Elon Musk’s tweets and a Chinese crackdown causing large fluctuations in the prices of a variety of cryptocurrencies, have put the technology back in the news. The headlines have increased interest in cryptocurrencies, and so we have tried to answer the most common crypto questions below.
What is a cryptocurrency?
According to HMRC, cryptocurrencies are “cryptographically secured digital representations of value or contractual rights that can be transferred, stored and traded electronically”. This sounds complex, but in reality means that cryptocurrencies are digital assets that can be traded for goods and services. Their prices are not based on any physical assets with intrinsic value such as gold, and so the price is determined entirely by supply and demand – how much buyers are willing to pay. This makes cryptocurrencies inherently speculative and unpredictable, with daily fluctuations often over five per cent.
How are cryptocurrencies different to fiat money?
Whilst in centuries past currencies were backed by gold reserves, that is not the case with modern fiat currencies. Fiat money is not backed by a physical commodity, with its value determined by supply and demand, but it is also backed by a national government and bank, such as the US government with USD and the UK government with GBP. The fact that these currencies have nation-state backing makes them more stable and predictable.
By contrast, cryptocurrencies by design come without the backing of any such government. This means that governments cannot bring stability to the market, but at the same time they cannot use tools like quantitative easing to affect the price to help control inflation. Cryptocurrencies are built without any such centralised control.
What is the blockchain?
The blockchain is the technological tool that is unique to crypto. Instead of having banks in control of managing which transactions are legitimate and their value, which gives banks significant control over fiat money, this is done automatically by the blockchain. The blockchain is essentially a digital ledger that keeps track of transactions and ensures that each transaction is legitimate, with both parties agreed.
Nobody owns or is in control of a cryptocurrency’s blockchain, and instead the ledger is distributed amongst all those that make up the network, with each computer processing transactions and keeping the system and the numbers up-to-date.
Is Bitcoin the only cryptocurrency?
Bitcoin (BTC) is important as it was the first cryptocurrency and was the first to successfully implement the idea of the blockchain, with Bitcoin version 0.1.0 released in 2009. Now, however, there are numerous different cryptocurrencies on the market, each with a slightly different technological implementation and created for a slightly different purpose.
Bitcoin is the most valuable cryptocurrency by a significant margin, with each Bitcoin currently worth around $39,000 and a market cap of $728 billion. Ether is the second most valuable cryptocurrency, with each ETH worth around $2,750 and with a market cap of $315 billion, but Ether is different from Bitcoin in that it is the token that supports the Ethereum blockchain upon which many other cryptocurrencies and blockchain platforms are built.
Other popular cryptocurrencies include Cardano (ADA) with a market cap of $54.3 billion, Polygon (MATIC) with a market cap of $13.3 billion, and Litecoin, with a market cap of $12.8 billion, and Nano with a market cap of $1.0 billion.
What about Dogecoin?
Dogecoin was originally a joke or meme cryptocurrency that got a little out of hand. Unlike many other cryptocurrencies, DOGE offers little in the way of invention or practical uses and 10,000 new Dogecoins are mined every minute with an endless supply. However, thanks to some high profile social media messaging from Elon Musk it has become a major speculation currency with a market cap of $44.5 billion. Many people cite the rose of Dogecoin as the best signal yet that we are in a crypto bubble.
How can you buy and sell cryptocurrencies?
A few years ago buying, selling, or just holding onto BTC or other cryptocurrencies was a technical process that scared off many users with the need for secure wallets installed on your device. More recently, however, platforms like Coinbase, Uphold, and Binance have created easy-to-use smartphone apps for iOS (iPhone) and Android that make it simple to buy and sell cryptocurrencies, with investment starting at just £1.
What are the risks?
By definition cryptocurrencies are inherently risky investments. The coins or tokens are neither backed by a physical commodity and a nation state and their prices vary wildly minute-to-minute, with the last few weeks alone seen some cryptocurrencies hit a new peak and then plunge in value by over 40 per cent before recovering much of their lost value. If you choose to invest in cryptocurrencies then you may make double-digit returns in a week or you could lose your entire capital.
MoneySavingExpert.com founder Martin Lewis was asked by viewer Alex on his live ITV show on 7 January 2021 whether you should invest in cryptocurrencies, to which he replied:
“The thing about investing – and Bitcoin is an investment – is that prices go up and prices go down. With Bitcoin, they go up massively and they go down massively. And the reason for stressing that so much is that you can make a fortune, but you may lose a fortune.”
He added, making clear any investment was a gamble: “So if you can’t afford to lose the money that you put in, then do not invest in it. It’s a gamble, like all forms of stocks and shares, and all forms of investment and putting money in gold. That’s your choice, but if you do it the right way the investment should work for you, but it doesn’t mean you won’t lose money though.”