Cryptocurrency basics

Cryptocurrency basics

Have you heard of Bitcoin? Probably, you’ve at least seen new headlines about the soaring price of this cryptocurrency. Don’t feel left out because you aren’t already on the crypto bandwagon. More than half of Americans who own cryptocurrencies have purchased them in the past year, according to a survey by The Motley Fool. And about 10 percent of those who own cryptocurrencies admit they don’t really understand how they work.

So perhaps it’s time for a few crypto basics — just enough information so you can nod wisely next time the topic arises. Here are some very simplified basics:

To understand cryptocurrencies, you need to understand some basics of the math behind them. That’s where the words “blockchain ledger” come in. Think of it as the place behind the scenes where all transactions are securely recorded — without any intermediaries and anonymously — in a ledger that every participant can see but no one can change unless through an authorized transaction recorded on the chain.

Here’s how I mentally think of it. When you buy a house, you always get title insurance to make sure no one else can file a claim to the property. That’s why we have title insurance companies and pay a fee to them. But if all “titles” were recorded on the blockchain, there would be no need for this insurance, or the title insurance companies.

Cryptocurrencies use blockchain technology as the basis for completely secure transactions. The most popular cryptocurrencies are Bitcoin, Etherium and Dogecoin. But there are literally thousands of cryptocurrencies — and many of those are started by scammers. So Lesson 1 is if you’re going to buy a cryptocurrency, stick with the best known.

How do you purchase cryptocurrencies? Today, that happens through a digital crypto exchange, where you transfer money in dollars from your bank to be securely exchanged for your cryptocurrency. Your crypto account resides in a “wallet” at the exchange.

You’ve likely heard of Coinbase, the largest of these exchanges, which recently went public. Another is Kraken, probably the oldest global crypto exchange. You can visit their websites or use their apps to get started. Or you can purchase crypto with your account at Robinhood. Other well-known names in financial services are also about to offer cryptocurrencies. The key lesson here is to stick with a recognized crypto exchange so you’re not sending money into a black hole.

You can also buy futures on cryptocurrencies, which are traded on the Chicago Mercantile Exchange, or buy shares of crypto-mining companies, or crypto-related stocks through several exchange-traded funds. You can even buy shares of Coinbase, the publicly traded crypto exchange itself.

The “Value” of Crypto

So is a cryptocurrency a wild speculation, without any intrinsic value? Dollars are no longer backed by gold but instead by the “full faith and credit” of the United States. And that’s part of the speculative interest in cryptocurrencies — as an alternative to the current system of dollar-based transactions.

Unlike paper dollars which are being “printed” by the billions every month by the US government, there is a limited and fixed supply of Bitcoin that can ever be created — 21 million Bitcoin. That limited supply has led many to call it “digital gold.”

But cryptocurrencies could also just be the latest wave of efficient financial technology. Kraken executive Jeremy Welch says: “This is just an upgrade in how we deal with money and financial technology.” He compares it to being able to take a picture of a check on your phone and deposit it electronically without going to your bank. And he notes that the Fed and Treasury are currently working on a digital dollar.

Privacy is another oft-cited benefit of cryptocurrencies. That’s why China recently banned Bitcoin and has created its own national cryptocurrency. Now it can track everyone and every purchase!

If you’re interested in crypto, Kraken’s Welch also has some advice: “I just generally encourage people to explore carefully. There’s no need to put an entire paycheck into cryptocurrency. I think just $5 or $10 into Bitcoin or another cryptocurrency will give you the exposure and teach you a lot.”

So don’t bet your entire financial future on a cryptocurrency. If you consider it “entertainment” with a possible upside — and are willing to risk a large loss — you have the right perspective. And that’s The Savage Truth.