Cryptocurrencies made big news in December when the leading cryptocurrency, bitcoin, lost about a third of its value in a day. The tumble raised questions about cryptocurrencies in general — are they good investments? Can they really take the place of mainstream currencies? What does the future hold?
Understanding cryptocurrencies is key to getting the most out of them. They are are a nontangible form of currency that exists exclusively in a digital database called a blockchain, says Fred Schebesta, CEO and co-founder of Finder.com, a financial comparison website. They let users transfer real-life assets such as cars, money and property instantly and without the involvement of third parties. They represent an opportunity for financial professionals, but like any investment they need to be carefully researched before you jump in.
“Approach all tokens with a sense of discovery and skepticism,” says Joseph Bradley, director of investor relations at Apex Token Fund, a crypto hedge fund firm. “Let the project win you and your models over organically. Don’t believe the hype.”
Here’s what you need to know.
Their Security Is an Asset
Cryptocurrencies work through exchanges made on a blockchain, which is a system that ensures trust, Schebesta says. A blockchain network enables an irrefutable and intensely secure data record, he says, and can be used to create smart contracts, to verify any data or file, or to give people access to computing power.
Bitcoin is the most well-known example so far. Bitcoin was the first blockchain-based application that scaled, Bradley says. “A bitcoin represents a unit of, arguably, one of the most resilient and persistent networks ever conceived. This network is almost impossible to hack and virtually impossible to take down,” he says. “When you hear of hacks associated with bitcoin those occur at the exchange or wallet level, not at the protocol level.”
Decentralization Makes Transactions More Secure and Fluid
There is no “central bank” of cryptocurrencies, so they’re seen as a currency vehicle that’s easy to share and use. “In essence, cryptocurrencies cut out the middleman,” Schebesta says. “All cryptocurrencies are purely digital, with no physical notes, and so are separate from banks and governments.”
This frees them from financial markets that determine the value of physical currencies, Schebesta says. “The decentralization will change the level of influence banks and other financial institutions have, changing the way we transact forever,” he says. ”Most countries have been resistant to adopting, as they’d essential lose control of their currency. But with more businesses and individuals demanding the ability to transact via the blockchain, I predict this will change very soon.”
See It as Expansion, not Disruption
Because cryptocurrencies give people a different way to exchange goods and pay for services, investors tend to see them as a disruption to financial markets. But it’s important to see them as something that runs “parallel” to traditional financial markets, Bradley says, rather than something that will fundamentally change financial markets themselves.
“The truth is this technology provides another perspective on existing data and systems,” Bradley says. “It adds a detailed layer on top of processes and data.” In that sense they’re similar to derivatives, he says, which are nothing without an underlying asset. The difference is that derivatives trade on their own markets, while digital assets represent processes on distributed networks, he says. “People need to understand that this technology is nascent but represents a set of processes and applications that will touch virtually every aspect of our lives.”