I’ve held off writing about cryptocurrency because I was never sure what to make of it. I’m still not sure what to make of it.
After watching it the past few years, I’ve yet to “invest” in it. I still can’t make sense of the long-term use of it.
With that said, here’s my attempt to gather my thoughts and put them out into the world.
What is Cryptocurrency?
First, let’s define cryptocurrency. Cryptocurrency is a digital asset that can be used as a form of exchange. Unlike the dollar or other forms of currency, it’s not backed by anything, such as a government. It’s purposefully decentralized.
How did Cryptocurrency Start?
Bitcoin is thought to be the first cryptocurrency. A programmer or group of programmers, known as Satoshi Nakamoto, created Bitcoin in 2009. Unlike other record systems, Bitcoin is based on blockchain technology. Instead of the bank saying you have $100 in your account, an entire network of computers verifies transactions to say you have $100 in your account. The power of who owns what is no longer with large institutions, but with everyone who participates.
Instead of governments controlling the currency, cryptocurrencies are validated by a system of computers timestamping transactions. For many cryptocurrencies, only a finite amount is created. Most cryptocurrencies gradually decrease the amount produced. Many people argue it will have more value over time because more of it can’t be printed like the US dollar.
To earn Bitcoin, computers solve complex equations to “mine” Bitcoin. Once a Bitcoin is mined, it is recorded on the blockchain, which you can think of as a ledger representing proof of who owns it.
From there, other cryptocurrencies were created. Many of the other cryptocurrencies were created to improve on the original design of Bitcoin. For instance, some aimed to process transactions faster.
Cryptocurrency was and probably still is very popular for criminals. Because a bank is not verifying transactions and it’s a decentralized network of computers verifying transactions, cryptocurrencies offer a great deal of anonymity. Imagine the difficulty of sending money for an illicit transaction using cash or by wiring money and then all of the sudden, it is easy to transfer funds anonymously to another source. You can see why criminals would adopt cryptocurrency. It essentially provides untraceable funds.
How Many Cryptocurrencies Exist?
It’s unknown how many cryptocurrencies exist. Some people report there are over 10,000 cryptocurrencies. It’s difficult to measure because anybody can create a cryptocurrency. People even create joke cryptocurrencies. Many end up worthless, but sometimes, they can go on quite the run.
The latest example is Dogecoin, which was created many years ago as a joke, but soared in value earlier this year. As of early July, Dogecoin was worth about $28 billion. It’s fascinating that the creators of this cryptocurrency started it as a joke, acknowledge it as a joke, but skyrocketed in value and created real wealth for people. Look at the chart below to see the astronomic rise.
The top cryptocurrencies gather most of the market share. Depending on the day, around 100 cryptocurrencies may have a value worth more than $100 million. On the other hand, the thousands of other cryptocurrencies have values worth less than $10 million.
Depending on the day, the most valued cryptocurrencies might be Bitcoin, Ethereum, Tether, Binance Coin, Cardano, XRP, Dogecoin, and USD Coin. As of early July, each of these was worth more than $26 billion, with Bitcoin worth more than $636 billion.
Cryptocurrency Regulation
As cryptocurrencies have risen in popularity, the regulation has increased – not only in the United States, but other countries. The IRS now asks all taxpayers when filing taxes if they received, sent, sold, or otherwise acquired any financial interest in any virtual currency. For years, many people failed to report cryptocurrency transactions, and the IRS was missing out on a huge source of tax revenue. The IRS even has a FAQ on cryptocurrency transactions.
While China has not banned holding cryptocurrency, it has banned miners, crypto exchanges, and barred financial institutions from helping people transact in cryptocurrency.
To combat the use of cryptocurrency, China has created its own digital currency. Other governments have also explored creating their own.
I think we will continue to see increased regulation of cryptocurrency. Governments tend to not like transactions falling outside of their purvey. Anonymous transactions are great ways to get around money laundering rules and also skimp on tax payments. Governments usually try to stop it.
On the other side of things, El Salvador adopted Bitcoin as legal tender.
It will be interesting to watch what stance each country takes on cryptocurrency in the future.
Cryptocurrency Impact on the Environment
One of the biggest criticisms of cryptocurrency, and particularly Bitcoin, is the impact on the environment. Early this year, it was estimated that Bitcoin consumed 0.55% of the global electricity production. It’s the equivalent of using all the energy consumed by a country like Sweden or Malaysia.
The impact on the environment depends on how the energy is created that is used, much like whether an electric car is actually helpful to the environment depends on if the electricity you use to charge it comes from a renewable source, such as solar, or a finite resource like coal. If miners use hydropower, a cleaner source of energy, the impact is less than if the miners use coal to power their mining operation.
Most of the energy consumption is due to the mining of Bitcoins. As the finite supply of Bitcoins is mined, energy consumption should decrease. Also, if fewer computers compete to solve transactions, less energy is used. The issue right now is that as Bitcoin’s price has gone up, more computer systems have been created, which consume even more power.
You can watch a specific story in the US about a mining operation that took over a retired power plant.
There are initiatives in some places to change the energy source, such as relying more on hydropower or changing cryptocurrencies to work by different systems. For example, some people are trying to create a proof-of-stake (PoS) mining model instead of a proof-of-work (PoW) model.
Proof of stake requires people to become validators and put a certain amount of cryptocurrency at stake to validate transactions. What they put at stake should minimize fraud and encourage them to validate fairly. Validators are chosen at random to validate transactions. This is different from proof of work where anybody and everybody is competing to solve complex problems and validate transactions.
Since only a handful of people are validating transactions instead of anybody in the world, less energy is consumed.
It’s an interesting system and yet to be fully tested. Personally, it’s nice to see the Ethereum community working on a system that consumes less energy.
Cryptocurrency Uses
Right now, the biggest use of cryptocurrency I see is speculation. Cryptocurrencies have gone through booms and busts. It seems to have taken on a similar profile to gold, where it can go through cycles where it has strong performance, and other cycles where it does very poorly. Plus, any time an asset class creates millionaires and billionaires, as cryptocurrency has done, it attracts attention and foolish behavior. There are plenty of people who have lost a ton of money in cryptocurrency, but we tend to only hear from those who were successful.
Although cryptocurrency has currency in the name, it should not be thought of as a currency because it’s not stable. The reason the US dollar works well, or most currencies for that matter, is because they don’t fluctuate wildly in value on a day-to-day basis. If they did, the economy would likely not be on a stable footing.
For example, imagine if you went to the grocery store one day and a loaf of bread cost $3 and then the next day it cost $1 or $5. Now, imagine that happens for every item in your daily life. Want to buy a car? One day it is $30,000 and the next it is $40,000. It makes it tough to plan and if the fluctuations were high enough, it would mean the difference between being able to buy basic necessities and not.
Another important use is transferring money. For example, people regularly send money abroad to family or friends, which can be a costly endeavor. Usually, there are exchange fees, wire fees, and other intermediary fees. What this means for many people is that less money ends up in the hands of family and friends. Some cryptocurrencies have low transaction fees that make sending money cheaper.
One of the areas I am most interested in watching develop is how cryptocurrency serves those who are unbanked or underbanked. There is still a good portion of the US that does not have a bank account. In fact, about 14 million American adults are unbanked. Statistically, the unbanked tend to be people of color and people with lower levels of income. The unbanked often face predatory lending, high fees, and high-interest rates. People have suggested cryptocurrency could create better access to the financial system, which would be a great change.
It’s estimated that the average financially underserved household has an annual income of about $25,500 and spends about 10% of their income, or $2,412, on interest and fees. Can you imagine spending 10% of your income on interest and fees? If that can be reduced, that would be a net positive, not only for those individuals, but also for society.
Cryptocurrency as an Investment
As I mentioned above, I don’t see cryptocurrency as an investment. Although there is not widespread adoption of cryptocurrency among individuals or big institutions at this point, it has started to gain traction with institutions. There may be enough momentum and interest behind cryptocurrency to establish it as an investment in the future. At the end of the day, if enough people believe something is worth something, it will be worth it.
For example, most people don’t value the most prized pieces of art as being worth tens of millions of dollars, but if enough people are willing to pay it, they will have a value in the tens of millions of dollars.
Unlike a stock, which rises in value based on future earnings or dividends, or a bond, which provides return in the form of coupon payments or changes in value based on interest rates, cryptocurrency rises in value based on what the next person is willing to pay for it.
In that way, it’s like art, wine, classic cars, watches, or musical instruments. It’s not backed by anything specific, it doesn’t produce anything, but it does have value based on what people are willing to pay for it.
I may change my mind and see it differently in the future, but that’s how I see it today. Cryptocurrency doesn’t produce anything and the value is not backed by anything, but if enough people believe it and put money into it, it could become a stronger asset class.
To this day, I’ve yet to invest in cryptocurrency, though I did open an account one day and almost funded it to buy a cryptocurrency. Then, I remembered it does not need to be a part of my financial plan. I can reach financial independence and have a solid financial life without it. Who knows what the future holds? I may decide to put money into it in the future. I’ve watched it closely over the years and of course, wished I had put money into it prior to the explosion in popularity, but hindsight is 20/20.
Plus, there is still the issue of storage. In an ideal world, I could own it in a brokerage account, but right now, the options are usually limited to cold storage where I need to track the password to my own private wallet not connected to the internet or a crypto exchange, such as Coinbase.
Crypto exchanges have been hacked before. People have lost passwords to their wallets.
Unfortunately, holding cryptocurrency requires either a sacrifice of security for simplicity or a sacrifice of simplicity for security.
Summary – Final Thoughts
It feels odd to write my final thoughts because when it comes to cryptocurrency, it feels anything but final. As I’ve watched it over the years, I’ve learned more and more – and will continue to learn more.
I’m amazed that cryptocurrencies have risen in value as much as they have. It’s tough for me to get away from the idea that it’s not backed by anything and does not produce anything, even if there are other asset classes, such as art, that have similar properties.
I hope that over time, better solutions are created to reduce energy consumption. To me, it’s problematic that Bitcoin uses the same amount of energy as entire countries.
Maybe one day I will own cryptocurrency, but for now, I’m happy with my boring, plain, and simple investments. I’ll continue watching from the sidelines, keen to see what happens with regulation, though I hope it opens access to people who have been neglected and taken advantage of by the financial system.