What are Cryptocurrency and NFTs — and how do they work?
As futuristic as it might sound, cryptocurrency — a form of digital money — is gaining broader acceptance as a way to buy and sell goods and services and transfer funds. Here’s what you need to know about how cryptocurrency works, how secure it is, where to get it, how to use it — and how to decide if it’s worth your while.
What is cryptocurrency?
“Cryptocurrency is a digital currency based on recently developed technology known as blockchain,” explains Brett Stewart, CFA, CAIA, Vice President, Senior Investment Research Analyst, Commerce Trust.
In concept, cryptocurrency is like a digital form of an arcade token or a poker chip. Bitcoin, which has been around since 2009, is the most well-known and widely used cryptocurrency, although there are many others, like Ethereum and Dogecoin.
Cryptocurrency is bought, sold and stored digitally — and can be used to buy goods and services at certain locations where it’s accepted around the world. Every transaction involving cryptocurrency is verified and recorded in code through blockchain technology, which acts as a decentralized, yet secure, online ledger.
“No banks are involved in the transfer of digital money and funds are distributed across a network of servers across the world,” adds Brent Schowe, CFA, Director of Investment Research, Commerce Trust.
How do you buy, store and use cryptocurrency?
Digital currency exists only in electronic form, and you’ll need an internet-enabled device (like a computer or smartphone) to buy and use it. You can purchase cryptocurrency with traditional funds (like cash or credit cards) through a trading exchange.
In general, you'll need a digital wallet — essentially an online app — to store your cryptocurrency and to make certain transactions. Some exchanges have their own wallet, but you can also create one online.
When you pay a person or business that accepts cryptocurrency, the transaction is made through secure, encrypted channels that interact with the blockchain to transfer the money between digital wallets. While it’s not yet a mainstream form of payment, cryptocurrency is accepted at a growing number of businesses and retailers, including, at the time of publication, AT&T, Burger King and Overstock.com.
Investing in cryptocurrency
Some people like the idea of using digital money to make purchases, while others are interested in buying cryptocurrency to hold as an investment, hoping it will increase in value. Because there is a limited supply of some types of cryptocurrency, proponents believe this scarcity — combined with increasing demand — will result in large price increases. However, many cryptocurrencies have no supply limits, and even the ones that do have limits experienced wide price fluctuations.
The pros and cons of using cryptocurrency
If you’re wondering whether you should buy cryptocurrency, understanding the benefits and drawbacks can help you decide if it makes sense for you.
Pros: “A major benefit of cryptocurrency is speed and 24/7 accessibility,” explains Adam Emig, CFA, CAIA, Vice President, Senior Investment Research Analyst, Commerce Trust. “You can send money anywhere, anytime, versus relying on the hours and rules of the banking system,” he adds.
Other benefits include transparency, security and user control. Once a transaction is recorded and verified on the public ledger, it can’t be changed or manipulated by hackers. And since no private information is made public during the exchange, user information stays safe and anonymous, minimizing the chances of identity theft. In addition, since cryptocurrency is not currently regulated by any central authority or government, it may not be impacted by inflation or interest rates, like traditional currency.
Cons: “The biggest drawback is its volatility,” says Stewart. “The value can go up or down significantly at any time. Cryptocurrency also doesn’t generate cash flow or dividends, so it’s very difficult to determine its true value,” he adds.
Schowe notes that even though transactions are encrypted on the blockchain, which is secure, cryptocurrency must be stored individually by its owner. “A person’s digital wallet can fairly easily be stolen or compromised,” he adds.
Cryptocurrency’s lack of federal regulation means that, unlike the money you keep in your bank account that is FDIC insured, there’s no central authority to manage, insure or maintain its value. For example, if you store cryptocurrency with a third party that gets hacked or goes out of business, or if you accidentally send cryptocurrency to the wrong person, there is no legal authority to help you retrieve your funds.
Another major drawback is that there’s no way to retrieve a lost password. Without your password, you may never be able to access your cryptocurrency. Earlier this year, an individual reportedly lost his password — and his cryptocurrency worth $220 million.1
The increased interest in digital money is also leading to a rise in fraud. According to the FTC, consumers have reportedly lost more than $80 million to cryptocurrency investment scams since October 2020. Common scams often start as “investment tips” that lead people to fraudulent websites, a promise of guaranteed returns supposedly endorsed by a celebrity, or receiving a notification that you must pay for something using cryptocurrency. The FTC has more information about cryptocurrency scams and how to avoid them.
What are NFTs?
While cryptocurrencies like Bitcoin have been around for several years, a new, trending type of digital asset is growing in popularity — an NFT, or non-fungible token. “Non-fungible” essentially means it’s a one- of-a-kind item. While every Bitcoin has the same value at the same time, each NFT is unique and can’t be replaced or exchanged.
Emig likens an NFT to a unique collectible item. “Think of it as a one-of-a-kind digital baseball card supported by blockchain,” he explains. And, like many collectibles, Stewart says that “an NFT is only worth what someone is willing to pay for it.”
NFTs can be bought with cryptocurrency on NFT marketplaces. “NFTs are the latest craze in the digital universe,” says Stewart, who adds that while there is a lot of hype around them now, experts believe they are here to stay.
Should you buy cryptocurrency?
Cryptocurrencies may have increased in value recently, but their long-term value is very speculative. It’s important to weigh the pros and cons if you’re thinking of purchasing cryptocurrency to spend or add to your investment portfolio. “It has outperformed many other more traditional investments lately, but any cryptocurrency’s ultimate value many years from now will be determined just like stocks, bonds, gold, or really any other asset. How much can you sell it for — or what things can you buy with it?” adds Schowe.
Financial experts believe the lure of cryptocurrency is likely to continue, since many advocates believe it’s the currency of the future and here to stay. But changes may be on the horizon as the popularity of cryptocurrency grows, and as potential competition, regulation and improvements to security could impact its future.
1 “Lost Passwords Lock Millionaires Out of Their Bitcoin Fortunes,” The New York Times, posted Jan. 12, 2021, https://www.nytimes.com/2021/01/12/technology/bitcoin-passwords-wallets-fortunes.html.
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