Cryptocurrency is encrypted (crypto) currency that is a form of digital money. The most well-known cryptocurrency is Bitcoin. Bitcoin was the original cryptocurrency introduced in 2008, over fifteen years ago. Bitcoin was created as a form of electronic cash, but many people today view it as a digital asset. Since 2008, the number of cryptocurrencies has increased dramatically. There are now thousands of cryptocurrencies.
Is cryptocurrency money? There is a debate about this because cryptocurrency has a split identity. Some think of it as a currency, some as a commodity, and some as a security. There have been legal settlements based on this uncertain definition. One of the main arguments against the definition of money is the volatility of price. However, stablecoins are cryptocurrencies whose value is pegged to a sovereign currency such as the USD. Therefore, it is likely only a matter of time before this issue can be addressed in newer cryptocurrencies.
Cryptocurrency can also be considered a digital asset (or cryptoasset). The CFA Institute recently released a white paper on this topic. Here is the CFA Institute Research Foundation’s Brief on Cryptoassets. It is a good guide to cryptocurrency and blockchain for investors. The Bank of New York Mellon, the oldest bank in the United States, recently announced that they are now offering custodial services on digital assets for their clients.
Most cryptocurrencies rely on a technology called blockchain. Blockchain is a technology for sharing information using a distributed ledger. This technology allows cryptocurrency to exist without a role for governments or banks as “trusted third parties.”
Once you have some understanding of Bitcoin, you should try to understand Ethereum. Ethereum is the second largest cryptocurrency by market capitalization. One benefit of Ethereum is the ability to write smart contracts on the blockchain, which makes Ethereum more of a platform for building applications. One of the hot areas right now is “DeFi” (decentralized finance), which is financial applications that remove centralized financial institutions.
The term “token” is often used for cryptocurrency as well. You may be familiar with physical tokens in gaming arcades. Cryptocurrencies are a form of digital token which has similar features to physical tokens. Crypto “tokens” can be purchased with traditional currencies (like dollars) and used for specific purposes (as in decentralized applications). The term token is also similar to other digital forms of money such as “Robux” in the Roblox gaming ecosystem. A close cousin of cryptocurrency is the non-fungible token (NFT). NFTs are used to record ownership of an asset like a digital work of art or digital music recording.
There are thousands of cryptocurrencies now on the market. Just like stocks, there are “large cap” and “small cap” cryptocurrencies. CoinMarketCap provides a list. Many smaller cryptocurrencies got their start as initial coin offerings (ICOs). An initial coin offering (ICO) is the creation of a currency as a form of crowdfunding for a new venture. In other words, it is a way of raising money by issuing a new cryptocurrency. However, newer cryptocurrencies have presented both opportunities and challenges . The ICO movement introduced significant fraud and market regulators (SEC/CFTC) were forced to intervene. The SEC has deemed many of these ICOs to be in breech of security laws. There is now significant debate about whether a given cryptocurrency is a “security,” which falls under security regulation. In general, the cryptocurrency market is becoming more regulated over time. More regulation will likely help this market to mature and become more transparent.
How do you buy cryptocurrency? There are a number of ways to buy and sell it. Cryptocurrency exchanges are platforms for buying and selling cryptocurrency. Another way to buy and sell Bitcoin is using a Bitcoin ATM machine. There are many ATMs available across cities like Chicago. Ultimately, cryptocurrency is stored somewhere in a wallet. You can also buy cryptocurrency directly from a digital wallet. A digital wallet is a blockchain address for storing value or information.
The price of Bitcoin has risen and fallen dramatically over different periods of time. The end of 2017 was one of the most dramatic increases, when the price of one Bitcoin approached $20,000. Many people now view this as a “Bitcoin bubble.” Following this period, there was widespread skepticism about the value of Bitcoin. Many traditional investors, like Warren Buffett, are dismissive of Bitcoin as having no value. However, others would argue that its value is in its network effects. Money has no fundamental value in itself. Its value is in its use within a community of users. If there is sufficient demand for money, then it will have value.
The price of Bitcoin is extremely volatile. Bitcoin rose dramatically in late 2020 during the COVID crisis and far surpassed the valuations of 2017. As of early January 2021, Bitcoin prices had risen to $40,000 per Bitcoin. This has attracted significant interest from the investment community. Many would consider Bitcoin to be in the “alternative asset” category, which has a place in a diversified portfolio. Interestingly, Bitcoin sometimes trades as “digital gold” during crises and sometimes as an innovative technology play.
Although some people now think of it as a speculative investment, cryptocurrency can function in multiple roles within the financial system. The innovation in this space shows that there are many different directions that it could take going forward.
Stablecoins are one example of cryptocurrency designed to address the volatility of Bitcoin. Stablecoins are tied to a sovereign currency like the U.S. dollar. This is an interesting idea, but some have questioned the mechanisms and transparency for maintaining this “peg.”
A number of central banks are now exploring the idea of central-bank digital currency (CBDC). This approach to “money” combines the governance of a central bank over a sovereign currency with a native digital currency. The People’s Bank of China recently announced initial testing of this approach. Central-bank backed digital currency raises interesting questions about the pros and cons of sovereign governance. Some people like that Bitcoin is ungoverned. Others think that all currency needs governance to be stable.
It will be interesting to see how private cryptocurrency and sovereign digital currency develop over time. Although there is debate about whether cryptocurrency fulfills the three functions of money, it is clear that this trend toward digital money will continue. Cryptocurrency could be the future of money and digital assets.
Glossary
Cryptocurrency. Digital money that uses encryption to maintain security and privacy