Cryptocurrency is all the rage in the investing world these days. It has entire segments dedicated to it on the news, in magazines, on finance websites and more, and everyone seems to think it's the "new new" when it comes to building wealth.
"Cryptocurrency is super trendy these days. It's worth looking at, but it's important to first educate yourself about it and to do your own research so you can make informed decisions."
It certainly is super trendy these days! It's worth looking at, BUT before you take the leap into investing in digital currency, there are a few critical things you need to know. Similar to every investment you consider, it's important to first educate yourself about it and to do your own research so you can make informed decisions.
Let's start by first defining what cryptocurrency is!
1. What is Cryptocurrency?
Cryptocurrency is essentially virtual coins or digital money that is not tied to any traditional financial institution, banking or currency system. It can be transferred between individuals without the need for any financial intermediaries (aka middle men). The demand for digital currency has grown steadily over the last few years, especially with the media showcasing how much initial investors have made thus far.
Investopedia defines it as "a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation."
2. Is cryptocurrency like gold?
I've seen and heard A LOT of comparisons between cryptocurrency and gold. Traditionally, buying gold (and other precious metals) has been a way for people to further diversify their investment portfolios. Tangible assets such as gold allow you to hedge against things like natural disasters, currency declines or collapses. Now, many people consider cryptocurrency to be a form of digital gold.
Because cryptocurrencies are not tied to any traditional banking or financial systems, some people consider it a way to hedge against risks associated with these systems that are severely impacted by things happening within a government-controlled economy.
Gold is a limited resource (limited by what's available to be mined from the ground, of course). What's surprising is that cryptocurrencies are also limited. Huh? That's right—there's a limit to how much of it can be created via its digital mining processes. For example, only 21 million Bitcoin can ever be mined due to the digital nature of how it's created (learn more here).
However, the main difference between cryptocurrency and gold is that gold has associated value. That's because it's actually used in industries and to make things like jewelry. So the demand for gold doesn't just come from the commodity itself, it comes from the associated industries and products in which it is used. Cryptocurrency, on the other hand, does not have this same associated value (right now). It's worth it determined pretty much by what investors are willing to pay for it.
3. What risks are associated with buying cryptocurrency?
Investing in cryptocurrency is considered high risk. That's because it is a very volatile and highly speculative investment (again, right now) that's based on supply and demand. And while high-risk investments also generate high returns, it's important to only invest what you can afford to lose. Should your long-term retirement savings be in cryptocurrency? I would not recommend it.
In addition, cryptocurrencies are susceptible to a certain level of hacking, despite high security. That's because all their online transactions are stored in online ledgers. Just ask Bitcoin—they've been hacked more than 40 times.
Also, keep in mind that there is a chance that many of these different cryptocurrencies we are hearing about today may not be around long term. So again, when investing in a high-risk asset such as cryptocurrency, only invest what you can afford to lose.
4. Is all cryptocurrency the same?
The answer is no, in the same way all currency is not the same. For example, the American Dollar is different from the British Pound, which is also different from the Chinese Yen in terms of value, buying power, supply, demand, inflation and other economic factors.
When buying cryptocurrency, you'll need to do some serious research to determine what type to buy. Believe it or not, there are cryptocurrencies out there that have no practical purpose or real value outside of the fact that people seem interested in buying them.
5. Where is your cryptocurrency stored?
When you invest traditionally in stocks and bonds, you have access to your investments via a brokerage account. With cryptocurrency, your assets are stored in a cryptocurrency wallet or digital wallet. That's basically a secure digital wallet used to store, send, and receive digital currency. It's important that you back it up securely as well as keep your pin or access details secure. If you happen to lose access to your wallet or lose your access details, it could be a nightmare to recover.
Now you know some of the key things to consider if you are thinking of getting into cryptocurrency. Remember, it's all about staying informed and not placing all your bets on any investment no matter how incredible it sounds!