Though a recent innovation, cryptocurrency has certainly taken the world by storm over the last several years. Originally introduced around 2009 with bitcoin, it did not at first attract international attention, viewed instead as a passing curiosity. But today, that has changed, and cryptocurrencies of all types are fast becoming an important focus of discussions on cybersecurity, regulation, and other financial issues as they continue to gain traction. For those new to cryptocurrency, here is more information about what you should know.
How Does Cryptocurrency Work?
Cryptocurrencies are, quite simply, forms of digital currency that can be used to purchase other goods or traded among users for profit. For most users of cryptocurrency, that trading is the main focus of their use. These virtual currencies are secured through the use of blockchain, a distributed ledger used to record and verify transactions made without a central authority. Cryptocurrencies are often called “tokens”, as well.
That essentially creates an important feature of cryptocurrency: the fact that it can bypass “the middleman,” so to speak, or that it can be used without one central regulating authority, like a bank or another type of financial institution. Practically speaking, this helps to lower transaction costs by allowing buyers and sellers to deal directly with each other, rather than with a middleman.
Understanding Blockchain Technology
If there is one aspect of cryptocurrencies that has captured the attention of industries outside of banking and financial services, it’s blockchain technology. Blockchain is what makes cryptocurrencies possible. However, blockchain has proven extraordinarily useful to many other sectors of the economy, including healthcare, supply chain management, insurance, real estate, and others.
The technology works with the use of a blockchain, a long chain made up of “blocks,” where each block contains information about transactions. These blocks can contain information about thousands of different transactions in the same place, and each block additionally contains a randomly generated cryptographic code, known as a hash, identifying it separately from every other block on the blockchain. The next block on the chain contains its own hash and the hash from the previous block.
This is part of why blockchain is so secure. For example, to change the details of a transaction after the fact, a hacker might try to edit the block, but that would generate a new hash, while the next block in the chain would still have the old hash. To alter details in a single block, the hacker would therefore have to change every single block after it—which would require a huge amount of computing power.
All computers in the network contain a copy of the blockchain, essentially ensuring that there are thousands of copies in existence. This is why blockchain is described as “distributed” ledger technology; it is also another reason why blockchain technology is so secure. With so many copies in existence, it is even more difficult for hackers to change the information contained in the blocks. To make a change, all copies of the blockchain would need to be edited, a virtually impossible task.
Types of Cryptocurrency
Even though bitcoin was the first cryptocurrency on the market, today, there are nearly 6,700 different types of cryptocurrencies. As an industry, cryptocurrencies in total were valued at over $370 billion as of early September 2020. Bitcoin, the most popular cryptocurrency, is valued individually at nearly $210 billion.
Other than bitcoin, there are many other types of cryptocurrencies that you might choose to invest in, including Ethereum, Litecoin, Theta, and Chainlink. Though most have similar uses, the different cryptocurrencies do sometimes differ in processing times, with Litecoin notably having faster processing times, and lower costs for transactions than bitcoin. Theta’s innovation is set to disrupt today’s rapidly growing online video industry, by improving video delivery at lower costs.
If you are looking to get into cryptocurrency as an investment asset, there are a few things you should know. First, consider that a cryptocurrency investment could be volatile, especially compared to more traditional types of investment assets. With regulation only recently beginning to be implemented and changing prices, enter cryptocurrency investment cautiously, only investing money you would be comfortable losing.
Many new investors in cryptocurrency also wonder where to purchase these assets. For most of the more popular cryptocurrencies, users can purchase them through a trading exchange like Coinbase, TradeStation, Kraken, or SoFi. More obscure cryptocurrencies can be difficult to purchase and may not be available on popular trading exchanges.
To hold your cryptocurrency assets, you will need a “wallet,” a digital app to keep your cryptocurrency in. You may hear wallets referred to as being either “hot” or “cold.” That simply refers to internet connectivity; a hot wallet is connected to the internet, while a cold wallet is not. Cold wallets are external storage devices that can hold your assets, and they offer increased security, though they can take longer to access than hot wallets. Hot wallets offer easier accessibility, but they are more vulnerable to security breaches.
Cryptocurrency as an investment is a relatively new asset class in the financial sphere, but it could have greater potential in the future. If you are looking to invest in cryptocurrency, consider that it is still a volatile market and prices can change often, and sometimes drastically. A handful of Self-Directed IRA Custodians already offer cryptos as investment choices for your IRA or ROTH IRA funds. Experts typically caution that you restrict your investments in cryptocurrency to a small and expendable portion of your portfolio. It’s also important to consider your own risk tolerance. With that said, cryptocurrencies can be an effective way to diversify your portfolio for the future.