Guide to Cryptocurrency Part 1: What it is & Why it Matters
Updated: Sep 21
As a relatively new concept, cryptocurrency is often misunderstood. This article will give potential investors a broad overview of the cryptocurrency market and explain its significance as both an investment asset class and technology.
There’s never a dull moment in the world of cryptocurrency. But let’s face it — how much do we really know about the phenomenon underlying all those attention grabbing headlines?
Here at Fintonia Group, we believe it’s important to understand the fundamentals before you buy, and that’s why we produced this guide for crypto-curious investors. We hope you find this article illuminating and enjoyable.
What is cryptocurrency?
At the most basic level, cryptocurrency is a type of currency that is decentralised as well as digitally verified. These two related features distinguish cryptocurrency from other forms of money, whether traditional or virtual.
First, let’s talk about decentralisation.
Traditional currency, such as SGD or USD, is managed by a central authority. For example, the US Federal Reserve controls the supply of the US dollar. By controlling the supply, the governing body can maintain and control the value of USD.
Crypto, on the other hand, is decentralised, so it’s not managed by any regulatory body. Instead, each cryptocurrency is set up with a rules-based programme which determines its supply and mechanics. (The level of decentralisation does vary between each cryptocurrency — a topic for future discussion).
But decentralisation is not enough to make it currency-like. After all, the virtual coins in Super Mario are also written in code, but you can’t exchange them for real-life goods and services.
That’s where digital verification comes in.
In order for cryptocurrency to function as a type of currency, it needs to be robustly verified. Otherwise, anyone can simply copy their coins and make fraudulent transactions with fakes, and it would quickly lose value as a way to transact.
To verify and record transactions digitally, but securely, most cryptocurrencies utilise blockchain technology. Without going into technical detail, blockchain is essentially a virtual bookkeeping ledger.
As new transactions take place, they are painstakingly verified by users in the crypto network (more specifically, crypto miners, because they work in exchange for cryptocurrency).
Once everything is verified, the data is stored in a block, which gets added to the chain of previously verified blocks. All data on the blockchain is irreversible, making the blockchain a permanent, transparent record.
What types of cryptocurrencies are there?
The oldest and most established cryptocurrency is, of course, Bitcoin. But because the barrier to entry for creating a new crypto is so low, there are thousands of other cryptocurrencies out there too.
Here are the top 10 cryptocurrencies by approximate market capitalisation, as of 3 August 2021. Data from CoinMarketCap.
As you can see, the next-biggest cryptocurrency in the world is Ethereum. However, ETH has very different applications from that of Bitcoin.
While Bitcoin is thought of as either a replacement for traditional money or a store of financial value (like gold), Ethereum powers the creation of apps for gaming, technology and finance. Other cryptos that are similar to Ethereum are Cardano and Polkadot.
Other big cryptocurrencies to note are “stablecoins” like Tether and USD Coin (which are pegged to the US dollar) as well as coins for transacting on crypto exchanges, like Binance Coin and Uniswap.
How did cryptocurrency get so big in 2021?
Cryptocurrency has certainly come a long way since Bitcoin was first launched in 2009. Although it had a small cult following in those early days, it’s safe to say that the public either did not know about cryptocurrency or did not take it seriously.
As early as 2012, we saw the emergence of major players like crypto exchange Coinbase and the new cryptocurrency Ethereum. This period signalled a shift in thinking as more people in the tech community saw the disruptive potential of cryptocurrency.
From 2017 to 2019, investors and speculators jumped on the crypto bandwagon, causing cryptocurrency prices to be extremely volatile, exploding one day and free-falling the next.
But in 2020, something else came along and disrupted life as we knew it: Covid-19. As economies reeled from the impact of the pandemic, investors started looking to cryptocurrencies as a growth asset in an uncertain world.
By early 2021, Bitcoin’s price had leapt to a record high, and its market cap surpassed US$1 trillion. It also became increasingly accepted by institutions, with more and more investment banks and major businesses backing it.
This breakthrough caused a ripple effect across the world of cryptocurrencies, resulting in crypto’s unprecedented acceptance and popularity in the mainstream today. This is aided, in part, by how easy it is to buy and trade cryptocurrency. Practically anyone can open a crypto exchange account online and start trading with just US$50.
The global cryptocurrency market currently stands at about US$1.6 trillion (CoinMarketCap). So, although cryptocurrency remains volatile, there’s no denying that it’s now too massive to ignore.
How is the value of cryptocurrency determined?
Despite the “currency” in its name, the way cryptocurrency’s value is determined has little in common with that of traditional fiat currency.
With traditional money, a central authority maintains the value of the currency by managing the supply of money in response to demand, among other considerations.
A simplified example: if high demand threatens to destabilise the currency, the authority may choose to release more money into the market. The increased supply should prevent the currency from soaring too quickly.
In the case of cryptocurrency, there is no such governing body. Instead, the supply is managed by rules-based algorithms in most cases.
For example, new Bitcoin is only released to reward miners when they successfully verify transactional data on its blockchain. There is no other way to mint new Bitcoin. Furthermore, Bitcoin has a built-in supply cap, meaning there is a maximum number of Bitcoins that can ever be released.
The supply of Bitcoin remains constant regardless of demand, a feature that can lead to astonishingly volatile prices.
Whenever demand for Bitcoin rises — perhaps fuelled by positive news — there is no way to increase the supply to meet the surge in demand. This results in a frenzied competition for the limited supply of Bitcoin in the market, which pushes the price of Bitcoin up dramatically.
However, because of its supply cap, Bitcoin has guaranteed scarcity, much like gold and other finite resources. So despite the short-term volatility, Bitcoin can also maintain its value in the long run.
It’s worth noting that not all cryptocurrencies work this way. Each one has a different algorithm to determine its supply mechanics, and some cryptos are uncapped. Since different supply mechanics can lead to different long-term results, it’s important to assess each cryptocurrency separately.
Can cryptocurrency replace traditional money?
The first cryptocurrency, Bitcoin, was originally conceived as a digital payment method — an alternative to paying with regular cash. So, can you use it as money?
In the case of Bitcoin, you certainly can. With a significant number of companies already accepting Bitcoin as payment, it’s steadily gaining traction as a mainstream currency,
For example, you can use Bitcoin to pay for apps and games on Microsoft’s online store, and there are rumours that Amazon is about to start accepting Bitcoin. Financial services like PayPal and Square allow their users to buy, sell and pay with Bitcoin too.
As long as the recipient accepts it, paying with cryptocurrency is possible thanks to an ecosystem of financial services. These include crypto wallets like BitPay, crypto debit cards like the Coinbase Card, gift card merchants like Gyft, and online shopping gateways like Purse.io.
However, cryptocurrency’s volatility is one major hurdle preventing its wider acceptance as a mode of payment. It’s hard to do business in a currency that fluctuates a lot.
In addition, cryptocurrency is increasingly seen as a store of value rather than a mode of payment. This is especially so for Bitcoin, whose mechanics and guaranteed scarcity are akin to that of gold.
While you technically can buy a burger with gold — albeit indirectly — you would probably prefer to keep the gold in its vault where it does its job best: preserving value in the long-term. The same goes for Bitcoin.
What are the other applications of cryptocurrency?
Above, we’ve talked about cryptocurrency’s most obvious uses, as either a store of wealth (like gold) or a form of payment (like cash).
But part of cryptocurrency’s appeal is its potential applications beyond the obvious. It’s a technology that can solve some of the world’s biggest problems.
For example, in many poorer parts of the world, there are segments of the population who are not even documented as citizens, let alone able to open bank accounts or receive healthcare or education.
Cryptocurrency’s blockchain technology offers alternative methods of verifying identities, transferring money, and providing essential services — all without having to rely on potentially corrupt governments or expensive middlemen.
We are also witnessing the growth of an entire financial ecosystem around cryptocurrency. Called decentralised finance (or simply DeFi), this emerging ecosystem allows us to perform common functions like borrowing, saving, investing and remitting, but with cryptocurrency instead of cash.
What’s unique about DeFi is that its financial instruments are decentralised, not owned by any institution. Users can transact on a secure peer-to-peer basis, avoiding middlemen like banks and investment brokerages. That said, DeFi also has challenges of its own — which we’ll discuss in a future article.
It’s definitely too early to say what exactly the future of cryptocurrency entails. But just from these initial developments, there’s no doubt that crypto is a very exciting field with seemingly limitless potential.
Are cryptocurrencies a good investment?
It should be clear that cryptocurrency isn’t simply a replacement for fiat currency. Rather, cryptocurrencies may have even more potential as a store of value and to catalyse breakthroughs in technology.
While some believe that cryptocurrency is simply a fad or bubble, we think it might actually disrupt the institutions and systems that have served us for decades, or even centuries, and change the shape of modern financial services.
In light of crypto’s technological potential, we believe it is a good long-term investment. And we’re not alone. In 2021, 14% of US financial advisors recommend investing in cryptocurrency, up from just 1% in 2020.
Coupled with its reputation as a hedge against inflation, professional investors also consider major cryptocurrencies to be low or negatively correlated with the equities market. This means holding cryptocurrency as an investment asset allows diversification within a portfolio and protection against economic uncertainty.
However, one challenge that investors face is the lack of consensus about what constitutes value for cryptocurrencies.
Whereas traditional currencies may be pegged to a reserve currency, like USD, or commodities like gold and silver, there is no external measure of value for cryptocurrencies. Instead, a cryptocurrency’s value is based on the trust that investors have in the blockchain network it is built on.
Also, since its regulatory framework is still developing, cryptocurrency is one of the most volatile investments right now. Because it’s so high-risk, experts recommend investing just a small part of any investors’ portfolio in cryptocurrency (watch video).
Most importantly, investors should understand the asset thoroughly, know why you’re investing, and be prepared to ride out the short-term fluctuations.
How to buy, sell and exchange cryptocurrency
As noted above, it is incredibly easy to buy and trade cryptocurrency on one of the hundreds of crypto exchanges on the internet.
Crypto exchanges are not subject to the same types of regulation as, say, banks or investment brokerages, so there is virtually no eligibility criteria. Just about anyone can open an account online. Furthermore, many exchanges allow you to start buying cryptocurrency with as little as US$50 or US$100.
But trading cryptocurrency through an exchange is fraught with risks. Because of the lack of regulation, investors are not safeguarded against scams, hacking, security breaches and platform closures.
A lower-risk alternative is to invest in a government-regulated, institutional-grade cryptocurrency fund.
While this method typically is only available to Accredited Investors and might require a larger initial capital investment than buying through an exchange, investors can rest easy knowing that their assets are in the hands of a regulated fund house.
There are additional upsides too. By virtue of their institutional status, fund houses can connect to a wide network of exchanges to obtain the best price and offer liquidity to investors. Essentially, it means you won’t be stuck with whatever your crypto exchange has to offer.
In summary, it’s easy to “play” on the cryptocurrency market with a crypto exchange. But an institutional-grade fund is more appropriate for serious investors looking to hold a sizable amount for the long-term.
Cryptocurrency: look beyond the headlines
Hardly a day goes by without cryptocurrency being in the news. But the informed investor should not allow dramatic price movements and talking heads to influence their investment decisions.
Underneath all those headlines, cryptocurrency is a technological phenomenon with enormous potential to change the way we do things.
Whether you eventually decide to invest or remain on the sidelines, we believe all investors should equip themselves with a solid understanding of this asset.
Have a special enquiry? Please get in touch.