Exceptionally volatile, which in turn translates to risky investments, cryptocurrencies have nonetheless captured the imaginations of would-be investors.
Take Bitcoin for example: according to Google Finance, the value of a single coin was pegged at $7,347 on January 3, 2020. From there it skyrocketed to $32,829 on January 1, 2021, went on to peak at $64,000 in April of 2021 and stands at $36,166 as of this writing in February of 2022.
And yet, even with these wild swings in value, the public’s fascination with the digital currency has yet to wane.
So just what exactly is crypto?
The term is a portmanteau of “cryptography” and “currency.” The name came about because the science of cryptography is used to secure the currency, ensuring that only its rightful owner uses it. Key to its functioning, cryptocurrency also bypasses traditional banks.
Unlike with physical currency, there is no Federal Reserve for cryptocurrency. Instead, transfers are made from one computer to another. A quick search of any app store will reveal a wide variety of “blockchain” applications one can use to trade in cryptocurrencies.
IBM defines blockchain thusly: “Blockchain is a shared, immutable ledger for recording transactions, tracking assets and building trust.” Pretty much anything with an agreed-upon value can be traced and exchanged on a blockchain network.
Transactions are recorded as individual blocks of data on the central blockchain ledger. In addition to the value of an asset, the data block can store whatever background data about it that would be considered germane to its value, such as who bought and sold it, when the transaction occurred, and where the transaction took place.
Each of these blocks of data is connected to one another as the asset changes hands. This allows the confirmation of sequential transactions. Blocks are linked securely to prevent changes to the data, or a new block being inserted between two consecutive blocks. This process edifies each block preceding it, which in turn gives veracity to the entire chain. It also makes it exceptionally difficult for the unscrupulous to tamper with the data, which in turn supports the trustworthiness of the ledger of transactions.
In all frankness, given sufficient time and a high degree of earnestness, one human being can infiltrate any security protocol created by another. However, that’s true for every system by which our lives are conducted. Nothing is 100% secure. Like other digital networks, blockchains are vulnerable to phishing attacks, routing attacks, code exploitation, stolen keys and code exploitation.
However, blockchain has some exceptionally robust protocols in place to help mitigate those threats. All activity is both transparent and readily traceable. Everyone can see what happened in the database and track it back to the person who did it. Blockchains are also decentralized, so there exists no single point of database entry. Moreover, user credentials are revoked if an attempt is made to alter data once it is recorded.
Still, it should be noted private blockchains are more secure than public ones.
While anyone can join a public blockchain, users must be verified to join a private one. Public users are also anonymous, where private users are required to employ a digital signature that can be traced back to them. Members verify transactions in private blockchains; cryptographic equations are used to verify transactions in public chains.
Bottom line, though, any network is only as secure as its users are careful. According to the Federal Trade Commission, consumers lost over $80 million to crypto scams in 2021.
In the simplest terms, cryptocurrency is digital money specifically designed for use over the internet. The oldest existing form of cryptocurrency, Bitcoin, was launched in 2008. Unlike traditional currency, no government issues cryptocurrencies the way they do dollars, euros, rubles, yen, pesos, and the like. This basically makes cryptocurrencies digital alternatives to governmental issued currencies.
Proponents of the currency refer to it as “Money 2.0” because it ushered in a new paradigm for value transfer. Managed by peer-to-peer networks and running on free open-source platforms, trading in cryptocurrency is open to anyone with a computer who wishes to participate, regardless of where they are located on the globe.
As we mentioned above, cryptocurrency is also independent of banks as well as payment processors. This means that value can be transferred between parties globally, at any time and practically instantly.
Cryptocurrency can be used to buy goods and services, or as part of an investment strategy.
As you might well imagine, crypto has a language all its own. Some of the terms you’ll encounter are intuitive, while others require a bit of unpacking. While you’ll find a comprehensive list of cryptocurrency terms at the Time magazine NextAdvisor site, here are some of the most common ones you’ll encounter:
Altcoin – Any form of cryptocurrency other than Bitcoin or Etherum.
Cold Wallet/Cold Storage – Cryptocurrency stored completely offline is said to be in cold storage or a cold wallet.
Decentralized Finance (DeFi) – Any financial transaction not involving a bank, government, or a similar financial institution.
Forks – These occur when a blockchain’s users amend its rules and a new blockchain results.
HODL – Its spelling the result of a Bitcoin forum typo, the term refers to buying and holding cryptocurrency in the hopes its value will increase (Hold on For Dear Life).
Public Key – Similar to an account number, it’s the address of the wallet with which you’ll conduct transactions.
How Does Cryptocurrency Work?
Transactions are conducted between peers, using cryptocurrency wallets.
Let’s say you’re making a purchase from a friend using cryptocurrency.
You’ll transfer an amount from your digital wallet using your private code. The transaction is encrypted, forwarded to the network, and added to public ledger as being credited to your friend’s digital wallet.
As we stated earlier, exchanges of currency are transparent in that any registered user of a given ledger can see transferred amounts. However, they are not privy to the identity of the originator, as transactions are pseudo-anonymous.
Each transaction is tied to a specific set of keys, the holder of which owns the cryptocurrency associated with them. A good way to look at this is like a bank account. Whoever owns the bank account, or has control over it, also owns and /or controls the money deposited to it.
Transactions are added to the ledger as blocks of data. A grouping of blocks becomes a chain — from which is derived the term blockchain.
Okay, so now that we’ve covered how transactions in cryptocurrency operate, let’s look at how the currency is created in the first place. The process is known as “mining” and with it, users can literally “make” money. Just as the U.S. Treasury mints new dollars, cryptocurrency users mint the currency and use it to conduct transactions.
They do this by solving complex equations generated by the blockchain system (mining). The underlying code rewards the “miner” with a set amount of the currency for solving the equation. Theoretically, this can be accomplished by anyone. However the reality is you need a pretty sophisticated processing platform to be the first to solve the equation — because you’re in competition with lots of other people who have the same goal and also have sophisticated computing systems.
These so-called mining rigs have evolved from standard personal computers into machines comprised of several high-end graphics cards configured to work together to solve multiple equations simultaneously. Preconfigured mining hardware is also now available for purchase, which consists of banks of microprocessors and an integrated cooling system. Some people also work together in co-operatives and share the proceeds their teams generate.
Once an equation is solved, a new block is added to the chain and the “miner” is remunerated with the underlying currency, the total amount of which is credited to their wallet. As of this writing, the Bitcoin reward is 6.25 coins. and a new block is created every 10 minutes. A new Bitcoin is mined approximately every 1.6 minutes.
The maximum number of Bitcoins ever to be mined has been set at 21 million and there are currently 18.9 million in circulation. While this might sound like the system is approaching capacity, estimates are that it will take until at least 2140 for the entire stock to be mined. This is because the mining reward halves at predetermined intervals and the equations get progressively more difficult to solve as more coins are mined.
In addition to adding more currency to the pool, solving the equations verifies transactions, which then get incorporated into the new blocks that are created. In other words, the system creates new currency by verifying and documenting transactions.
Any platform upon which you can buy and sell cryptocurrency is considered a crypto exchange. They can be used to trade one form of crypto currency for another or convert a crypto currency into a mainstream national currency such as the U.S. Dollar.
You can also buy crypto currency using a regular currency, or park regular currency in an account with the intent of purchasing crypto currency later. These transactions take place at whatever market price is current at the time of the exchange.
There are a wide variety of options when it comes to crypto exchanges, the choice of which should be dictated by your overall goals. Tyrone Ross, a financial advisor and CEO of Onramp Invest, a crypto investment platform for financial advisors, told Time magazine, “There’s no one crypto exchange that’s best for every user.” Instead, he says it’s best to evaluate your own interests and find an exchange that aligns with your goals.
Money magazine designates the following as being among the top crypto exchanges.
The two leading cryptocurrencies in circulation today, Bitcoin is currently the most traded cryptocurrency with Etherum running second. Although the duo shares several traits, they also have some significant distinctions. Both are digital currencies traded through online exchanges, and both are stored in the wallets we spoke of earlier. Moreover, both are decentralized, and both use blockchain distributed ledger technology.
However, where the creators of Bitcoin aspired to create an alternative money system, the founders of Etherum intended it to facilitate and monetize its own smart contracts. In other words, Etherum was designed to be a system unto itself, where Bitcoin’s aim is to be universal. To that end, Bitcoin is a medium of exchange and a store of value, while Ethereum is used specifically for decentralized finance (DeFi), smart contracts and the purchase of non-fungible tokens (NFTs).
The most common vehicle for crypto trading is a crypto exchange. You may recall we listed one of the functions of a crypto exchange as the buying and selling of currencies. It is entirely possible to use this activity to speculate on the rise and fall in price of various currencies.
One needn’t currently own one of the currencies to trade in it, as you can purchase them using traditional currencies. Most traders operate in Bitcoin and Etherum, as these leading currencies tend to move in a more predictable fashion than altcoins. With that said, the added risk of trading in altcoins can be offset by the potential to realize more significant gains.
If this is your first foray into the market, you could benefit from taking some time to study the market more comprehensively with one of the readily available online trading courses. Trading can be automated as well, using one of many automated crypto-trading platforms. These use bots programmed to respond to the trading parameters you establish in accordance with your overall goals.
You’ll also need to acquire a cryptocurrency wallet in which to store your holdings. Available as software or hardware, experienced investors recommend hardware wallets for traders intending to hold on to currency as a mid- or long-term investment. This keeps your currency stored offline in a physical device, which can help keep it squirreled safely away from would-be interlopers.
Purchasing stocks in companies that facilitate crypto trading is another method of investing in cryptocurrencies. These include Coinbase, Square, PayPal, and the CME Group. You’ll forgo some of the upside potential with this approach, but you’ll also mitigate some of the risk associated with investing in crypto.
There are several options available to traders interested in using crypto to generate passive income. Like traditional currencies, you can open an interest-bearing digital asset account, or engage in lending cryptocurrencies.
You can also get involved in crypto-specific activities such as crypto staking, which entails “locking up” crypto holdings to earn interest on them or use them to gain a reward. Cloud mining is another way to earn passive income on crypto. Instead of racing to beat other miners to the solution of an equation, you can purchase contracts that give you the right to work on an equation all alone for a certain amount of time.
These are but a few of the ways you can earn passive income with crypto, SoFi Learn lists a host of other methods you can consider. With that said, it should be noted your investment capital is 100% at risk when trying to earn passive income with crypto as an alternative investment.
Meanwhile, Yieldstreet offers a curated selection of alternative investment opportunities that were previously only available to institutions and the ultra-wealthy, that have the potential to return high monthly or quarterly income. Offerings currently focus on several alternative asset classes, including Real Estate, Legal Finance, Marine Finance, Commercial and Consumer Finance, as well as Art Finance.
As a tool for portfolio diversification, crypto has shown next to no correlation to the stock market. There has also been a lot of growth in this area since its inception back in 2008, and it looks like it will continue for the foreseeable future. However, the regulatory framework in this area is next to non-existent, so you’ll be taking on a great deal of risk. One should spend considerable time studying this market before investing. Yes, the potential is there, along with a great deal of volatility and a rather steep learning curve.
Here is what Yieldstreet’s experts think about crypto:
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.