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Cryptocurrency: A crash course for the confused

You’ve heard it, I’ve heard it, we’ve all heard it. ‘Cryptocurrency’ is the hot new word of the year. But what is cryptocurrency? Read on to know all about it.

It’s the rage of the season. Everyone from school students to seasoned investors is talking about it. Cryptocurrency has taken the financial world by storm and has shaken the foundations of money and transactions as we know them today. But, before examining why cryptocurrency is so revolutionary, let’s first understand what it is.

The tech behind cryptocurrency

Cryptocurrency, or just ‘crypto’, is a digitally encrypted currency that is encoded on a blockchain platform and is native to it. Blockchain platforms signify a new way of recording and conducting virtual transactions by encrypting them in the form of blocks that contain information and time stamps of the data. As the virtual asset/data changes hands, more and more blocks are added to the chain, thus strengthening the blockchain and making it tamper-proof. Many kinds of data can be stored and exchanged via blockchain, with money being the most prominent kind of asset. Cryptocurrency, as the name suggests, is a virtual currency that is recorded on a blockchain stamped with unique cryptographic proof to make it more immune to theft and duplication. Now, determining how effective it is, is a thought experiment in itself.

Benefits of cryptocurrency

Decentralisation

Cryptocurrency operates on blockchains that are P2P or peer-to-peer. This means that, unlike traditional financial systems, no central system has a monopoly over your data or funds. In these open market exchanges, you can trade currencies with any other player in the market without the interference of an external third party that is in possession of all your information. This ensures more freedom and empowerment for those who partake in the crypto market.

Security

As mentioned earlier, what makes this mechanism even more secure is the fact that it is near impossible to bring about changes in the blockchain or to manipulate it; data once recorded on the blockchain is memorialised for life. Since transaction details are all recorded through encryption, it becomes quite difficult to manipulate or defraud them. This offers multiple extra layers of security as the currency changes hands between personal wallets and public ledgers. However, this is not to say that scams or frauds are non-existent in the crypto world. That is far from the truth but more on that later.

Low transaction fee

One of the biggest hassles of traditional bank transfers is, undoubtedly, the transaction fee. Along with a flat fee, no matter the amount, banks also usually take a percentage cut (based on the amount transferred) as the transaction fee. While there are options that don’t charge this fee, they are woefully few and far between. It is also not always free to trade in cryptocurrency, but it is extremely low, relatively speaking. The lack of a middleman nullifies the requirement of a hefty transaction fee. In fact, for Bitcoin, the current average transaction fee is just $0.825! Other cryptocurrencies with some of the lowest transaction fees are Litecoin, Tron, and Digibyte, the transaction fee of which is just $0.0005. A cryptocurrency called Nanocoin which was founded in 2015 has no transaction fee at all! There’s a reason they say that crypto is the future.

High returns (if you’re lucky)

Even though Bitcoin has been around since 2008, it’s only in the recent past that people really began paying attention to this new phenomenon of handling money. And that is precisely because of the sheer allure it presents as a seemingly simple way to make quick cash. To an extent, it is true. Thanks to cryptocurrency, hundreds of crypto billionaires like Changpeng Zhao and Brian Armstrong have emerged. If the market conditions are favourable and if you’re intuitive (and lucky) enough, there is a good chance that you might strike gold with cryptocurrency.

But in recent times, the crypto market is depressed, and so are its investors. With prices dropping to lower than $20,000, all those who invested have their hearts in their mouths. A few swift ones are quickly liquidating their crypto cash, unlike their more ideological counterparts who are waiting for the inevitable domination of cryptocurrency in the financial market. While it carries with it large risks, it cannot be denied that cryptocurrency is a game-changer for independent traders and newcomers who are willing to put in the work and believe in the phenomenon.

Investment diversification opportunities

If you’re a seasoned investor who primarily invests in traditional assets like stocks and bonds, there is no great harm in funnelling some of your funds into crypto assets so as to diversify your investment portfolio; to put your eggs in different baskets. This ensures that even if the stock market goes down, you can still fall back on your crypto-returns. However, fair warning; crypto investments need to be done with great caution and research as it is one of the most volatile assets to invest in.

Protection from inflation

Inflation is what happens when there are more notes than usual in the market. Prices of goods and living expenses climb higher while wages remain the same. While it’s not always bad, it usually signifies bleak times for those who aren’t extremely well off. Cryptocurrency, like Bitcoin, insures against inflation as, unlike fiat (physical) currency, there is a fixed top ceiling to the number of coins that will ever be minted—21 million coins. This means that all the trading happens within this limit and this promotes stability.

During times of inflation, it's not unheard of for those with a lot of cash to pour their fiat into investing in property or cryptocurrency, as this will stabilise the value of the money until the wave of instability passes.

Inclusivity and accessibility

One of the main reasons why cryptocurrency is as lauded as it is is because it offers a fairly inclusive, equalizing model of financial participation. Not every individual owns physical assets or even a bank account of their own. However, you can start trading crypto with as little as $2 if you have access to a computer and an internet connection. By paying a small fee, you can register onto trusted crypto exchanges on which you can conduct transactions. If you’re entirely inexperienced in the game, you could also hire a crypto broker who will break down the entire process for you and provide easier, less technical interfaces to interact with. Anyone from anywhere across the spectrum of age, gender, race, class, and ethnicity can master and stand the chance to harness the full potential of cryptocurrency, thus opening up the possibilities of financial independence and freedom to erstwhile vulnerable communities.

Challenges faced by cryptocurrency

High exposure to frauds and scams

Security and privacy are touted as two of the biggest pros of cryptocurrency, but the ground reality can be quite surprising—and not always in a good way. Trading cryptocurrency will require you to have a crypto wallet. This wallet bifurcates into a private key and a public key. The former is a long password that the user needs to remember and safeguard to ensure that nobody else gets their hands on it. Theft or misplacement of this key could mean losing access to your assets entirely. It is also very prone to phishing, hacking, digital identity theft, and all the cybersecurity attacks that blockchain networks are generally susceptible to.

Immutability

While absolute immutability could be an advantage when it comes to security threats, it can also be a pain when you take into consideration the fact that blockchain technologies, that support these currencies, essentially operate on permanence. Transactions that are made cannot be reversed or cancelled and it will be impossible to make any changes in these transactions, once completed.

Extensive energy consumption

If you’ve heard of cryptocurrency, you’ve probably also heard about the environmental concerns it evokes in people. In fact, this is one of the biggest barricades that is keeping those who are attracted to this new mode of investment and trading on the fence; the sheer amount of energy the technology utilizes.

As with all blockchains, most cryptocurrency platforms, too, use the Proof of Work (PoW) mechanism in which new blocks are mined through miners solving complex cryptographic puzzles. This mechanism of sealing blockchains utilizes a staggering amount of power. According to the Columbia Climate School, Bitcoin releases 150 terawatt-hours of electricity every year which is "more than the entire country of Argentina, population 45 million.” While the gains of cryptocurrency can no longer be denied, the ethical question of the hour is if we, at this current stage of humanity and climate crisis, can afford to sacrifice the future of our planet at the altar of financial freedom and innovation.

Volatility

Another red flag that seems to be flapping on the crypto peak is that it is an extremely volatile market. Don’t all investments involve some degree of risk? Sure. But the crypto market is relatively underformed and rather underdeveloped. Because of how new it is, the market is yet to reach a stage of stability and investors are yet to gain a firm foothold or understanding of the texture of the rise and fall of cryptocurrencies like Bitcoin and Ethereum. New investors jump in and out of the market after quick returns further rocking the crypto boat and clouding the profit waters. Besides, crypto market trends highly depend on media hype, too.

Owing to all these reasons and more, many cryptocurrencies are still in their initial price discovery stage. Needless to say, it would not be smart to buy into the hype and jump headfirst with the intention of making quick cash. Rather, doing copious amounts of reading and research, fully grasping the risks involved, developing a crypto strategy, and hiring a knowledgeable broker would be your first steps. Dips in crypto prices are far more dramatic than in the regular stock market so arm yourself for losses and play the long game. Many seasoned investors suggest investing just less than 5% of your total funds in cryptocurrency. In short, you should invest in cryptocurrency that you wouldn’t mind losing.

Regulation difficulties

Imagine a scenario where you encounter a scam and lose a large sum of money from your savings account in a bank. Chances are that the bank and civil officials would intervene and assist in restoring that amount to you as soon as possible. With crypto scams, there is no such guarantee. Even though a few futuristic governments are warming up to the prospect of legitimizing cryptocurrency as tender, it is still largely considered ‘no man’s land’. The grievance mechanism when it comes to cryptocurrency-related cyber-crimes is still fairly murky precisely because blockchain networks boast of a decentralised mode of transaction that ousts any central authority or middlemen from the process. This just happens to be the ugly flipside of that (Bit)coin!

If approached with an equal measure of caution and curiosity, cryptocurrency can be an interesting experience to dabble in. However, it should be noted that much of this new mode of transaction is still vastly obscure and unexplored. While it is a fair levelling ground for all, it would be smartest to first read up on it extensively and then decide to dive into investing and transacting in Bitcoin and/or other cryptocurrencies.

Please note that the above article is intended to provide a general insight into cryptocurrencies and their advantages/disadvantages. They are not investment advice on financial services, financial instruments, financial products, or digital assets.