Cryptocurrencies are on the rise.
And if you just read that and asked yourself “What the heck is a cryptocurrency?” don’t worry, you’re not alone.
If you follow financial news or have dabbled with investments or money transfer apps, or even if you’re just a social media browser, chances are you’ve stumbled across cryptocurrencies, often known as the shortened form “crypto,” at least once before.
You’d be hard pressed not to have ever heard about Bitcoin, but beyond that oft-talked about digital currency, there are literally hundreds of others in existence, although some are certainly more well-known, popular and valuable than others.
But if there’s been one storyline in financial news to start 2021, it’s been the rise of retail traders (that whole to-do with ordinary people driving up the stock price of GameStop sky high, remember that?) and, coinciding with that, the rapid rise in the value of some cryptocurrencies that are available to trade in.
But before we even start talking about some of the different type of digital currencies out there, what they are and how they work and what’s been happening with their value over the past few weeks and months, let’s start with the basics:
What is a cryptocurrency?
At the simplest, cryptocurrencys are, well, currency, just digital.
Unlike the coins and dollar bills that you might carry in your wallet, cryptocurrencies are currencies that are created and exist solely in the digital world.
Think of cryptocurrencies in kind of the same way in the number in your bank account or the money you spend via a credit card — cash that you never physically touch but that still has value and use.
Crypto allows for exchange and transactions and is recorded in a public ledger that is strongly secured but that tracks ownership and transactions across the globe.
The “crypto” root means secret or hidden and privacy and security was one of the main reasons why cryptocurrencies started to attract interest globally when they first came onto the scene.
Most cryptocurrencies share common features including:
• They are decentralized, meaning a government or central bank doesn’t have authority over them and they are instead maintained by a public system
• That system keeps track of ownership of the currency and its transactions
• Ownership of units of the currency can be proved via cryptology
Like other currencies such as the U.S. dollar, more can be created by printing money (physically or digitally), but that process is usually conducted via “mining,” digital calculations that verify transactions and which are rewarded with new units of the currency.
Some cryptocurrencies have a finite number of units that can ever be created — Bitcoin, for example has a hard cap of 21 million coins that will ever exist — while others have no cap and can be mined or created infinitely.
In the end, cryptocurrency is, well, money, just not like the tender that the U.S. functions on day to day.
How do cryptocurrencies get value?
This is an important question, but one that a lot of people may find stretches their understanding and the concept of “money.”
The globe is long past the days of a gold standard, where the money you carried was backed by the value of physical gold stockpiled somewhere on Earth. But even in a gold standard system, the value of the money is dependent on what the value of gold is, which in itself has fluctuating value depending on its supply, demand and the value people put into it.
Gold standards have been replaced globally by the concept of “fiat money,” money that isn’t backed by any physical resource but instead secured by people’s confidence in the government that issues it.
Basically, the U.S. dollars in your wallet have value only because people have faith that the money issued by the U.S. government is worth something.
If a government prints too much money or if faith in the currency falters, it can cause inflation, making each unit of the currency worth less or, in extreme cases of hyperinflation, basically nothing because the money has no inherent, physical value.
Cryptocurrencies gain and lose value in much the same way.
Like any other currency, you can take the U.S. dollars and exchange them for cryptocurrency in the same way you might exchange your cash for Mexican Pesos or British Pounds or Japanese Yen if you’re on vacation.
The value of those cryptocurrencies fluctuates depending on concepts like scarcity (how many are out there and is that limited or not?), demand (if lots of people want the currency it can increase in price) and utility (can you actually use the cryptocurrency for commerce?).
One of the main differences, however, that you’ll find in cryptocurrency versus government tender is in volatility. While the price of government currencies can increase or decrease based on market factors and global impacts — the value of the U.S. dollar in comparison to the European Euro may change depending on what’s happening in the world — those currencies generally have long-term stable value.
Cryptocurrencies, however, have a tendency to be really volatile in their value, which can make them an enticing (but also risky) investment option.
So while cryptocurrencies are technically money, they’re also viewed as an investment option like stocks, mutual funds or bonds, too.
Speaking of investing…
What’s up with cryptocurrency values?
If you’ve heard about cryptocurrency lately, it’s probably been related to financial news about prices, as many major cryptos have been seeing huge spikes in value so far in 2021.
Historically, Bitcoin, the father/mother of the cryptocurrency market, is the major case study here.
When Bitcoin was first created, it’s value was, well, zero.
In its infancy, Bitcoin had basically no value because it was new, unheard of, there were few of them in existence and they had no practical use. In 2011, Bitcoin’s value hit $1 for the first time, them jumped up as high as $32 per coin that year, before crashing down to $2 by the end of the year — again, volatility.
But over time, as Bitcoin became more and more known and people placed more value into it, the value of each individual coin rose. Price crested $100 in the early 2010s and rose to hundreds of dollars.
In 2017, Bitcoin saw a huge spike in value, rising to upward of $15,000 per coin. Then, the price crashed again, falling back to a somewhat steady value around $3,500 per coin in 2019.
Since then, however, Bitcoin has seen a meteoric rise in value since late 2020, going from about $10,000 per coin to hitting an all-time high of $64,829.14 just last month.
Simply put, if you owned 100 Bitcoins back in 2011 when it hit $1 dollar, you’d be a multi-millionaire nowadays if you held onto them.
But Bitcoin hasn’t been the only digital currently that’s seen huge long-term gains and insane short-term spikes in value recently, as multiple other top-valued cryptos have also exploded in price.
For example, Dogecoin — a darling of the social media crowd — has shot up more than 19,000% in value this year alone. Other cryptocurrencies have seen gains in recent months in the hundreds and thousands of percent, too.
By comparison, the index of stocks on the New York Stock Exchange have risen just over 10% so far this year.
Those gaudy returns have attracted a lot of new interest to cryptocurrency this year, especially from younger, retail traders who have been inspired to get into investing after the tumult with GameStop earlier this year, when everyday people poured money into the video game retailer’s stock, driving its price up from $17 to nearly $350 per share, reaping big profits along the way.
Cryptocurrencies, some of which can be purchased for literal pocket change like Dogecoin, have been an area a lot of people have turned to in pursuit of a quick buck.
Practice smart investing tactics with crypto
Compared to more traditional investments, you can realize big gains in relatively short time by investing in cryptocurrencies.
Likewise, you can suffer big losses in relatively short time, too.
As mentioned above, cryptocurrency prices tend to be extremely volatile. While a stock’s price will usually fluctuate up or down a percent or two per day, with bigger swings reserved for major breaking news that causes people to snap up or dump a security, cryptocurrencies can and have seen double-digit percentage swings in their prices pretty regularly.
For example, the low-price Dogecoin topped 74 cents per coin at the start of May 8. By 8 a.m. on May 9, the price had plummeted to just under 43 cents, a 42% drop in just 32 hours.
This past week, after several coins hit record highs, they plunged sharply later in the week.
And unlike stocks, which are mostly traded during business hours on weekdays, cryptocurrencies can be exchanged 24/7, meaning that volatility can occur at any point during the day, including wild swings up or down while you’re asleep.
Although the general trend of most cryptocurrency prices has been up, up, up so far in 2021 — anyone who has practiced some fortitude and not sold during crash periods has generally made it up longer-term — some experts wonder whether a bubble is preparing to burst, not unlike when Bitcoin prices dropped from nearly $20,000 per coin in late 2017 to just about $3,500 at the start of 2019.
Any type of investing comes with a risk of loss, but investors, especially ones who are new to financial markets and maybe don’t have a great understanding of how they operate, should tread cautiously.
Some tips that apply to general investing also apply well to crypto:
• Buy low and sell high — The most basic tenet of turning a profit on investments. Unlike stocks, where you can research a company, its leadership, its earnings, and its future plans, cryptocurrencies don’t give you much to go on, so guessing ups and downs may be more difficult.
• Diversify — Spreading your money out among multiple investments can help reduce risk if one particular coin is suffering a big downturn. That being said, cryptocurrency values do tend to move up and down in tandem, so when one drops, you may find others are dropping too.
• Set short- and long-term goals — Whether you’re investing for a few days or weeks trying to turn a quick buck or planning to hold coins long-term in hopes of big growth over years, know your limits and be disciplined in your buying and selling patterns.
• Don’t invest what you’re not afraid to lose — Highly volatile investments can sometimes be more akin to gambling, so don’t put in more than you’d be comfortable losing. It’s possibly to lose 10-20% or more of your principal in mere hours in cryptocurrency.