The world of cryptocurrencies is like the Wild West right now. A cryptocurrency is a digital currency that has no central bank. Instead, it uses a decentralized system to record transactions and manage the issuance of new units. It relies on cryptography to prevent counterfeiting and fraudulent transactions. Because there is no central bank, money cannot be printed based on governments’ needs. Security and the efficiencies of transfer are also greatly enhanced due to the reliance on cryptography. These simple facts have some people believing that the future of money might be cryptocurrencies.
Bitcoin was created in 2009 by someone or a group of people called Satoshi Nakamoto. It is considered the first cryptocurrency of significance and makes up about 35% of the entire $530 billion market of cryptocurrencies.1 It is considered the “reserve” currency or “digital gold” of the entire crypto universe because it is the most well-known and is transparent. It is also worth noting that this currency cannot be inflationary since there will only be 21,000,000 coins ever created.
The naysayers of this technology will comment on the lack of intrinsic value of Bitcoin and other cryptocurrencies. The value, however, lies in the peer-to-peer interaction without an intermediary or middle man, and the coins cannot be artificially manipulated. Arthur Levitt, the former commissioner of the SEC, recently said, “I don’t know [which digital currency will win out]. But it’s here to stay [. . . ].”2
As more people and businesses see cryptocurrencies as a useful form of payment, in the future they will become part of the mainstream. This is especially true in countries where citizens have minimal access to financial institutions for transactions but have access to mobile phones. There are already a number of businesses in the United States taking Bitcoin for payment, and Japan has more than 250,000 retailers accepting Bitcoin.3
As investments, cryptocurrencies are still in their infancy. The entire cryptocurrency universe is a little more than half the size of Apple. Most emerging technology comes with volatility, and cryptocurrencies are no different. It is not unusual to see 30%–40% rallies and downswings with these investments on a daily basis. Investors who have difficulty stomaching volatility should not get involved in this arena unless they invest in mutual funds or exchange-traded funds (ETFs) that have cryptocurrencies in them. (These are not available yet, but possibly will be later in 2018.) Investors who have a higher tolerance for this type of volatility should allocate only a very small amount of their portfolio to cryptos.
For those who want to dip their toes into this space, the starting point is what is called a crypto-fiat exchange, such as Coinbase or Gemini. This is where the investor coordinates a current bank account (fiat) with the crypto exchange. Coinbase enables the investor to convert dollars into a limited number of cryptocurrencies, such as Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. They perform their due diligence when you set up an account, but it is a fairly easy process. Proof of identity with driver’s license or passport and possibly proof of residence (utility bill) and photograph are needed. Something called two-factor authentication (2FA) with a mobile phone (e.g., Google Authenticator) is also necessary and provides additional security for the account.
Because there is no central or local bank to store one’s cryptocurrencies, there needs to be a place to send, receive, and manage one’s crypto assets. This place is called a “wallet,” and these wallets are either “hot” or “cold.” Within these wallets, there are two keys—a private and public—that are associated with every wallet. The private key must not be revealed to anyone because this is what keeps one’s cryptos secure from hackers and others who want access to the account. The public key is a series of letters and numbers that are used to transfer cryptos from peer to peer or exchange to exchange.
Hot wallets are connected to the internet, either by a desktop computer or mobile device. Storing one’s cryptos here is convenient, but not as secure. It is much more susceptible to hackers. Jaxx, Exodus, and MyEtherWallet are examples of hot wallets. On the other hand, cold wallets, such as a dedicated hardware wallet, a USB stick, or paper, are much more secure because the private key is stored offline. Therefore, one’s cryptos are safe with a cold wallet if the computer or mobile phone is lost, stolen, or hacked. An example of a dedicated hardware wallet is a Trezor or Ledger device. These can be purchased online.
The next level of investing in cryptocurrencies is on a crypto-to-crypto exchange. There are similar ID requirements to set up an account, and this process can be frustrating. There are hundreds of exchanges to choose from, and they are not as regulated as the crypto-fiat exchanges. These exchanges do not accept fiat money, so the investor’s money needs to go through the crypto-fiat exchange first. These exchanges are typically funded with Bitcoin or Ethereum. There are more than 1,000 cryptocurrencies to invest in today, and most of them are new and extremely risky. Here is where a lot of the volatility is created. Since these exchanges are online, they are more susceptible to being hacked. They are not as secure as crypto-fiat exchanges or cold wallets. Examples of crypto-crypto exchanges are Bittrex and Binance. These exchanges are not as easy to use and are more confusing than the crypto-fiat exchanges. There are also integrated wallet exchanges that combine the wallet and exchange experience into one, which is very convenient.
If one decides to start investing in cryptocurrencies, one must go in with the understanding that one should only invest that which one can lose entirely. We say, “Never invest more than you can lose in a second.” What we mean by this is not only are cryptocurrencies volatile and risky by themselves, but once the investor pushes the send button for investment or storage, that money could be gone forever if the exact public address is not copied and pasted properly. There are few to no outlets to recover funds that are sent to the wrong place. Links for “Forgot your password?” are nonexistent.
The world of cryptocurrencies is similar to the Wild West, where the cowboys and outlaws found the untapped potential of the Western frontier. The crypto investors of today are discovering the unrealized potential of digital currency. They are like the pioneers who headed west and did not know what the future would bring, but who sought for opportunity beyond their wildest dreams.
The future of money is already heading in the direction of digital currency, and cryptocurrencies look like the medium in which money may take its next form. This may create the next generation of millionaires, but investors today are similar to the prospectors of the California Gold Rush in the 1840s—some will strike gold, and others will strike out.
Disclaimer: This article is for informational purposes only and not a recommendation of Macro Wealth Management. Any financial decision should be discussed with your trusted financial advisor prior to making any investment. Past performance is no guarantee of future results. Any questions can be directed to Dr. Mart McClellan at [email protected].
References
1. Cryptocurrency Market Capitalizations. CoinMarketCap website. https://coinmarketcap.com/. Updated January 17, 2018. Accessed January 17, 2018.
2. De Silva M. Former SEC Chair Arthur Levitt: Cryptocurrency Is Here to Stay. ETHNews website. https://www.ethnews.com/former-sec-chair-arthur-levitt-cryptocurrency-is-here-to-stay. Published September 14, 2017. Accessed January 8, 2018.
3. Helms K. Bitcoin to be Accepted at 260,000 Stores in Japan by This Summer. Bitcoin website. https://news.bitcoin.com/bitcoin-accepted-260000-stores-summer/. Published April 5, 2017. Accessed January 16, 2018.
