Cryptocurrency is an extremely high-risk and complex investment. Don’t invest unless you’re prepared to lose all the money you invest. You are unlikely to be protected if something goes wrong.
Forbes Advisor has provided this content for educational reasons only and not to help you decide whether or not to invest in cryptocurrency. Should you decide to invest in cryptocurrency or in any other investment, you should always obtain appropriate financial advice and only invest what you can afford to lose.
Cryptocurrency is like a form of digital money. It is a way of making payments from person to person without any organisation or institution in the middle to facilitate it.
For example, if you want to pay a dog groomer, you’d either need to use cash minted and distributed by the state, or a bank transfer facilitated by the payer and payees’ banks.
If, however, your dog groomer accepted Bitcoin, the largest and best known of all the thousands of cryptocurrencies in existence and referred to by the ticker code ‘BTC’, you’d be able to make payment from your digital wallet to theirs without any fees to a middleman, or any delays that might cause.
With cryptocurrency, the infrastructure which makes payment possible is decentralised – no single person, group or interest controls it.
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Chain of command
It all works using blockchain technology. Blockchains are indelible, digital ledgers maintained by volunteers, governed by communities of ordinary people and distributed to anyone who wants to get involved.
Volunteers offer their time and effort in exchange for the chance to earn cryptocurrency, and encryption technology makes it practically impossible to cheat the system.
When you carry out a transaction with cryptocurrency, volunteers around the globe make a record of it in their copy of the relevant ledger. When a certain number of transactions are recorded, a block of those transactions are added to a long chain of previous blocks which represent the canonical history of transactions in that currency.
To add a block to the blockchain you first need to validate it. To do this, you need to either: correctly guess a 64-character, alphanumeric string with trillions of possible combinations, or stake your own cryptocurrency for the opportunity.
If you’re lucky enough to be chosen – either because your computer rig was powerful enough to make the correct guess (or the closest guess within a 10-time limit), or you staked enough of your assets to tip the odds in your favour – you’ll need a 51% majority of the volunteers to agree yours is an accurate record of transaction.
If you tried to claim there was more cryptocurrency in an account than there actually was, the majority would reject it. In order to cheat the system, you’d have to control at least 51% of the votes on the network. In either case the cost would be prohibitive.
When your block is added to the blockchain, you’re rewarded with a small amount of a given cryptocurrency.
There are no cryptocurrency coins or notes, there are only records of transactions keeping track of who owns which assets.
Cryptocurrencies can be used to pay for goods and services, traded for other cryptocurrencies, or held onto for speculative purposes.
Ways to trade
Within a chosen crypto exchange, a trader will be able to check current prices for a range of tokens, and see how they’ve been performing over the past hours, days, weeks, months and even years.
Exchanges will generally show users the tokens that are trending upwards and downwards in price, new tokens, popular tokens and so forth. Users can use all of this information to decide which coins to buy and sell.
Buying a cryptocurrency means someone else is selling with both parties just using the exchange as an intermediary. When there are more buyers than sellers, the price of a token tends to rise – and vice versa.
How and when an investor chooses to buy most likely depends on his/her approach to investing, what they may hope to gain, and the risk each trader is happy to tolerate as part of the transaction.
Day traders buy and sell tokens within the same day to take advantage of movements in the market. This offers the potential for quick returns and mitigates risks of big price drops from one day to the next.
On the other hand, day trading is such a short-term strategy that it prevents investors from riding out price dips that might correct themselves over longer periods.
Swing traders hold coins for longer periods of time, monitoring prices of assets over a period of weeks to determine the best assets to buy, sell and hold.
Observing price movements over longer periods can help traders to make more informed decisions, but potentially requires more discipline and the ability to not act impulsively on changes.
Position trading takes a long-term view on crypto investing. Position traders buy coins in anticipation they’ll make gains over the longer term, and are less concerned with day-to-day volatility.
Position trading also has the benefit of being able to build a portfolio over time, starting with a small investment and increasing it over time. The trade-off is that investors cannot make quick returns.
What makes prices change?
There are countless factors that can affect the price of a cryptocurrency, but supply, demand and sentiment are useful bellwethers for predicting trends.
When demand is met with sufficient supply, or more supply than is needed, prices tend to remain flat or fall. In crypto, supply is determined by how coins are mined.
For example, next year the amount of Bitcoin given to miners who successfully add a block to the blockchain will halve from 6.25 BTC to around 3.125 BTC.
This drastic slowdown in the rate of new Bitcoin issuance could, in theory, push prices up as supply becomes constrained. However, if demand were to drop significantly, the supply squeeze would be insignificant.
Demand is the other side of the coin. When more people are interested in buying something, the more those who can afford it are willing to pay for its relative scarcity. If, for example, a major public figure were to say they believed a coin would become very valuable, their support could pique interest and lead demand to outstrip supply, pushing prices up.
On the other hand, if a coin begins to be seen as less valuable – perhaps if there were rumours of liquidity issues behind the scenes – demand could fall and sellers would need to accept lower prices in order to get rid of their coins, hence prices fall.
Such a scenario hinges on sentiment, that is to say public perception of value can have a direct effect on value.
When Ethereum went from using a Proof of Work consensus mechanism to a Proof of Stake mechanism last year, it was predicted that the environmental benefits of the change would make it more sustainable, making it a safer and more valuable investment.
Similarly, crypto prices rose after the collapse of Silicon Valley Bank (SVB) last month. Both SVB and Signature, another US bank that failed, were used by crypto companies like Avalanche and Ripple for payments between cryptocurrencies and fiat currencies.
The intervention by US authorities to protect SVB deposits appeared to have inspired confidence in the market, and major tokens’ prices rallied by as much as 14%.
Keep abreast of the news
Monitoring the news for changes in these three factors can help to predict how prices might change, but countless external factors are also at play.
To make trades with crypto assets, investors need to provide their public and private keys. They can’t authorise a trade without these long alphanumeric strings, the latter of which should be known to the owner alone.
Crypto owners’ keys need to be stored in a secure wallet to prevent their unauthorised use. Most, if not all, crypto exchanges offer a free wallet in which to store keys.
These ‘hot’ wallets live online, which makes them vulnerable to hackers. On the other hand, they’re convenient and come with support from the provider via account recovery if a user were to, for example, forget their crypto exchange password.
Investors can store their keys offline to keep them at arms’ length from hackers, but they’ll have to pay for a USB device and they won’t get third party support if they lose their device or forget their passwords for it. Plus, the protection from hackers is weakened once one plugs their ‘cold’ wallet into a web-connected computer.
Whatever investors decide to trade in, wherever they choose to do it and whenever they buy or sell, they should be aware that crypto is extremely volatile and, for the time being, unregulated.
This means they’ll get no support from the government if they’re scammed or lose money because an exchange or token collapses.
The government is currently consulting on bringing the crypto market into regulation, which would force providers to play by the same rules as traditional financial services companies or else lose their trading licences. This would offer consumers much greater protection if implemented.
Either way, the Financial Conduct Authority (FCA) – the UK financial regulator – has taken great pains to remind would-be investors they should be prepared to lose all of the money they put into crypto.
The advantages and disadvantages of trading cryptocurrencies are almost completely subjective, and depend entirely on how you feel about crypto as a concept.
Enthusiasts often argue crypto can serve as a hedge against inflation, that it’s faster and cheaper than centralised fiat currencies, that it’s free of interference from vested interests and that it’s private.
Detractors say cryptocurrencies are volatile, unpredictable and lack real-world utility. Environmentally-minded critics say certain cryptocurrency systems are unsustainable because of the huge amounts of energy they use.
Without regulation, some people also fear investors are exposed to rogue traders, scams, platform collapse and other risks. Some say the relative privacy of cryptocurrency, coupled with a lack of regulation, makes it a haven for fraudsters, money launderers and criminals.