Bitcoin, Ethereum And Other Cryptocurrencies: Should You Invest?
I get asked lots of questions about cryptocurrencies lately (street named ‘cryptos’), so I thought I’d look into them in more detail.
My conclusion: Cryptocurrencies are worth looking into as a long-term investment, provided you:
- Know exactly how to invest in them.
- Are fully aware of the risks involved.
- Only invest a very small portion of your portfolio (CNBC market commentators suggest around 1%), preferably with money you can afford to lose.
What are cryptocurrencies?
Per Wikipedia, a cryptocurrency is “a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency.”
In other words, it’s a form of digital money that uses unique codes to:
- Secure each transaction.
- Control how much of it can be created.
What makes cryptocurrencies so interesting is that they cut the middleman out of transactions:
- No PayPal.
- No banks.
- No government intermediaries.
- No platform fees.
- No supermarket or air-mile reward points.
This drastically lowers transaction costs.
If I buy something from you and pay for it with cryptocurrency, I transfer that currency directly to you. That transaction is logged with a unique code, signifying that I now have ownership of the thing I bought from you.
Although the transaction codes are logged, our personal details remain anonymous. Instead, you own digital wallets where you store cryptocurrencies which only you can access.
Each wallet has a unique address. If I send you money, you tell me the address to send it to.
Cryptocurrencies are the first new asset class since 1694 (when the first UK government bond was created) so they’re kind of a big deal!
Blockchain is a secure online record for every transaction made. Hundreds of transactions make up a single block. There are lots of blocks.
No person, business or government controls the blockchains – they are spread out across the computers and digital wallets of the people who own the cryptocurrencies.
Unlike paper money, Blockchain leaves no physical imprint, making currencies impossible to steal or counterfeit.
What are the main cryptocurrencies?
Bitcoin is the most well known, but as of July 2017, there are over 900 different cryptocurrencies.
This number is growing rapidly. Just like the dot.com boom from 1995 to 2001, there are new developments every day.
Bitcoin and Ethereum are getting the most press right now, and together make up more than half of the $100 billion global cryptocurrency maket.
- Bitcoin was invented in 2008 by an unknown person (or group of people…) using the name Satoshi Nakamoto.
- Bitcoins can be ‘mined’ by anyone with the computer power and software to do so. Miners use special ‘mining software’ to solve maths problems and receive a certain number of bitcoins in exchange.
- The maths problems get harder with time so they need progressively more computing power.
- Per Satoshi’s Bitcoin algorithm, only 21 million bitcoins can ever be mined. Each bitcoin, however, can be divided into 100 million different ‘Satoshis’.
- Unlike paper money, central banks can’t print Bitcoins into infinity, which makes them good for inflation protection.
- You can use Bitcoins to buy things without paying transaction fees. Transactions are logged using Blockchain technology.
The graph below shows the price changes of Bitcoin over the last year, going from about $500 to over $4,000 per coin at the time of writing.
In July 2010, a Bitcoin was only worth five cents!
- Ethereum was first introduced in July 2015.
- Ethereum coins are called Ethers.
- Like Bitcoin, Ethereum uses Blockchain technology to limit its supply and secure each transaction.
- However, unlike Bitcoin, Ethereum’s blockchain uses smart contracts, which can represent anything from virtual shares to golf club memberships.
- Smart contracts allow transactions to be programmed. Your money could be programmed to invest, save and spend all on its own!
Here’s what the price of Ether has done over the last year…
Is there more upside in the cryptocurrency market?
The global market cap (total market value) of all the different cryptocurrencies now stands at roughly $100 billion. Of this, around $40 billion are Bitcoins and around $30 billion are Ethers.
Most funds are prohibited from investing in cryptocurrencies because they are still considered too risky by their investors. This is likely to change with time, as the cryptocurrency market grows in size and more people start using digital currencies in their everyday lives.
Even if a few large fund managers were to start investing just 0.1% of their funds into cryptos, the market would grow to astronomical levels.
In fact, some hedge funds – who have more power to invest as they please than regular funds do – have already started investing in cryptocurrencies. Given the graphs above, most of these hedge funds have done rather well.
What are the risks of crypto investing?
There are plenty.
- Governments don’t like it. They want to keep control of their monetary systems and be able to print money to boost their economies as needed. They can’t do this with Blockchain.
- Big banks don’t like it either. They make money from their customers on transactions. With Blockchain there are no middlemen.
- Crypto exchanges can get hacked. Bithumb, one of the world’s five largest Bitcoin and Ethereum exchanges, was hacked in July 2017.
- Cryptocurrencies are highly volatile in price. Something that goes up by 4,000% in a year can just as easily go the other way.
- Twenty-five percent of Bitcoin’s computing power is located in a couple of warehouses in Shenzen, China. This poses a threat to the decentralized nature of Bitcoin mining.
Should you invest in cryptocurrencies?
Despite the risks, there’s enormous long-term growth potential for this new and exciting market. That said, you should only invest with the spare change you have lying around that you could easily afford to lose.