Cryptocurrencies have been getting a lot of attention lately. One could get whiplash from the tales of overnight millionaires who lost fortunes as quickly as they gained them. And no wonder: a single bitcoin ranged in price from $1,000 in early 2017 to more than $63,000 in April 2021—before plunging to $34,000 in late May.
While Bitcoin is perhaps the best-known cryptocurrency, it has competition in Dogecoin, Ethereum, XRP, and many others (see “Crypto king,” below). Understandably, investors have questions about this emerging asset class. Here are answers to five of the most common.
How do cryptocurrencies work?
Cryptocurrencies let users store money and make and receive secure payments outside the traditional financial system while remaining anonymous. Cryptocurrencies run on a decentralized public ledger called a blockchain—a database of every transaction maintained by all of that currency’s users.
How are cryptocurrencies managed?
Unlike so-called fiat currencies such as the U.S. dollar and the euro, which are managed and backed by central banks, cryptocurrencies are decentralized, meaning no single entity has control over how they’re governed. Instead, they’re driven by consensus and the peculiarities of the cryptocurrency itself. For example, bitcoins are “mined” using high-powered computers that solve exceedingly complex math problems. However, by design only 21 million bitcoins can ever be mined, making them a finite resource more akin to certain commodities than a printed currency.
Are cryptocurrencies a legitimate asset class?
Bitcoin and other cryptocurrencies are highly speculative investments, since supply and demand drive their volatility—not intrinsic value. That said, the cryptocurrency market has matured from its experimental phase into a unique and sizable asset class with a global market capitalization of some $1.5 trillion1 (see “Crypto roller coaster,” below). As a result, several established corporations and institutional investors have begun investing in Bitcoin.
What are the risks and drawbacks?
As you might expect with a highly speculative investment, cryptocurrencies carry notable risks, including:
- Volatility: Cryptocurrency prices historically have been highly volatile, and fluctuations could result in significant financial losses.
- Fraud: According to the Federal Trade Commission, “Many people have reported being lured to websites that look like opportunities for investing in or mining cryptocurrencies, but are bogus.” And while login credentials are typically required to access a cryptocurrency exchange, these can be stolen or lost.
- Lack of recoverability: With conventional financial accounts, there’s normally a recovery process if you forget or misplace your login credentials. If you lose your cryptocurrency “key,” however, you cannot retrieve your cryptocurrency. Similarly if you lose access to the place where you store your key, you will effectively lose possession of your cryptocurrency.
Should I invest in cryptocurrencies?
Whether cryptocurrencies are right for you depends on your goals and risk tolerance. While some traders have made money on the dramatic swings in the price of Bitcoin or other cryptocurrencies, others have found out the hard way that what goes up can most definitely come down. Thus, investors in this speculative asset should never venture more than they can afford to lose.
1TradingView.com, as of 06/07/2021.