following the implosion of stablecoin terraUSD in May 2022, with BTC prices tumbling below the $30,000 threshold.
Ethereum
Ethereum is the second-biggest cryptocurrency, but it is vastly different from bitcoin.
It is attempting to become the base layer of a new decentralized system. Other cryptocurrencies and decentralized applications can be launched on top of ethereum. A good way to view it is as a playground for developers.
Decentralized finance and non-fungible tokens are two of the most famous areas of development on ethereum, although both have seen massive outflows throughout this crypto winter.
Litecoin
Litecoin is another older cryptocurrency, launched in 2011 by former Google engineer Charlie Lee.
It was inspired by bitcoin, with Lee describing it as “the Silver to Bitcoin’s Gold.” With bitcoin viewed as more likely to be used as a store of value, the thesis behind litecoin was an offshoot of bitcoin that was more suitable for payments.
Tether
Tether is a stablecoin, meaning its value is pegged to a fiat currency — in this case, the U.S. dollar. One tether token will always trade for $1.
At least theoretically.
Tether has been dogged by concerns over whether its tokens are really backed one-to-one with full reserves. That, combined with the emergence of rival stablecoins, has seen its market share dip in the last couple of years.
However, it remains the biggest stablecoin in the space.
Dogecoin
Dogecoin is a memecoin, meaning it is an asset inspired by a meme or internet joke, in this case, a shiba inu dog named Kabosu who went viral after her owner posted a photo of her on her personal blog in 2010.
But that hasn’t stopped dogecoin from actively trading for real money. It even reached a market cap of $88 billion in May 2021.
Since then, it has fallen back down to earth, but memecoins like Dogecoin symbolize how much speculation and volatility exist in the cryptocurrency space.
Understanding the cryptocurrency market
The cryptocurrency market can be confusing because it is tied so symbiotically to human emotion.
The pandemic period brought meteoric gains, but bone-crushing losses have followed as the wider economy has pulled back amid rising interest rates to combat inflation worldwide.
“Not all cryptocurrencies are created equally. There are projects with real-world utility and then those with little weight behind them,” says Arie Trouw, founder of blockchain startup XYO.
2022’s returns highlight that nothing within crypto was immune to immense losses. Last year was a cautionary tale of the risks inherent in the space.
“During this bear market, we’ve seen significant consolidation and pruning within the space,” Trouw adds.
Crypto tips for beginners
The crypto space might be confusing and overwhelming to a beginner, and the risk is high. If you want to consider crypto, here are four basic tips to help you get started.
1. Understand the risks
It’s important to educate yourself on crypto’s risks as well as how to store it, how to buy it, whether it is legal in your country, and how to avoid common scams and pitfalls in the space. Beyond that, because of crypto’s volatility, many experts recommend an asset allocation of no more than 5% for crypto.
2. Check past performance
Past performance can indicate how volatile a coin is. But remember, past performance is not necessarily indicative of future performance.
3. Watch volatility
As we mentioned above, crypto’s volatility is unmatched. Depending on your risk tolerance, investment horizon or existing portfolio, cryptocurrency may not be a suitable purchase.
4. Invest only what you can afford to lose
It should be clear by now that cryptocurrency is risky. Many cryptos have gone to zero, and there will be more crypto projects following a similar plight. Therefore, you should invest only money you can afford to lose.
Is cryptocurrency a safe investment?
Cryptocurrency is a risk-on investment. There are countless examples of investors losing it all by investing in crypto.
Cryptocurrency volatility is also dangerous. Many coins carry no real intrinsic value and will almost certainly go to zero someday. There are also many scams in the space, so if you invest in crypto, you must be vigilant.
Frequently asked questions (FAQs)
Cryptocurrency’s legal status is murky.
Most nations allow the purchase and sale of digital assets by investors, but the rules beyond that — legislation regarding companies, mining and securities laws, for example — vary.
Some countries, such as China, have banned crypto activity of any kind.
Unless you live in El Salvador, it is likely not possible to stroll into your local cafe and buy an iced latte with bitcoin or any other crypto (and even then, from my experience in El Salvador, bitcoin is far from ubiquitously accepted).
But several companies, such as Virgin Galactic, AMC and Microsoft, accept payments in crypto for certain products. And features from companies like PayPal and the crypto exchange Binance allow customers to automatically convert crypto into fiat cash while purchasing items in certain countries.
However, in everyday life, crypto remains largely unused for direct transactions.
