Cryptocurrency Explained

May 5, 2021
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There is a lot of talk lately about cryptocurrency (or just “crypto”). It’s for good reason. Serious investors have taken notice and many see it as the currency of the future. So, what exactly is it and how should you involve it in your investment portfolio?

What is Cryptocurrency?

Crypto is essentially a digital currency system. It can be used to buy and sell goods, or it can be traded for profit like a stock. It utilizes an online ledger system with strong cryptography to make it secure, yet many forms of crypto are unregulated. More and more cryptocurrencies seem to pop up every day, so it can be overwhelming. A recent count by showed over 6,700 different cryptocurrencies available, valued in total around $2.2 trillion!

Many companies have created their own cryptocurrencies, often called tokens, and transactions are made through blockchain technology. This is a decentralized system that is spread across many computers. Blockchain manages and records transactions, and is generally very secure. You can exchange real currency to buy cryptocurrency, and there are other ways to “farm” tokens online. Investors are drawn to crypto because of its security and, of course, because it has grown so rapidly. Many people dismissed the idea when Bitcoin came out, while others jumped all in and have seen significant gains.

How Do Cryptocurrencies Work?

Cryptocurrencies start through initial coin offerings (ICOs)? This all sounds familiar to stock market investors. Just like the stock market, the crypto market is a roller coaster. However, it is even less predictable. And with so many new cryptos being developed, it can be very hard to keep track of which ones might be legitimate investment opportunities. Most investors see them as speculations and not real investments.

The thing to remember is that they don’t generate real cash flow. For you to make profit, someone else will have to pay more for the same currency than you did. When used to buy and sell goods (or NFTs, as featured in my last blog article—click here), cryptos are essentially a substitute for cash. This means most earnings come from the purchasing and trading of the currency for real money, more like a stock exchange.

Still, cryptocurrency investments and trades continue to grow in popularity for several reasons:

  • Future Speculation—Crypto is seen as the currency of the future by many supporters, so they are racing to buy now and get in on the ground floor.
  • Decentralization—Cryptos remove central banks from the equation. The money is managed independently and less affected by inflation and government regulation.
  • Technology—The blockchain technology behind cryptocurrency is truly innovative, and it’s exciting to see how it will evolve even more.
  • Security—Blockchain technology is very secure and this is very important in today’s market where there are so many hacks, data leaks and identity theft attempts.
  • Value—So far, most cryptos have only gone up in value since they were introduced, making for potentially lucrative long-term investments.

Are Cryptocurrencies a Smart Investment?

This is the big question that we have to answer as an investment advisement company. Like with any investment, it depends on the individual, their financial situation and their specific financial goals—both short-term and long-term. Crypto investment may make sense for some who are in a position to speculate and willing to do the research to know when to buy and sell. However, it is not a get-rich-quick scheme and there is always a chance the bottom drops out as the market becomes more and more flooded with competition.

Another thing to consider is regulation and taxation. There isn’t much regulation around cyrptocurrency right now, and that makes it appealing for some. There are also many gray areas when it comes to taxes on crypto transactions. The IRS is always watching, though, and the central banks are still very powerful. It remains to be seen how cryptocurrencies will evolve for better or worse.

It’s important to talk with your investment advisor and review your financial plan to know if cryptocurrency is a smart investment for you or not. Stay tuned to the Illumination Wealth Blog as we continue to explore the confusing and exciting world of crypto in upcoming articles. Contact us today if you would like to discuss your financial plan and investment strategies.