Cryptocurrency comes under many names. You have probably read about some of the most popular types of cryptocurrencies such as Bitcoin, Litecoin, and Ethereum. Cryptocurrencies are increasingly popular alternatives for online payments. Before converting real dollars, euros, pounds, or other traditional currencies into ₿ (the symbol for Bitcoin, the most popular cryptocurrency), you should understand what cryptocurrencies are, what the risks are in using cryptocurrencies, and how to protect your investment.
What is cryptocurrency? A cryptocurrency is a digital currency, which is an alternative form of payment created using encryption algorithms. The use of encryption technologies means that cryptocurrencies function both as a currency and as a virtual accounting system. To use cryptocurrencies, you need a cryptocurrency wallet. These wallets can be software that is a cloud-based service or is stored on your computer or on your mobile device. The wallets are the tool through which you store your encryption keys that confirm your identity and link to your cryptocurrency. 2022 comes to an end, cryptocurrency traders worldwide are encountering a rough time. The collapse of cryptocurrency exchange FTX following the arrest of founder Sam Bankman-Fried, once the golden boy of cryptocurrency, only made matters worse. The Securities and Exchange Commission said Bankman-Fried, “orchestrated a years-long fraud” to conceal from FTX investors the diversion of customer funds to his crypto-trading hedge fund. To predict future scenarios for cryptocurrencies, it may be useful to consider what happened in the past and clarify a few key points. First, the world of blockchain consists of cryptocurrencies and crypto derivatives. For example, Bitcoin is a cryptocurrency while stablecoins Tether and Terra USD are crypto derivatives. These are “derived” from cryptocurrencies and/or pegged to a widely recognized and centralized currency, like the dollar. Put simply, a financial investor hands out dollars to a company and receives a derivative in return. The company converts the dollars into cryptocurrencies and lends them to global borrowers. At the same time, the company promises the financial investor to exchange the derivatives on demand for a fixed amount of a given cryptocurrency, possibly pegged to the dollar, or backed by dollars.
The upshot is that if you have bought Bitcoins or other cryptocurrencies, you win/lose following the exchange rate of the cryptocurrency in your portfolio. If you have bought a derivative, however, you may find out that it is not really backed by an adequate quantity of cryptocurrencies or that the dollar-convertibility guarantee is porous, to say the least. If so, the derivative turns out to be all but worthless. This is what happened during the past few months with several crypto derivatives. Companies issuing such products are very active on the market and contribute to making the underlying assets volatile, especially if they promise stellar returns, which boost the demand for cryptocurrencies and crypto derivatives. If the derivatives products are poorly collateralized, investors are scared away in bad times. A second key point is that cryptocurrencies are currently considered both a speculative instrument and a store of wealth, rather than a means of payment for ordinary transactions. For example, more than 60 percent of the total bitcoins in circulation are held in accounts (“wallets”) with more than 100 Bitcoins each, and are rarely traded on the market, other than to adjust portfolios: in late July 2022, only about 250,000 Bitcoins were traded daily it is likely that just a small portion related to commercial transactions. Moreover, cryptocurrency holders seem to have a long-term view. For example, both “shrimps” and “whales” (accounts with less than 1 and over 1,000 Bitcoins each, respectively) have taken advantage of the recent sell-off to buy the dip in large amounts.
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