It’s hard to scan the financial headlines these days and not spot at least one call to action related to Bitcoin’s latest moves. Has all the attention given you cryptocurrency fever, or are you at least wondering what is cryptocurrency all about? Before you start loading up on bitcoin or any other form of cryptocurrency, let’s take a closer look at what you may be getting yourself into, in three parts, starting with the first today:
- Understanding cryptocurrency
- Spending cryptocurrency
- Trading in cryptocurrency
What is Cryptocurrency?
Our quick take? Cryptocurrency is an interesting development with a number of promising possibilities. Human ingenuity is always a marvel to behold. But like any relatively new, highly volatile pursuit, it entails considerable risk.
If you’d like to try earning and spending cryptocurrency, be sure you’re familiar with the nature of the beast. If you’re thinking of trading in it for fun or profit, we advise against putting in any more than you could afford to lose entirely. In our estimation, cryptocurrency remains more of a speculative venture than a disciplined investment.
With that, let’s proceed!
Beginning with What is Bitcoin?
Cryptocurrency was introduced in 2009 by a pseudonymous Satoshi Nakamoto. Nakamoto described a new kind of money, or currency, which was meant to exist in a secure, stable, and limited supply strengthened by electronic security, or encryption. Pair “encryption” with “currency,” and you’ve got cryptocurrency.
Bitcoin became the first cryptocurrency, and is still the most familiar kind. According to CoinMarketCap, Bitcoin had a market cap of nearly $600 billion as of January 22, 2021, with its closest competitor Ethereum at $140 billion. Market caps drop considerably after that, but there are plenty of others. As of September 30, 2020, a CFA Institute Cryptoassets Guide reported: “More than 6,000 different cryptoassets exist, and many new ones are created each month.”
Unlike a dollar bill, cryptocurrency only exists as computer code. You can’t touch it or feel it. You can’t flip it, heads or tails. But increasingly, holders are spending cryptocurrency in ways that emulate “regular” money (although limitations remain) – and potentially even adding to its uses. There’s also growing interest in trying to build or at least preserve wealth by trading in cryptocurrency, which some describe as being like “digital gold.”
Cryptocurrency vs. “Regular” Money
In comparing cryptocurrency to regulated fiat currency – or most countries’ legal tender – there are at least two components to consider: limiting supply and maintaining spending power.
- Limiting Supply: Obviously, if a currency “grew on trees” it would cease to have any value to anyone. That’s why central banks like the U.S. Federal Reserve, Bank of Canada, and Bank of England are tasked with limiting their currency’s supply, without strangling its demand. For Bitcoin, supply is limited to a maximum of 21 million coins. While cryptocurrency proponents offer explanations for how supply and demand will be managed, some systems will undoubtedly be more effective than others at sustaining this delicate balance, especially when exuberance- or panic-driven runs might outpace reason.
- Maintaining Spending Power: Neither fiat currency nor cryptocurrency are still directly connected to the value of an underlying commodity like gold or silver. Thus, both must have another way to maintain their value, or spending power, in the face of inflation. In most countries, the nation’s central bank is in charge of keeping its fiat currency’s spending power relatively stable; only the government can add or subtract from its supply of legal tender. For cryptocurrency, there is no central bank, or any other centralized repository or regulator. Stability is instead backed by its underlying blockchain.
What’s a Blockchain?
Using bitcoin to illustrate, a block is essentially a bitcoin transaction waiting to be settled. Think of it as being like a written, but uncashed check; it’s not real money until the transaction is verified and added to a permanent ledger.
Except there is no bank to complete the transaction. Instead, bitcoin “miners” compete against one another for the role. Each block is secured with a complex mathematical equation. The first miner to solve the equation gets to add the new block to a blockchain. The winning miner is then rewarded handsomely for their effort. They are paid with bitcoin, which can currently be valued at tens of thousands of dollars for settling a single block.
Cogent’s Take on Investing in Cryptocurrency
Blockchain and digital assets are new asset classes with the potential to transform commerce on a global scale. Our responsibility is to our clients as a Registered Investment Advisor in adopting new asset classes and investment solutions. Cogent and Buckingham Strategic Partners are investigating crypto digital assets products, solutions and custodians as we speak. There are many concerns which need to be addressed for us to feel comfortable in making a recommendation. The U.S. Security and Exchange Commission also is looking at this currently, letting special purpose broker-dealers to custody digital assets, under certain conditions, and is requesting comments on the “evolving standards and best practices” with respect to custody of digital asset securities.
We are looking forward to the day when our industry can provide a solution which affords a high level of safety, security and confidence in the marketplace, helping to reduce the risk of scam, fraud and abuse for our clients. Till then, we are not recommending digital assets in our clients portfolios.
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 You may notice, we sometimes capitalize Bitcoin as a proper noun, and we sometimes leave it as lower case. General practice is to capitalize the entity, “Bitcoin,” but to use lower case for the coins themselves. Think of it like the difference between “the U.S. Dollar,” vs. “a dollar bill.”
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© 2021,Wendy J. Cook