You may have noticed cryptocurrency hitting the news headlines quite a bit over the past year or so; but if you haven’t quite grasped what it is, you’re not alone.
Still in its relative infancy, cryptocurrency remains shrouded in mystery for most of us – even those who have traded in it will often admit to having limited knowledge of how it all works.
But, as stories of profits being made off the back of cryptocurrency investments steadily filter through the grapevine, you may have found your interest piqued. So, how does it all work?
What is cryptocurrency?
Cryptocurrency is basically a digital asset that people can store or use to make payments online. However, the key attraction lays in its ultra-secure, fast and, in many cases, anonymous system design.
The technology behind it – cryptography – was actually developed during the Second World War to convert information into near indecipherable code. Cryptocurrencies themselves date back to 2009 when the first and most well known of them all, Bitcoin, was launched.
Now, there are more than 1,000 different cryptocurrencies in circulation. Those that were developed as alternatives to Bitcoin, introducing various improvements to the original cryptocurrency model, are often referred to as ‘altcoins’.
Some of the key players are Litecoin, Ethereum, Ripple, Dash and, of course, Bitcoin. Meanwhile, one of the newest entrants to the market is CashBet Coin, which is now advertised at Arsenal Football Club’s Emirates Stadium as part of the first ever cryptocurrency sponsorship deal.
“Historically, in times of financial uncertainty people have often reverted back to gold – one of the earliest forms of currency – and I think that cryptocurrencies have evolved because of this desire to have an alternative to conventional coins and notes,” says John Whitehead, Managing Director at Alan Boswell Financial Planners.
How cryptocurrency works
Cryptocurrency can be stored, traded and used to make fast payments online without the need for a bank account. In fact, this digital currency has nothing to do with banks or governments at all, which for many people is an alluring prospect – perhaps because they are having difficulty opening a traditional account; they’re seeking a quicker, cheaper, more advanced money-transfer service; or, in some cases, they want to stay under the radar.
Instead, it uses a global ‘distributed ledger’ (specifically, ‘blockchain’), which means there’s no central administrator or data storage hub. Information is encrypted, and transactions are pretty much anonymous as the currency isn’t tied to people’s names, but rather to specific ‘keys’ or ‘addresses’.
The currencies can be bought via online brokers, or in some cases, for the more technologically savvy users, they can be created through a process called ‘mining’. This requires a high-powered computer to solve complex mathematical problems in order to generate units of the currency. Samsung has just announced plans to begin manufacturing chips specifically designed for cryptocurrency mining.
Whether bought or created, these cyber-coins are then kept in a virtual ‘wallet’ ready to be used as a method of payment or, as is often the case, to be traded in the hope of making a profit. Once sold or ‘cashed out’, the proceeds can be deposited into a bank account as GBP.
Recent innovations have seen the cryptocurrency sphere steadily widen. Ripple, for example, can be used to track many more types of transactions, and is now actually being used by banks. Santander recently launched a pilot programme among its staff members, introducing blockchain technology to facilitate international payments through a new app. It’s therefore quite possible that one day stocks, bonds and other financial assets could be traded using this technology.
There’s even a growing number of pubs, restaurants, retailers and other businesses in the UK that accept cryptocurrency payments for goods and services.
Is cryptocurrency legal?
While people across the globe are struggling to understand how cryptocurrency works, they’re also grappling with its legality. As such, its status is in flux as world leaders and lawmakers try to keep up.
Here in the UK, it’s perfectly legal to own and use cryptocurrency, but, as in every other country, it does tend to attract illicit activity. This is primarily because of the anonymity it affords users, thus making it a hotbed for black-market trading, money-laundering and drug deals. As an internet-based system, it’s also a target for hackers and scammers.
“Another problem with cryptocurrency is that there’s no regulation,” adds John, “so even if it’s safe in terms of what it’s trying to achieve, you’re likely to get bad money chasing it and people being led astray by poor advice, unscrupulous dealings and bribery.”
Indeed, calls for regulation of the market have been gaining strength, and experts are now predicting an imminent crackdown. Similarly, global tax authorities have begun to monitor the situation, and in some cases clamp down on cryptocurrency investors. In the UK, capital gains tax or even income tax could potentially apply to profit-makers, depending on their individual circumstances.
How to trade cryptocurrency
Cryptocurrency isn’t like other investments. For a start, this market is active 24/7 – you don’t have to wait for the stocks to open in the morning to be able to trade. Therefore, you could go to bed at 11pm and wake up eight hours later to a significant profit or loss, because people in other time zones have been busy trading while you’ve been asleep.
And that’s the other key difference. It’s a market that’s directly open to anyone with internet access – which, as it currently stands, is just over half of the global population. “You don’t even need to invest a huge amount of money in it – it can be as little as £200 or so,” adds John.
You don’t even need to invest a huge amount of money in it – it can be as little as £200 or so
There are various ways to trade in cryptocurrency, either as long- or short-term investments, and the first step is to choose a trading platform. Many exist – such as Etoro, Coinbase and Binance to name but a few – and each one will offer different capabilities, charges, features and cryptocurrencies. Having signed up for an account, users can begin buying their digital assets using a credit or debit card, and then storing, using and/or selling it.
“If you’re prepared to dig around there’s lots of information out there about each cryptocurrency and what it’s trying to achieve – but I wonder how many people are actually doing that?” questions John.
“The main risk seems to be the volatility,” he continues. “Most mainstream shares tend to go up or down in value by 1-3% a day – they don’t change dramatically unless something major happens like a takeover bid. But the value of cryptocurrencies can go up or down by 50% in the space of hours, let alone days.
“Just before Christmas 2017, for example, Bitcoin was valued at more than $19,000, but by the end of January 2018 that figure had nearly halved. So anyone who bought in mid-December and didn’t sell up before the crash would have made a massive loss. You can often apply a stop-gain or stop-loss, however, so when the currencies reach a certain value they trade out automatically.”
Is it a bubble?
“History has seen several economic bubbles. The earliest recorded incident occurred in the early 1600, when tulips became a prized asset. The value rocketed up, but then collapsed catastrophically,” says John. “Invariably some of the assets, companies and concepts that have emerged completely failed and fell by the wayside – but others, such as Amazon and Facebook, have ended up being hugely successful, and the people who took a chance on them have made a lot of money. This feels a little like one of those bubbles, and so we can surmise how that might end up: there’ll be winners and there’ll be losers.
“If Ripple, for instance, becomes a big, recognised payment system that everyone is using, then in 10 years’ time it could be a household name – and hugely valuable. I mean, 10 years ago who’d have thought that the scale of online shopping and speed of deliveries we have now would even be possible? These things are so difficult to predict.”
These things are so difficult to predict
Although John and his company are by no means experts in this field – nor in a position to advise potential investors in cryptocurrency – he does suggest that research and caution are key.
“Try to understand cryptocurrency as much as you can before entering the market,” he says. “In terms of your ability to make money, I’d treat it more like placing a bet at the moment, because it’s just so volatile and uncertain that you might win or you might lose.
“Ultimately, though, it’s best not to invest in anything if you don’t understand it. And never forget the old saying: ‘a profit is never a profit until it’s in your back pocket’!”