Dr. Scott Brown
Cryptocurrency - the Basics
Updated: Apr 27, 2022
Cryptocurrency is a popular topic and fast becoming a developing theme across the global investing world. The crypto world is full of terms and concepts that we are just beginning to hear about. With all the buzz surrounding it, we would surely like to know more – but where to begin? Here are some basic concepts to start with:
What is cryptocurrency?
Cryptocurrency is an intangible digital asset that exists on a digital ledger called a blockchain. The word itself is a combination of two previously unrelated terms:
- Cryptography: the study and practice of sending secure messages or data between two or more parties and
- Currency: a system of money enabling financial transactions between parties.
Cryptography provides encrypted security for financial transactions using digitally created currency, enabling secure transactions between two or more parties.
Central to the functionality of cryptocurrencies is blockchain technology. Without blockchain technology, cryptocurrencies as we know them, would not exist. Blockchain technology eliminates digital assets’ need for a central controlling authority or intermediaries such as
banks or other financial institutions. The technology allows for secure transactions between two parties.
Blockchain is a transparent and decentralized digital ledger technology that makes and records transactions on a peer-to-peer computer network. As the name indicates, a blockchain is a set of connected blocks or ledgers within a computer network.
With the unique transparency feature, blockchain allows all users to view all activity occurring within the blockchain. This is akin to a fully transparent accounting record of ownership and irreversible transactions on a digital ledger. When a transaction is sent from one party to another, it cannot be reversed or modified. Once completed, a transaction becomes part of a permanent record. Blockchains are described as a form of “public ledger” where details of all transactions are recorded and verified by the members of the network.
How is Cryptocurrency created?
Cryptocurrencies are created by a computer-driven process often called digital mining. That process is generally a complex, computational problem-solving endeavor. The mining effort requires large inputs of energy and time to run the calculations that create cryptocurrencies. The basic idea is that a digital miner attempts to solve a complicated math problem on a particular blockchain and when successful, is awarded full or partial shares in the digitally created currency they mine.
With over 9,000 types of cryptocurrencies and digital assets available, there is not a one size fits all process of mining, or minting, crypto. Every blockchain and cryptocurrency will have its own proprietary criteria and algorithms for minting the specific digital currency on the host blockchain.
What gives cryptocurrency value?
The simple answer is: The worth of an asset is what someone is willing to pay for it. People in the crypto world believe cryptocurrency has some value either as an inflation hedge, speculative investment, or even as a diversifying asset class in their portfolio.
Digital assets like cryptocurrency, represent a new decentralized blueprint for money and financial transactions. In this system, centralized intermediaries – banks, brokers, or other financial institutions are not necessary to enforce or monitor transactions between parties.
With the decentralized and transparent cryptosystem, there is not a single point of possible failure or compromise with the network. The current banking and financial systems rely on entities between transaction parties, adding layers of unnecessary intermediaries and time delays to the process. The cryptosystem is intentionally designed to operate independent of a third party between transactions.
Cryptocurrencies feature ease of transferring money between parties with speed, transparency, and irreversible transactions. Some, but not all, cryptocurrencies will determine a hard limit on the number of units that can exist, creating a limited supply of that crypto. This lends to, and reinforces, the theory that unlike fiat money printed at will by governments, some forms of crypto can be considered as a hedge against currency inflation.
Bitcoin is digital currency:
Bitcoin was the first successful cryptocurrency, believed to be created by Satoshi Nakamoto. Bitcoin was created in response to the 2007-2009 financial crisis for the primary purpose of minting a currency that could not be inflated. Satoshi constructed the computer algorithm Bitcoin runs on to be completely decentralized, transparent, and securely encrypted.
Bitcoin is created by digital mining using complicated equations within the Bitcoin blockchain. When successful at solving the equations, miners are compensated with newly minted Bitcoin. Each Bitcoin created is verified by the blockchain algorithm and assigned a unique identifier, unable to be duplicated or compromised by others. The mining process is responsible for providing cryptographic identifiers and confirmation proof of the complex process of minting new Bitcoin.
Not all cryptocurrency has a predetermined limit on the quantity that could be created. By design though, the Bitcoin algorithm puts a cap on Bitcoin mining at 21 million. As this is written, 18.6 million Bitcoin have already been minted. Almost 89% of all Bitcoin that will ever be in existence has already been mined. This limited supply dynamic differs from U.S. dollars and other fiat currencies that could have an unlimited supply created via the printing press.
Bitcoin is the most widely accepted and largest cryptocurrency by market cap with roughly $870 billion in value. As Bitcoin becomes more established as a medium of exchange, it will likely be the rarest and securest currency in the world. Businesses, banks, and now countries are accepting Bitcoin and other cryptocurrencies as legal tender. In El Salvador, Bitcoin is the official national currency. Colorado is the first state in the U.S. to accept cryptocurrencies for tax payments.
Buying and selling cryptocurrency:
While the popularity of Bitcoin and other cryptocurrencies have soared, it’s not for everyone. The crypto world is incredibly volatile, and large swings in prices occur frequently. Cryptocurrency trading is currently unregulated by the SEC. Traditional, mainstream brokers like Fidelity and Schwab are waiting for SEC guidance and approval before offering crypto trading on their brokerage platform. Currently, only limited Exchange Traded Funds featuring crypto futures are available with mainstream brokers.
However, there are independent brokers and exchanges, unregulated by the SEC, that offer various options and features for individuals to buy and sell cryptocurrency. Fidelity Investments, in March of 2022, identified what they believe are the best brokers, and exchanges, to trade cryptocurrency. Firms such as, but certainly not limited to are: Coinbase, Binance.US, Kraken, Interactive Brokers, and Robinhood along with several more. Ask us for that list and we’ll be happy to share.
Crypto exchanges and brokers have different features, options, and costs that investors need to understand before venturing into the crypto world. Once an exchange and/or broker are selected, the next task is to create an account, fund it, and buy crypto.
Currently there are over 9,000+ digital assets available. The exchange or broker selected should be able to point investors in the right direction to start. A good place to visit having a comprehensive listing, current prices, and history of virtually all cryptocurrency available is www.coinmarketcap.com. The site lists most, if not all, crypto available and allows you to sort and research choices as well. As of this writing the top five digital assets listed by market cap: Bitcoin, Ethereum, Tether, BNB, and USD Coin.
It is very important for investors to fully understand the mechanics of the exchanges and how they work, and to have a good understanding of the crypto asset you’re interested in - before you take the plunge into the crypto world.
To sum it up:
All in all, digital currencies may not be as complex as one may think. That said, it’s vital to know that the prices of cryptocurrencies are known to be rather volatile--prices can move 10-40% or more on any given day, both up and down. By taking some time to learn more, a person can become familiar with crypto and gain the necessary knowledge to successfully participate in this market. Due diligence and serious research are the keys to successful crypto investing.
If you’d like to discuss the crypto topic further, request more crypto information, or even explore other traditional investing approaches to grow and preserve your wealth, feel free to reach out to us.
Dr. Scott Brown
Registered Investment Advisor
You probably already know this, but just in case it slipped, we’ll remind you:
The information provided here is for informational and educational purposes only and should not be construed as an offer, or a solicitation, to buy, sell, or to entice you in any other way to get involved with the above securities or financial topics in general. You’re on your own to perform proper due diligence, don’t say we didn’t tell you…