Cuckoo for Crypto-Puffs

Bitcoin has been one of the best-performing assets of the past decade. Keep in mind that the last decade has also included strong performance for traditional indices like the DJIA and the S&P 500. When something is successful, people copy it. Several additional cryptocurrency flavors have joined the ranks since 2013, when Dogecoin, a currency initially launched as a joke, hit the market. Despite the dizzying gains, cryptocurrency investments remain highly speculative at this point in time. However, they may be here to stay and are worth understanding. Here is the story on crypto.

Chain of Fools

It’s hard to understand cryptocurrency unless you have a basic understanding of the platform on which it operates. The thing that makes cryptocurrency possible is the underlying blockchain technology. Blockchain is a type of database that is usually decentralized. That means it is housed on servers in several locations. Whereas the contents of most databases can be altered, blockchain keeps an essentially unalterable, chronologically timestamped record of activity and transactions. Every time a transaction occurs, it is added as a block to the end of the database’s chain-like transaction record, hence the name blockchain. The blockchain database is transparent, meaning the information on it can be viewed by anybody, making it easy to verify records of transactions. Cryptocurrencies are the method of exchange by which users of the blockchain transact business. Each blockchain database houses its own cryptocurrency. The Ethereum blockchain uses Ether as its currency. Bitcoin and Dogecoin also have their own underlying blockchains. While this can be an entirely separate blog topic, the recent publicity of NFTs (non-fungible tokens) and their record-breaking sales prices is worth mentioning here as an example of how transactions can take place. An NFT is a piece of code that exists on a blockchain that manifests as a digital image. What blockchain the NFT is on determines what cryptocurrency is used to buy it, since different cryptocurrencies exist on their own blockchains. A company can set up a settlement application on a particular blockchain in order to accept payments and make transactions in the blockchain’s currency. If somebody owned Bitcoin but wanted to purchase an NFT on the Ethereum blockchain, they would have to exchange their Bitcoin into Ether, moving the stored value across blockchains, in order to make the purchase. However, there are companies that have brought apps to the marketplace that will make these exchanges and settlements for you, facilitating transactional ease across blockchain platforms.

What Goes Up

Ease of use definitely seems to influence the value of a currency. Cryptocurrency prices continue to react to regulatory changes, media coverage, and adoption trends, creating sharp swings. What people forget about volatility and risk is that it encompasses both downside and upside potential. Bitcoin was launched in 2009 for $0 per coin and has reached historically high prices since then. With ongoing development in how cryptocurrencies can be used, volatility is likely to remain. Many platforms now allow the average person to invest directly in cryptocurrencies, and cryptocurrency ETFs are becoming available in certain international markets.

The Difference

Capital continues to flow into the marketplace. With fewer publicly traded companies listed on exchanges, investors often seek alternative avenues. Stocks are backed by assets and cash flows, allowing investors to estimate value and potential returns. Cryptocurrencies, however, have no underlying assets or cash flows. Their price fluctuates purely based on market perception and speculative demand..

The Takeaway

Cryptocurrency may play a role in a diversified portfolio for investors who understand the risks and have the appropriate time horizon and risk tolerance. Due diligence and professional guidance are essential when exploring this evolving asset class. While the upside potential exists, the volatility and uncertainty mean this asset class is not appropriate for every investor. As always, evaluate how crypto fits within your broader financial plan.