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What is Cryptocurrency?
Summary
Cryptocurrencies and tokens are digital assets that operate on decentralized networks using blockchain technology. While they offer new ways to transfer value and invest, they are complex, highly volatile, and carry unique risks. Understanding how they work, how they are traded, and how they differ from traditional investments can help you make more informed decisions.
Bitcoin, Ethereum, Cardano, and Tether are just a few examples of cryptocurrencies and tokens. While some of these digital currencies and tokens have been around for over a decade, confusion and misinformation still remain. There have been attempts to make Cryptocurrencies legal tender in some nations. While others have banned it completely. Let's take a closer look at what Cryptocurrency was, what it is now and what it might become.
Why are they called Cryptocurrencies?
The first coin factory is thought to have existed around 640 BC. It produced bronze coins. This was physical currency that could be exchanged for goods and services. Cryptocurrencies are 100% virtual i.e., they are digital assets with no physical form. Cryptocurrencies are called that because they are secured by cryptography, a method of storing and transmitting data securely. These digital currencies are decentralized, meaning they are not issued by governments or banks. When you buy or sell crypto assets, including coins and tokens, the transaction is recorded in a shared digital ledger that everyone can access.
How Cryptocurrencies work
With Bitcoin and other crypto assets, including tokens, each transaction is recorded in a ledger known as the blockchain. The blockchain is made up of a list of records called blocks. Each block holds within it a cryptographic hash of the previous block, a timestamp, and transaction data. When you purchase a Bitcoin, that purchase is recorded in a block, which is replicated across many computers. Recording a transaction across multiple devices increases data security exponentially. Bitcoin itself is an example of how this decentralized system works.
Types of Cryptocurrencies
Bitcoin was the first cryptocurrency to gain widespread recognition. Cryptocurrencies and tokens that followed are commonly referred to as altcoins, with Ethereum (ETH) being one of the most prominent examples.
In addition to altcoins, there are also stablecoins, which are designed to maintain a more stable value by referencing external assets such as currencies or commodities. For example, USD Coin (USDC) is intended to track the value of the U.S. dollar. However, stablecoins may still fluctuate and may not always maintain their intended value.
Are Cryptocurrencies safe?
While Cryptocurrencies have its benefits they also have a few inherent risks.
Volatility
Whether it’s Bitcoin, Cardano, or Ethereum, the fact is that all crypto assets, including tokens, are can be volatile. Unlike gold or silver, no one really knows what they are worth. Their prices are speculative and are tied to the news cycle. If a company agrees to accept a certain Cryptocurrency as payment, its value rises. But the opposite can also happen. Speculation and hype can cause massive price swings. These fluctuations in price can make Crypto a risky investment.
Vulnerability
Cryptocurrencies are unregulated. There is no designated authority to keep this asset class in check. This means that, if you are the victim of a hack, there isn't an official body you can turn to for help.
Over the years, a number of scams and hacks have cost investors billions. As government regulations are yet to be put in place, Cryptocurrency markets carry less certainty with them, and hence, greater risk than the stock market. This has also caused many Crypto lenders such as Celsius and FTX to file for bankruptcy.
Criminality
The anonymous nature of Cryptocurrency has made it a powerful tool for financing crime. Criminal organizations suddenly have access to a new means of laundering money and committing fraud. The untraceable nature of Cryptocurrency transactions may have created a new generation of cybercriminals.
Cryptocurrency Mining
Cryptocurrencies and some tokens can be purchased from a cryptocurrency exchange such as crypto.com, or they can be mined through a process that uses computing power to validate transactions. Currently, you can even mine some forms of Cryptocurrency on your phone. Essentially, you are dedicating your device's computing power to mining. Large scale Crypto mining has received some criticism as it is estimated to be responsible for 0.1% of world greenhouse gas emissions.
What are Crypto ETFs?
A Cryptocurrency exchange traded fund (ETF) is essentially a fund that is comprised of one or more Cryptocurrencies. While traditional ETFs track an index or a basket of assets, a Crypto ETF tracks the price of one or more Cryptocurrencies. And just like traditional ETFs, the price of Cryptocurrency ETFs fluctuates on a daily basis.
You can buy and sell Crypto ETFs with a TD Direct Investing account, find out more here.
Cryptocurrencies vs traditional asset classes
The speculative nature and volatility of Bitcoin and other Cryptocurrencies make them a risky proposition. Traditional fundamental analysis cannot be applied to Crypto as they are neither a traditional currency nor commodity. They are shrouded in secrecy with no real methodology to assess their value. Add to this the complexity of the underlying technology and unfamiliar terminology, which results in a steep learning curve for novice investors.
Stocks vs Crypto
While stocks and Cryptocurrencies both offer the potential for returns, they have quite a few dissimilarities. Stocks are a share of ownership, allowing you to own part of a company. Cryptocurrencies and tokens, on the other hand, are digital currencies with no intrinsic value. Bitcoin and Ethereum are common examples. To buy and sell stocks and securities you need to open an account with a brokerage which means, disclosing personal information to fulfill the account opening process. To buy and sell Crypto, you generally don't need to disclose any personal information. The downside to this is the fact that you are responsible for the security of the Crypto you own. Stocks are also highly regulated while Cryptocurrencies are not. This means that there are no safeguards if something goes wrong with your Crypto investment.
Mutual Funds vs Cryptocurrency
A mutual fund is an investment vehicle that consists of a portfolio of stocks, bonds, or other securities. Their value is derived from their underlying assets. Meanwhile, Cryptocurrencies derive their value from speculation. Mutual funds are governed and regulated by laws while Cryptocurrencies are not.
ETFs vs Crypto
ETFs or exchange-traded funds help investors diversify their portfolios by providing access to an entire asset class. ETFs are traded on exchanges just like traditional stocks. They are considered to be low-risk investments as they are low-cost and offer genuine diversification. While ETFs are simple to buy and sell, Cryptocurrencies have a more involved process for investing. Cryptos are also vulnerable to hacks and cyber attacks while ETFs offer some protection as investors don't directly own the asset.
You can learn more about some other traditionally regulated investment types here.
Crypto Currency News
The cryptocurrency landscape is constantly evolving, with new developments, regulations, and technologies shaping the market. Staying informed on the latest news can help you better understand how these digital currencies are changing and what it may mean for investors.
Cryptocurrency Frequently Asked Questions
How are Cryptocurrency transactions recorded?
Cryptocurrencies are secured by cryptography and are recorded on a distributed digital ledger called a blockchain. In Canada, Cryptocurrency transactions often have tax implications.
Are blockchain and cryptocurrencies the same?
While Cryptocurrencies are a medium of exchange like the dollar, the blockchain is the underlying technology. It is a cryptographic medium used for saving data on decentralized networks.
Is it legal for me to purchase Cryptocurrency in Canada?
The Canadian Investment Regulatory Organization (CIRO) requires that cryptocurrency trading platforms, often referred to as cryptocurrency exchanges, register with provincial regulators and may require users to provide personal information to comply with regulatory requirements.
What is Blockchain Technology?
Blockchain technology is a shared digital record of transactions that is maintained across many computers. Information is stored in blocks that are connected in a chain, helping ensure transparency and security.
What is a Crypto Coin?
A crypto coin is a type of digital currency that operates on its own blockchain, while tokens are typically built on existing blockchain networks. It is typically used as a medium of exchange, a store of value, or both. Bitcoin and Ethereum are common examples of crypto coins.
What are Crypto Markets?
Crypto markets are platforms where digital currencies and tokens are bought and sold, typically through cryptocurrency exchanges. Prices are determined by supply and demand and can change quickly based on market activity, news, and investor sentiment.
What is the Top Cryptocurrency?
There is no definitive “top” cryptocurrency. While Bitcoin is often considered the largest by market value, other digital currencies such as Ethereum are also widely used. Remember that rankings can change over time.
On a final note
While Cryptocurrencies may be a tremendous technical achievement, volatility, absence of regulation and lack of inherent value continue to be a challenge.
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