Cryptocurrency has generated a lot of buzz, but the asset is still not widely understood. This article explains the basics and how it can be used for investment purposes.
Cryptocurrencies (like Bitcoin) are digital assets that are not backed by banks or companies. They are generally not regulated like stocks or bonds, and they have a high degree of volatility. Some investors use them to make speculative investments, while others view them as potential money-making machines.
What makes crypto different from traditional currencies? Crypto is a medium of exchange, a store or measure of value, and a unit of account. Unlike a piece of paper or a coin, it cannot be physically touched and must be stored securely. Its value is determined by supply and demand. Currently, many people use crypto as a way to pay for goods and services online, but the investment community is increasingly interested in purchasing and holding crypto for price appreciation and to potentially profit from arbitrage opportunities.
The current state of cryptocurrency regulation is uncertain. Some governments have signaled that they may crackdown on the market, while others appear to embrace it as an innovative technology with transformative potential. Regardless of what happens, it is likely that new laws and regulatory changes will affect the crypto market in unexpected ways.
In addition to the risk of market disruption, investing in crypto also carries certain other risks. For example, cryptocurrencies are not insured by the Federal Deposit Insurance Corporation or Securities Investor Protection Corporation, and they can be subject to hacking. As such, it is important to only invest in crypto with money that you are willing to lose.
Lastly, there are transaction fees associated with purchasing and selling crypto. These fees can vary widely, and they can cut into returns. Additionally, the current US tax code requires that any time you buy or sell crypto at a profit, you must report that activity to the IRS on your taxes.
A major source of crypto controversy is its popularity among criminals for illicit purchases and transactions. The Dread Pirate Roberts, for example, ran a marketplace on the dark web where he sold illegal drugs using crypto. It is also a popular tool for ransomware attacks.
Despite this controversy, the cryptocurrency market is growing rapidly and becoming more mainstream. Institutional participants like family offices, corporates, and major investment fund managers are starting to allocate capital to cryptocurrency. These investments can be made through CME futures, the Grayscale Bitcoin Trust, or directly on exchanges. There are also stablecoins, which are designed to track the value of existing currencies such as the US dollar, and many of them maintain a reserve of dollars in order to keep their values close to those of the existing currency. This helps to mitigate some of the volatility that other cryptos experience. However, stablecoins have been known to depreciate in value in the past, and some have even lost their entire value.