By now, you must have heard, or you know a thing or two about the cryptocurrency called Bitcoin.
But then, what is a cryptocurrency, or simply, ‘crypto’?
Crypto is any decentralized, digital currency based on cryptography. Those three terms are crucial to understanding the thousands of types of crypto traded today.
Decentralized means that cryptocurrency is not regulated by a central authority like a government or a central bank the way the shilling, dollar, euro, yen, and other fiat currencies are. Fiat currencies are government-issued currencies that are not backed by a physical commodity, such as gold or silver, but rather by the government that issued them. Instead, a peer-to-peer network creates, exchanges, and oversees cryptocurrencies.
Crypto is digital, meaning two things. First, with a couple of exceptions, the value of most crypto is not pegged to a fiat currency, nor is it determined by a precious metal like gold. In as much as many people may refer to crypto in physical terms (e.g., as coins), crypto is generated and traded only in a digital format.
On the other hand, Cryptography refers to the mathematical technique used to secure each cryptocurrency unit and ensure it is not copied. It simply means nobody can intercept the code in between. (Remember that WhatsApp message; “Your chat is now end-to-end encrypted”)
Bitcoin, the first crypto, introduced the world to blockchain or distributed ledger technology. As a crypto asset, it is the center of the universe. But bitcoin is hardly alone. An entire galaxy of crypto assets has been created, including Litecoin, Ripple, and Ethereum. Since they are alternatives to Bitcoin, they are commonly known as Altcoins (Alternative Coins)
Blockchain, the technology on which the cryptos are transacted, is slowly spreading into (and potentially shaking up) other pursuits, such as real estate, music, and gaming. Blockchain is the digital ledger that records most crypto transactions. This platform as a foundational element for cryptocurrency began in 2009, in tandem with the launch of Bitcoin.
Blockchain records are theoretically unchangeable because the system is built from data blocks chained together in chronological order (hence the name blockchain). This makes all transactions visible to everyone on the network. The distributed, self-governing nature of blockchain thus makes fraud and duplication far more complicated than legacy record-keeping systems.
As of December 2021, the total market capitalization of cryptos was over $2 trillion.
How do cryptos work?
Crypto is transacted and secured by a peer-to-peer network. Users can trade or transfer value — globally and almost instantly — without relying on any third party to enable the financial transfers. The system itself is self-governing.
Cryptos are kept in digital wallets, commonly, blockchain wallets, allowing users to manage and trade different crypto. Some include Coinbase, ZenGo, Exodus, BitGo, Trust, and Metamask. As of December 2021, the total market capitalization of cryptos was over $2 trillion. Bitcoin has the largest market capitalization, followed by Ethereum, Binance Coin, Tether, and Solana.
Why have cryptos become so popular?
Investors are intrigued by the potential of cryptos to grow in value and the potential transformation of the financial system that crypto might bring.
When Bitcoin first launched in January 2009, few imagined a single Bitcoin would be worth over $66,000 (as of December 15, 2021) — or that a single digital currency would spur the creation of thousands more. But it has. In just 13 short years, cryptocurrency has gone from being viewed as a financial fad to becoming a new market sector worth trillions.
Ways to invest in cryptos
As with any form of investing, one can also invest in crypto. But the specifics of the crypto market — being wholly digital, decentralized, and dependent on blockchain technology — means that investing in this realm can look quite different from trading stocks or bonds. However, even crypto is inching into more traditional financial markets.
- Trading Crypto
Perhaps the easiest way to invest in a crypto is by trading, much as you would trade traditional securities like stocks or bonds. You can open an account on a crypto exchange, fund the account by connecting your bank or using a wire transfer of cash (MPESA, Skrill, Paypal, Payoneer, etc.), and begin buying and selling the crypto of your choice. You can start trading crypto with as little as $5, and you’re able to trade 24/7. All you need is a crypto wallet and some money, to begin with.
- Crypto Staking
An alternative to the proof-of-work model is proof-of-stake (PoS). This is also a consensus mechanism, but it employs a process considered more passive and therefore more energy-efficient than Proof-of-Work(PoW). Staking crypto involves purchasing crypto and waiting to be selected as a validator on the network. Like miners in a PoW system, Validators validate blocks on the blockchain and are rewarded with more coins. Thus far, fewer projects have used PoS, and there is some debate about whether PoW or PoS is more efficient or more secure.
- Bitcoin Exchange Traded Funds
After a prolonged regulatory battle, exchange-traded funds (ETFs) based on bitcoin futures have been allowed, opening the door to a wave of new investment opportunities. As of November 2021, these ETFs only invest in bitcoin futures, not actual bitcoin assets. Investors can also consider certain funds that are investing in blockchain-based technologies.
- Crypto-Based Stocks
As cryptos grow, so do the companies that provide hardware and other backend services. Investors can consider investing in companies that do large-scale cryptocurrency exchanges or companies that use crypto as part of their business or payments model. Like the emerging crypto-based ETFs, crypto stocks are likely to provide investors with an increasing number of opportunities as this space expands.
Why Do Cryptos Have a Volatile Value?
There are a few reasons why the price fluctuates.
Liquidity
Liquidity is a concept in financial markets that relates to how much an asset’s purchase or sale will move its overall price. Liquidity, in general, supports overall asset values. If you have a price of KES 5000 but when you need to sell it, there’s no one to buy it, the KES 5000 it’s worth is not worth that much. Low liquidity may be rendering the price of Cryptos unstable.
By shrinking the number of cryptos in circulation beyond the limits built into the system, liquidity for cryptos can dry up. This means that movements to buy or sell could quickly influence the price, driving it up or down violently.
Speculation
One of the biggest debates regarding cryptos is what exactly it’s for—and why people buy it. For individuals who live in countries with unstable or despotic governments, Bitcoin can be a lifeline of stable value and resistance to seizure. Still, it is not a convenient payment mechanism for many people compared to the fiat currency of existing banking systems.
Some people think the price will go up because of crypto’s special protection against inflation due to its 21 million coin cap. Some expect wider adoption of it as a payment protocol. And some expect it to become a widely used store of value for institutions that generate large amounts of cash.
Essentially, interest in crypto is generated by the idea that other people will buy at a higher price in the future than it’s selling for today. Speculation like this often leads to volatility because the price can turn down as sharply as it turns up.
Cryptos volatility can be tied to its low potential liquidity and its highly speculative nature. As a result, investors and anyone who follows the news are aware of incredible highs and lows in the value of this well-known crypto.
Common Altcoins
Many altcoins are hitting the market every day. However, the following are common:
- Ripple: It was designed for use by businesses and organizations rather than individuals, as it is often used to move large amounts of money worldwide.
- Ethereum: Ethereum is a programmable internet platform used to build decentralized programs and applications, and its native currency, Ether (ETH), is the altcoin in question that investors can trade.
- Litecoin: Litecoin is one of the largest and most popular cryptocurrencies on the market and operates similarly to Bitcoin.
- Dogecoin: There are a bunch of “joke” altcoins on the market, and Dogecoin is perhaps the most recognizable right now. Dogecoin started as a joke (its genesis is an internet meme), although it has gained value in recent months.
- Cardano: Cardano allows developers to write smart contracts and decentralized applications (dApps) to use the Cardano blockchain. Cardano is also used as a medium of exchange.
Some checks before you buy a crypto
If you’re looking to buy crypto, look out for the following information:
- Who owns the company?
2. An identifiable company, business, or well-known owner is a positive indicator.
3. Are there other significant investors who are investing in it?
4. It is a good sign if other well-known investors want a piece of the currency.
5. Will you own a stake in the company or just currency or tokens?
This distinction is essential. Owning a stake means you get to participate in its earnings (you’re an owner), while buying tokens means you’re entitled to use them, like money in your wallet.
It can take a lot of work to comb through a crypto prospectus. However, the more detail it has, the better it is legitimate.
But even legitimacy doesn’t mean the currency will succeed. That is an entirely separate question, requiring a lot of market savviness.