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Cryptocurrencies: Are they the investment of the future?
The rise of cryptocurrencies over the past decade promises to transform the payments landscape. Since the release of the first cryptocurrency, Bitcoin, in 2009, more than 6,000 alternatives have been created. Unlike other mediums of exchange, cryptocurrencies rely on decentralized controls using distributed ledger technology. Trusted third parties are not involved in the transaction processes. Cryptocurrencies are borderless digital forms of currency that are not controlled by governments. These digital currencies can be valuable investments, but investors should be aware that they are highly volatile.
What is cryptocurrency?
Cryptocurrency is a virtual currency that is used as a medium of exchange. Unlike fiat currencies, cryptocurrencies do not have centralized controls. Instead, they are decentralized, with each user of an exchange having control over his or her wallet. Cryptocurrencies have seven key characteristics, including the following:
- Digital forms of payment
- Use of a decentralized network
- Peer-to-peer transactions only
- No involvement of trusted third parties
- No personal information has to be given
- Cryptography with each user having his or her private code to access his or her wallets
Unlike fiat currencies, which are the individual, physical currencies used in different countries, cryptocurrencies are entirely digital and only exist online. They use a decentralized network comprised of all of the individual users of an exchange. These currencies use distributed ledger technology to remove the need for the involvement of trusted third parties. The most widely used distributed ledger technology is blockchain technology, which is a database that contains the history of all of the transactions that have ever occurred with a cryptocurrency. The data on the blockchain cannot be altered and can be seen by everyone on the exchange.
Cryptocurrencies use cryptography to secure their exchanges and the transactions that occur. The users do not have to provide personal information, and they use private codes to access their wallets. Because of the pseudonymous nature of cryptocurrencies, it is crucial for investors who own Bitcoin or an alternative coin to closely guard their private codes. The only way that they can access their holdings is to use their codes, and it is impossible to prove that they own cryptocurrencies without their codes.
When a user wishes to make a transaction, the request to send bitcoin or altcoin is submitted to the decentralized network or announced. Individual nodes called miners take the transaction information and encrypt it in a process called hashing while adding additional transaction information and hashing that as well until enough information exists to form a block. The miners then work to solve cryptography puzzles to elucidate the encrypted code of the block. The first miner who can figure out the code will be able to add the block to the cryptocurrency’s blockchain, and he or she will receive a reward.
Once a new block is added to the blockchain, the other nodes on the network will verify it. The entire blockchain for the cryptocurrency will be checked to ensure that the information matches. Once the block is verified through a process called consensus, it will be validated and confirmed so that the miner will be allowed to add the block to the blockchain. The transaction will then be completed, and the recipient will receive the cryptocurrency that was sent by the sender.
A person cannot physically hold a cryptocurrency. Instead, it exists on the blockchain. People have public keys that they can give to others to send them cryptocurrency. They also have private keys that they can use to access the cryptocurrencies that they own. The private and public keys are stored in wallets, which can either exist as digital wallets online or offline on paper or a hard drive. The person who has the private and public keys owns the cryptocurrency, making it crucial for people to take steps to protect this information.
What are the advantages of cryptocurrencies as a payment system?
Cryptocurrencies offer several advantages as a payment system over fiat currencies. Moving a fiat currency across the world is more difficult because of the various exchange rates and governmental and banking regulations. Since cryptocurrencies are global, they are simple to send and receive across borders without requiring approval from external authorities or sources. The peer-to-peer focus of cryptocurrency exchanges removes the need for trusted third parties to verify and approve transactions.
Cryptocurrency transactions are much more discrete than other types of transactions. Since they are pseudonymous, a user’s transactions with cryptocurrency are not readily associated with his or her identity. While cryptocurrency transactions are not truly untraceable, they are much more difficult to link to an individual than traditional types of transactions are.
A major benefit of cryptocurrencies is the greater autonomy that they afford to people. Users have a much greater level of control over their money and how they spend it since there is no intermediary authority such as a government or bank in control of cryptocurrency exchanges.
Cryptocurrencies are also not subject to many of the types of banking fees that are inherent with fiat currencies and traditional banking systems. While there may be occasional fees for sending or receiving cryptocurrency, there are no minimum account balances, account maintenance fees, overdraft charges, or returned deposit fees associated with cryptocurrencies. International payments using cryptocurrencies are much cheaper than sending money by wire. Since the transactions occur quickly, there also are no lengthy weights for bank authorizations on international transfers of cryptocurrencies.
One great promise of cryptocurrencies as a payment system is its ability to provide access to money to people wherever the internet is available. People who live in areas without access to traditional banking systems may participate in cryptocurrency exchanges. Women in countries that don’t allow them to open bank accounts can have greater control over their money with cryptocurrency exchanges.
Overview of common cryptocurrencies
After Bitcoin’s creation and subsequent success, many other cryptocurrencies have been created and released. While there are thousands of these altcoins, a few have emerged that are more common than others.
Bitcoin (BTC) was the first cryptocurrency and was released in 2009 by Satoshi Nakamoto, an unknown person or group of people. As of Feb. 6, 2020, Bitcoin had a market cap of $177.5 billion and was trading at $9,753.11 for one Bitcoin.
Ethereum (ETH) is an altcoin that offers a software platform from which developers can build and run decentralized applications and smart contracts without concerns about fraud, control, or downtime. Ether is the token offered by Ethereum. This cryptocurrency was launched in 2015 and is now the second-largest cryptocurrency behind Bitcoin. As of Feb.6, 2020, it had a market cap of $23.3 billion and was trading at $213.05.
Litecoin (LTC) was launched in 2011 by Charlie Lee, a graduate of MIT. It is similar to Bitcoin but offers a faster confirmation process because of its quicker rate of block generation. As of Feb. 6, 2020, Litecoin had a market cap of $4.7 billion and was trading at $73.22.
Bitcoin Cash (BCH) was created in 2017 as a hard fork from the original Bitcoin. A hard fork occurs when a disagreement arises between the coders and miners. In the case of Bitcoin Cash, its creation arose out of an argument about the size of the blocks allowed by Bitcoin. The proponents of Bitcoin Cash wanted to make the blocks larger to make the transaction process faster. As of Feb. 6, 2020, Bitcoin Cash had a market cap of $8.0 billion and was trading at $439.08.
Libra (LIBRA) is the much-hyped digital currency that Facebook has yet to launch as of Feb. 2020. On June 18, 2019, Facebook released a whitepaper on Libra. This digital currency is planned for launch later in 2020. With Facebook’s massive global reach, Libra will likely garner substantial attention because of the potential for large exchanges on its platform.
In addition to these common cryptocurrencies, there are thousands of others. Investors should conduct due diligence and thoroughly investigate any cryptocurrencies before investing money because of their high degree of volatility.
Criticism of cryptocurrencies
Governments and taxing authorities around the world have had some strong criticisms of cryptocurrencies. Since they are relatively anonymous, governments worry that they could be used for money laundering and illicit trade.
A few countries ban cryptocurrencies, while most have some type of regulatory scheme to address and tax profits made from cryptocurrencies. In the U.S., cryptocurrency profits are taxed at the capital gains tax rate, which starts at 15%.
As an investment, cryptocurrencies are known for their volatility. Investors who fail to conduct due diligence before investing in cryptocurrencies could sustain substantial losses. Like other high-risk investments, investing in cryptocurrencies should not be viewed as a get-rich-quick scheme. Individuals should take the time necessary to learn about cryptocurrency and to thoroughly research any altcoin that they might be considering before getting into the digital currency market.
A big problem with cryptocurrencies can occur when someone dies. If the person has cryptocurrency holdings, those holdings may be lost if no one else has access to his or her private and public keys. Some cryptocurrency owners are wary of giving these numbers to anyone. However, if they have not made arrangements for the keys to be passed on to their intended beneficiaries, their holdings will vanish when they die. A solution to this issue is to draft a will. Some people are concerned about providing their lawyers with their keys, but including cryptocurrencies in estate planning is important for ensuring that their loved ones will have access to them after they pass away.
Outlook on cryptocurrencies: Where is the journey headed?
While cryptocurrencies occupy a small space in the financial marketplace, they are unlikely to go away. Following a meteoric rise in 2017 and a large crash in 2018, cryptocurrencies had a relatively quiet year in 2019. Various cryptocurrencies have been unstable assets. However, many tech and financial industry experts believe that cryptocurrencies are disruptive and transformative, making it likely for them to change the banking and payments landscape in the future.
Bitcoin and altcoins have experienced tremendous volatility as investment assets, however, they could become more stable with greater acceptance. Many transactions are increasingly occurring online, including banking and payment functions. The availability of cryptocurrencies as a safe, decentralized option for payments could help to move them more into the mainstream. The key to whether to invest in cryptocurrencies depends on an investor’s understanding and acceptance of blockchain technology and his or her willingness to conduct the necessary research before getting into the market. As with any other type of investment, people should make certain that they are diversified to protect themselves when they invest in cryptocurrencies.