If bonds are the traditional gentleman in a top hat and stocks are the pushy loudmouth with a gigantic phone to his ear, cryptocurrencies are the nerdy kid in a hoody who sits at the back of the class coding and doodling heavy-metal album covers. They’ve been around for over 10 years, but only really broke through to mainstream consciousness in 2017 as their prices surged (before reversing most of those gains in 2018).
OK, but what are they? Cryptocurrencies are an attempt to facilitate payments – or other exchanges of information – between people without the oversight of a central body (like a government or a bank). Many people had attempted to create such digital cash before – but all had failed until bitcoin was launched in 2008.
What was special about bitcoin? Bitcoin runs across a distributed network of computers as opposed to a centralized set of servers – like those used by traditional banks or ecommerce websites. All transactions are recorded on an immutable ledger (basically a long list that can’t ever be changed) – which goes by the much-hyped name of blockchain.
And what about other cryptos? While bitcoin (and others) have taken on the field of digital money, many other projects are attempting to apply blockchain technology to different areas. Everything from social media to file storage has blockchain-based projects seeking to disrupt established industries. You will also hear the word token in the blockchain world. These are not the tokens you use at the arcade. These are a digital asset which exists on the blockchain and can operate as anything from a currency to a digital good or service.
But why would these cryptocurrencies and tokens even have any value? It’s all about supply and demand. If a token can attract users, it will rise in value. For example, if there’s demand to use bitcoin to transfer monetary value, a market starts to develop for it. Digital tokens can also be tied to real-world assets such as real estate or a barrel of oil and derive their value from this. Although the crypto transactions that get the most media attention tend to be the most nutty – like when somebody paid $170,000 for a token representing a digital kitten.
Once you start understanding a bit about bitcoin (so to speak!) the next question is if it’s worth an investment – or should that be a speculative punt? That depends on your goals and risk appetite. The market is still in its early stages. It’s mostly unregulated and prices can swing wildly. It may not be best suited for lumping your emergency savings into.
“My crypto holdings have been a massive loser, as I’m sure you can imagine from the news. It was doing really well for a while and then it fell off a cliff.”
Have cryptocurrencies caught your attention? Great! Time to find answers to some of the key concerns investors have before delving into cryptocurrencies.
It can be overwhelming trying to dip your toe into the turbulent cryptocurrency waters. Headlines are filled with intimidating phrases like “51% attack” and “exchange hack.” As the comedian John Oliver said, “it’s everything you don’t understand about money combined with everything you don’t understand about computers.”
But, if you do decide you want to tinker with tokens, in this session we’ll show you how to get started.
Where do I go to buy a bitcoin? First of all, you’ll need to find a crypto exchange. These exchanges enable you to purchase cryptocurrencies with your plain old dollars or euros (known in crypto circles somewhat derisively as fiat currency). They also allow you to trade between different cryptocurrencies.
How do I pick an exchange? They come in all different shapes and sizes so it’s not an easy choice. Not every exchange allows you to trade every crypto token – and not all allow you convert to or from fiat currencies. Worse, hackers will occasionally attempt to hack exchanges and steal tokens – so consider how much protection it will be able to provide for your funds. You can check out reviews of crypto exchanges from fellow Finimizers elsewhere in this app.
What else do I need? It’s a risky deal leaving your funds on an exchange because if anything happens to the exchange, you can likely kiss them goodbye. For that reason, it’s a better security practice to transfer your funds to a wallet. Named (with a no doubt unintentional gender bias) after the leather pouch used for storing notes and coins, a wallet is a place where you can store and manage your cryptocurrencies. Wallets come in all different shapes and sizes. Some will have support for just one cryptocurrency while others will be compatible with over a hundred.
The key thing to know about wallets is they come with a public and private key. Similar to the way you share your email address so you can receive emails, you can share your public key to receive funds. But – just as you would never share the password to your email account – you should never share your private key. If two people have the private key to a wallet, they have an equal claim to control those funds. And, as cryptos are decentralized, there’s no third-party authority to resolve disputes or enforce ownership.
And what about these 51% attacks you mentioned? A so-called 51% attack is a vulnerability in many cryptos – when hackers take over the majority of computing power on a network it gives them the ability to spend tokens twice, effectively creating money out of thin air. The smaller the crypto, the more vulnerable it is to such hacks.
Next, we’ll discuss the key things to watch when trying to identify a strong project.
If you’ve decided to take the leap and buy some cryptocurrency, the next question is: which one?
Despite the name, only a few cryptocurrencies are attempting to replace the traditional functions of currency – i.e. storing value or buying stuff. Most are projects aiming to tackle a real world problem – transferring data files around the globe, for example – and draw their value from how much demand there is for that action.
So how do I value a crypto token? Cryptos typically pay no income to the holder. They’re more like a lump of gold that just sits there, rather than a stock or a bond that generates a steady flow of dividend or coupon payments. So most people buying crypto are taking a punt on the likelihood that a certain token will be widely used and hence highly sought after.
The most common theme is cryptoprojects proposing to apply blockchain technology to established business areas. The idea is that these projects will disrupt existing industries through the power of decentralized blockchain technology. You can think of this as similar to how Uber disrupted the taxi market and captured a lot of its value (though of course Uber didn’t use the blockchain…).
How do I evaluate a project? The blockchain hype has led a lot of projects to try to apply the technology in situations where it doesn’t make sense. This is the first thing that needs to be considered. Is there an actual need for blockchain in the area being addressed?
A lot of projects will take it a step further. They will not only look to apply blockchain technology but they will also look to issue their own cryptocurrency or token. The question needs to be asked whether there is an actual need for this. In most cases, the answer to this will be no.
“Projects really should make sure they have good answers for ‘why use a blockchain?’”
What else should I think about? The people behind the project. A perfectly planned project with a poor team is ultimately going to be a poor project. The performance will always drop to the level of the people building the technology.
Next, we’ll delve deeper into the unique risks associated with the crypto ecosystem and some of the most common ways investors have lost money.
The cryptocurrency market is notorious for scams. There are a number of reasons why. Transactions which are completed on the blockchain are immutable, meaning there’s no going back. Hello, hacker paradise!
The industry is also unregulated which means teams can fundraise for projects that would be laughed at by banks or other traditional investors. It also means that there are no consumer protection laws to help you out if a business folds or makes some shady moves.
What does this mean for me? Firstly, it means there are more ways you can lose your money. The main risks in markets such as stocks is that your investment falls in value or the company goes bankrupt. In cryptocurrencies, you need to also consider how much you can trust the services you use and you also need to be careful what you click on and who you trust. Social media sites such as Instagram and LinkedIn have been flooded with scam artists working to get your hard-earned money.
What can I do to protect myself? Don’t trust, verify. Make sure that anybody who contacts you is legitimate. If the dots aren’t connecting, it’s safe to assume that they’re trying to pull one over on you.
If the promised returns seem too good to be true, they likely are. There have been several high-profile projects that imploded in recent years after offering unrealistic payouts. Bitconnect, a project claiming to be able to pay you interest on your bitcoin holdings, collapsed in 2018 – losing an estimated $1 billion for investors.
The rule is: be very careful where you put your money. Even a lot of exchanges around today won’t exist 10 years from now. Make sure the exchange you use is credible and has built trust with users. You can check out reviews from fellow Finimizers in this very app to help with this.
And what about wallets? Remember the private key we mentioned in session two? It is the password that allows you to access your funds. Unless you store it securely offline, be warned that the wallet provider could gain access to your funds.
Finally, we'll cover overall approaches in managing your cryptfolio.
Once you have familiarized yourself with cryptocurrencies, there are a few different approaches to investing. It really boils down to whether you want to actively trade or just expose yourself a little to this new area of technology.
What’s the difference? Active traders are buying and selling regularly, trying to catch the dips and the peaks – just like people who speculate in any other market, from oil to orange juice. They will deeply analyze projects. They will ask questions like the ones we covered in session three and will generally have a good knowledge of the overall industry. Many will use technical analysis techniques, where past price data is studied to assist in making decisions about the future. Check out our pack on Technical Analysis for more on this contentious topic.
“I was lucky. I bought a lot of bitcoin early in 2017 and I sold it on 19th December 2017. Basically I had a mate – a friend of mine who’s in the army. He’s not in tune with the financial world or the tech world or anything like that. And he sent me a text saying, ‘Oh, I’ve just bought a load of bitcoin.’ And it suddenly dawned on me that this had really gone super-mainstream and it felt very bubble-ish.”
What about those who don’t want to be so active? It is, of course, perfectly possible to just buy some bitcoin (or any other token) and keep hold of it, in the hope it will climb.
You might hear people talking about a “buy and HODL” strategy. This is basically an in-joke in the community after a post in a crypto forum in 2013 featured a typo in the word “hold”. HODL has become a term for holding on to what you buy come what may, ignoring the ups and downs of the market.
There are also cryptocurrency bundles or passive index funds which can be bought through companies such as Coinbase. But the fees can be high so you should always check when going with an option like this.
That’s it for our Pack on crypto trading!
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.