The virtual world of cryptocurrency still mystifies millions of people, even though Bitcoin, widely regarded by investors around the globe as the original, was introduced more than a decade ago in 2009.
Despite its high profile, especially on social media platforms and online forums, many people are still confused by the fact that cryptocurrency, or crypto, isn’t connected to anything tangible in the real world. Unlike the pounds and pence of the UK’s monetary system, the units of crypto are simply computer-generated files.
However, even though it’s not legal tender in the UK, it is a form of currency and was created to be a new kind of money that could one day be as commonly used as cash or credit.
Although it was the first, and is still hugely popular, crypto goes beyond Bitcoin and depending on whether you include failed ones or not, there are around 5,000 to 7,000 cryptocurrencies in existence right now, according to research by Nerdwallet.com.
However, Bitcoin is the largest cryptocurrency, with a market cap of around $600billion (£507.5billion), followed by Ethereum.
Other popular cryptocurrencies include XRP, Tether, Dogecoin and Litecoin with the top five cryptocurrencies currently accounting for more than 80 per cent of the market.
As more people explore different ways to invest their money away from traditional financial channels such as savings accounts, stocks or ISAs, many may be considering cryptocurrency.
To help more people understand the ever-evolving world of virtual currency, below is our beginner’s guide to understanding cryptocurrency.
What is cryptocurrency and how does it work?
Cryptoassets or cryptocurrencies are “cryptographically secured digital representations of value or contractual rights that can be transferred, stored and traded electronically”, according to HM Revenue and Customs (HMRC) definition.
This means a cryptocurrency is a digital asset that can be traded and used to pay for things, however, this is where it can get a bit tricky as it’s not based on any actual asset, so there’s no intrinsic value – the value is determined by supply and demand, which means it’s only worth what a buyer is willing to pay.
This makes cryptocurrencies speculative, unpredictable and hard to accurately value.
How do cryptocurrency transactions work?
What’s different about cryptocurrencies is that they are not overseen or controlled centrally, and they operate on an open network – transactions are conducted peer-to-peer rather than being run by a bank or other financial authority.
They use ‘distributed ledger technology’, the best-known type is blockchain, to keep a public record of all transactions. It’s a way of synchronising and sharing data globally through a decentralised database, and is meant to prevent double-spending of cryptocurrencies.
Cryptocurrencies are legal, but they’re not legal tender and in the UK, you may have to pay tax on them because they are not eligible to be held in tax-free accounts such as ISAs.
How to buy, spend and trade cryptocurrencies
To buy cryptocurrency, you need to buy and sell via an exchange.
This means you need to create an exchange account and store the cryptocurrency in your digital ‘wallet’.
If you simply want to trade cryptocurrency you just need a brokerage account, rather than accessing the underlying exchange directly. The broker will be exposed to the underlying market on your behalf – this is usually quicker and easier to set up.
There are loads of startups offering ways to trade cryptocurrency, but you might be sceptical about trusting your money to a brand new name, especially if you’re new to the cryptocurrency market.
How to choose a cryptocurrency
The first thing to recognise is that it’s not a decision to be made lightly without doing your own research and seeking expert financial advice.
The main reason being that there are simply too many crypto options to choose from.
There are stacks of information readily available about each crypto, so start by reading some guides and user reviews. Usually, there will be a white paper for each cryptocurrency when it launches, explaining what it is aiming to do.
Key things to research and remember:
- Look at the strength of the user community
- Research the quality of the tech and team behind the cryptoasset
- Check out the cryptocurrency’s price performance to date
- Check whether it has longevity – what will drive future price movements?
If in doubt, delay investing and do more research.
Crypto research tools
The experts at the Coin Bureau have compiled a list of their top crypto tools which could help you make the right investment decision because “when investing in something it’s best the decision comes from you, made on the basis of information you’ve found while doing your research”.
They explained how relying solely on a third-party opinion is “risky” as some of the information might be outdated and there may have been new developments that ”impact the quality of the investment significantly”.
Three tools to check out
For the full list of research tool recommendations by the Coin Bureau, visit the website here.
- CryptoQuant – offers data on Bitcoin, Ethereum, Stablecoins, and generally on most Altcoins (any type of cryptocurrency other than Bitcoin). This data consists of market data, on-chain data, and exchange flows
- Coin Dance – one for people interested in Bitcoin as the website has loads of useful statistics on volume, nodes, politics, and adoption (the process of something becoming more widely used and well known)
- Glassnode – offers a variety of different metrics and they support many cryptos including big names including Bitcoin, Ethereum, and Litecoin
Just remember, the more research you do and the more tools you use, the more informed you will be to make the right investment decisions – so don’t just rely on one, two or even 10 research tools, take the time to gather as much information as possible.
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What are the risks of investing in cryptocurrency?
Crypto scams are widespread and the currencies themselves are volatile, but that doesn’t seem to be putting off consumers, and cryptoassets are gaining mainstream acceptance.
Earlier this month, a decision by PayPal to allow its customers to buy, sell and hold cryptocurrencies including Bitcoin, Ethereum, Bitcoin Cash and Litecoin signalled that the use of digital currencies could become much more commonplace.
Warning: Nothing in this article should be read or understood to be financial and/or investment advice. Readers should take their own financial advice from a suitably qualified independent financial adviser before making any investment decisions.
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