Assuming you haven’t been living under a rock for the past few years, you’ve likely heard the terms cryptocurrency, bitcoin, and blockchain. Mainstream media throws around these words, yet so many people still aren’t certain what exactly the buzz is all about.
Despite the lack of knowledge, it hasn’t stopped people (myself included) from pouring money into cryptocurrency, a form of alternative investment.
But like any investment, jumping in wallet first may cause some major issues for your finances down the road.
That’s why in this guide we’re going to cover everything you need to know about cryptocurrencies before you actually start investing in them.
Here’s what you’ll learn:
- What is cryptocurrency?
- How does it work?
- What are blockchains?
- How do you use cryptocurrency
- The pros and cons of cryptocurrency
- Is cryptocurrency a good investment?
- How to invest in cryptocurrencies
Cryptocurrencies can be a strong asset to your financial plan, but the key to mastering crypto is understanding the basics, and knowing your options.
What is cryptocurrency?
The terms cryptocurrency and bitcoin are used interchangeably. But bitcoin is actually a type of cryptocurrency. (You can think of it this way: bitcoin is to cryptocurrency what a 401K is to retirement investments.)
Cryptocurrency is the umbrella term for the various kinds of blockchain-based digital currencies that rely on cryptography to ensure transactions are only handled between the intended recipients.
Cryptocurrencies cannot be physically handled like coins and paper notes. They operate entirely online through a distributed ledger system called blockchain (more on that later). They’re also the only types of currencies that aren’t regulated through a central entity, like a bank, which means they are not under the control of any world government.
How does cryptocurrency work?
Cryptocurrency is a digital payment method used to exchange goods and services, like good old cash money. When you first purchase cryptocurrency using real dollars, you’re given a wallet that holds each of your coins, or fractions of coins, until you decide to spend them.
The real difference between crypto and traditional money is the method by which it’s exchanged using transactions on the blockchain.
What exactly is a blockchain?
Blockchain is the underlying technology on which cryptocurrency sits. To truly understand blockchain’s inner workings, you need to have an understanding of cryptography, distributed ledgers, and smart contracts. But in case you don’t have time to go deep on those subjects right now, here’s a high-level overview.
Blockchain technology works by storing data on a secure chain of blocks to create verifiable and permanent transactions. The concept behind blockchain is that by utilizing a distributed ledger for transactions in which each subsequent transaction verifies the one before it, it becomes immutable or unchanging.
How does that work?
Each entry into the blockchain contains a hash unique to the previous entry, a timestamp, and the data for the transaction. The hash for the previous block, which is algorithmically generated and one-way, is critical in creating immutability.
If someone wanted to manipulate a transaction on the chain, they’d need to go back and modify the hashes of every previous block created until this point. When you get into tens of thousands of transactions, that becomes a virtual impossibility.
The fact that the ledger of transactions is public and only linked to the address of a wallet, not an individual, means transactions can be kept entirely anonymous. Only the information associated with the wallet, often a username, will be known to the world.
What makes the blockchain secure?
In addition to the complex cryptography used in hashing algorithms, the high-level of security of the blockchain can be attributed to the fact that it doesn’t rely on a central repository and is overall more transparent.
Thousands of computers around the world are updated in real-time as transactions are processed, meaning a hacker can’t access information in a single database as has been seen too many times to count in recent years (hi Equifax). The peer-to-peer network used in blockchain technology is still vulnerable to sophisticated attacks, but far less so than traditional databases.
Where can you spend cryptocurrency?
Since its creation, crypto has been used primarily for gaming (Microsoft has been allowing bitcoin payments in their Xbox store since 2015) and transactions on the black market and dark web. Anonymous transactions have been particularly appealing for groups doing less than legal money transfers.
There are a surprising number of big-name retailers that are now getting into the cryptocurrency game. More mainstream retailers like overstock.com, Whole Foods, and Expedia now allow payment with bitcoin.
This is all possible thanks to several companies working together to enable payments through the same systems that allow for contactless payment and Apple pay.
The Pros and Cons of cryptocurrencies
Why would people want to use cryptocurrencies instead of paper money or credit as it exists today? Here’s some of the advantages and disadvantages of cryptocurrency:
- Greater security through blockchain technology
- Faster transaction times for large transfers (minutes compared to days for traditional banking institutions)
- Pay for anything from your phone
- Anonymous transactions create less likelihood of identity theft
- Difficult to understand
- Relies 100% on technology to pay for goods and services
- Lack of inherent value (not backed by the gold standard or similar, though I’m not sure paper currencies truly are anymore either)
- Anonymous transactions open up crypto to uses on the dark web
Is cryptocurrency a good investment?
Dare I say it, that depends who you ask. Cryptocurrency experts insist it will continue to rise as market adoption increases. Once large financial institutions hop on board the blockchain and cryptocurrency train, it could very well be the next age of money.
As with any alternative investment, you probably don’t want to rest your entire portfolio on crypto. It could be an exciting investment opportunity if you do your due diligence and truly understand the potential crypto has in the broader global market.
My rule of thumb for cryptocurrency investing is to think of it as a gamble and be prepared to lose everything I put in. That way, if it ends up making high returns, it will be a pleasant surprise rather than something I’m white-knuckling and constantly checking my phone waiting on.
How can you get started investing in cryptocurrency?
There are several things to do to get started investing in cryptocurrency.
- Choose a service – Now household names like Coinbase and Kraken facilitate the online purchasing and trading of a range of cryptocurrencies. Find a service you’re comfortable with and get to know the rules of buying and selling.
- Decide on your investment strategy – Do you want to make a one-time purchase, recurring investments, buy when the price dips below a certain threshold? Much like investing in the stock market, you’ll need to decide how much and when you’ll buy.
- Know where you can spend – When all is said and done, you hope that the investment pays off. If it does, you’ll want to know where to spend those earnings. While crypto ATMs are popping up worldwide, you may still need to use apps that assist with payments. Consider where you do most of your spending and verify if the retailers accept cryptocurrencies or plan to soon.
Blockchain and cryptocurrencies are the wave of the future. New companies are cropping up every day with an eye towards this technology and creating systems to make it possible.
Only time will tell how long it takes before digital payments via an online-only wallet are all we’re using. Money clips, whatever happens, know that you did a good thing, and we’ll always remember you.
Contributor’s opinions are their own. Always do your own due diligence before investing.
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