Cryptocurrency: What you need to know
Cars. Airline tickets. Video games. Pizza. As cryptocurrency has become more mainstream, there’s almost no limit to what you can buy if you’re lucky enough to have a little cryptocurrency in your digital wallet. Of course, you can also use it to build wealth – like investing in any other asset.
But what exactly is cryptocurrency and how does it work? Why is it so popular, and how can you invest in it while being mindful of the risks? Our guide reveals what you need to know, but please remember that the ideas and information below don’t take your personal circumstances into account. Like any investment, it’s important to do your research, and always seek financial advice before you make any decisions.
What is cryptocurrency?
Cryptocurrency (also known as ‘crypto’) is a kind of ‘electronic cash system that’s fully peer-to-peer, with no trusted third party’. That’s the official definition for Bitcoin, arguably the most famous type of cryptocurrency, as stated by its pseudonymous founder Satoshi Nakamoto. (For a bit of trivia, the true identity of Bitcoin’s founder or founders is still a mystery.)
You can buy or sell cryptocurrency using legal tender – via an online ‘exchange’ platform. These transactions are secured by cryptography and generally have no or low transaction fees. You can use your digital cash to buy goods and services, trade it for other cryptocurrencies – or, hold onto it, watch the price go up and grow your wealth.
And while cryptocurrency may still seem a bit pie-in-the-sky, its rep is on the rise – according to our Choosi Digital Finance research, 1 in 10 Australians are already investing in cryptocurrency, with almost 1 in 2 expecting to be investing in cryptocurrency in the future.
Why is it so popular? Lots of reasons, including that crypto supporters think it’s the currency of the future, and getting in while the industry is in its infancy is considered a smart financial move (and cheaper too, of course). The transactions are also considered more secure.
Choosi research from the Digital Finance Trends report also shows that for 60% of investors, crypto represents a bit of fun and excitement, while 46% believe it has long-term growth possibilities.
How does cryptocurrency work?
There’s an assumption out there that cryptocurrency and blockchain are the same thing, but they’re not. Let’s dive into the tech a bit more to see how it all works.
First up: cryptocurrency is like any other form of currency, except it doesn’t use a bank for transactions. It uses blockchain technology, a specific type of database which stores information in ‘blocks’ which are then chained together in chronological order. There are different uses for blockchain and it can store different types of data, but it’s most commonly used as a digital ledger of sorts, managing and recording transactions.
There are different kinds of blockchain – for example, Bitcoin is an example of a public blockchain, which is a decentralised sort of database that enables all users to collectively retain control (rather than a central bank, as is the case with typical currency transactions). In a decentralised blockchain, the data entered is irreversible – so with Bitcoin for example, transactions are time-stamped and essentially ‘set in stone’, creating a timeline of data that can’t be altered and is viewable to anyone.
As an investor, you have a unique identifier that can’t be stolen or hacked, unlike credit cards (you may be familiar with this if you use Apple Wallet). And if you decide to buy some cryptocurrency, that transaction is recorded by everyone using the system, in a distributed digital ledger. Try changing your copy of that ledger and suddenly it won’t match all the other copies – which sets alarm bells ringing. In this way, the system prevents fraud.
Ultimately, blockchain technology’s appeal is that it’s perceived as being more trustworthy, secure and a fast and low-cost way to transfer value (or in other words, make investments). That’s not to say it can’t be hacked, but the technology makes it a more complex proposition for hackers to do so.
The different kinds of cryptocurrency
There are thousands of cryptocurrencies being traded publicly, according to CoinMarketCap.com, a cryptocurrency data and analytics provider.
The top five largest trading cryptocurrencies by market capitalisation are Bitcoin, Ethereum, Cardano, Binance Coin and Tether.
The Choosi Digital Finance Trends report
Choosi research revealed some interesting findings on cryptocurrencies.
- Most crypto users are trying to keep up with the cryptocurrencies (80%) and feel confident in their abilities to trade crypto currencies (62%). Despite this, nearly 2 in 5 (38%) admit they have little or no idea how it all works.
- The most popular reason for crypto investing is that it’s a bit of fun and excitement (60%), however many also agree that they are in it for long-term growth opportunities (46%), strong short-term returns (32%), the privacy of transactions (21%) and because they trust it more than other financial assets (16%).
- While crypto investors have a lot of enthusiasm for the asset, the general population of Australia mostly agree that it is a very risky investment (60%) and there is a lack of transparency and regulatory accountability (51%), which is significantly higher than the sentiments among those already investing in crypto (37% and 35%).
Ways to start investing in cryptocurrency
Always do your own research and gain proper financial advice, that is the first step towards any type of investing. If you’re thinking about investing in cryptocurrency but aren’t sure how to go about it, here are the basic steps to getting started and please talk to your financial advisor before taking the plunge.
- Do your research. Studies show 38% of crypto investors have little or no idea how it all works. Following Twitter accounts that report on crypto or joining a reputable FB investing group may help you to understand the market.
- Choose a cryptocurrency. A lot of investors choose one of the more popular currencies, such as Bitcoin or Ethereum. Browse ‘coin guides’ to get a sense of the most commonly-traded cryptocurrencies out there before you start exchanging.
- Find a cryptocurrency exchange. Like a broker for shares, this is a platform on which you can buy and sell cryptocurrency. You may start by purchasing cryptocurrency with AUD, then trading between different cryptocurrencies.
- Store your cryptocurrency. You might want to leave it on the exchange platform you buy it on, or in a more secure crypto wallet for safe-keeping – but check that the cryptocurrency you want to buy is supported by the crypto wallet you have.
Risks and how to protect yourself
As with any investment you make, having a trading plan and a risk management plan in place is important. Cryptocurrency is an unpredictable investment that requires research and caution – it could double in value one day, and crash the next. You should also be aware of the tax consequences when investing.
And you’ll want to know from the outset how much you’re willing to invest (and to lose) on the trade. It’s worth remembering that platforms you trade on may not be regulated by ASIC, which means you may not be protected if the platform is hacked (or if it fails).
Here are some tips for protecting yourself when investing in cryptocurrency:
- Put in the effort to learn about how trading works and the risks involved
- Learn about risk management and position sizing
- Stay alert to scammers and hackers
- Be mindful of offers to invest for very high returns
- Look out for scams involving fake support from celebrities or government agencies
- Be wary of people who contact you about cryptocurrency via social media
- Multiple bank accounts for transfers or bank account numbers that constantly change are also a red flag
Cryptocurrency isn’t just a fad, but it is still a relatively new asset – so if you’re thinking about investing, it’s important to do your research, set limits on how much you invest, and have a risk-management plan in place.
While we can’t help you with investing at Choosi, we can compare a range of insurance policies to help you find the best fit for your needs. Compare a range of policies with Choosi online.
13 Jan 2022