Business headlines are filled with news about cryptocurrencies, blockchain and the next big swing in prices. But what is it about these digital assets that has so many people jumping into the crypto market, despite a lack of regulation and momentous ups and downs?
The short answer is: gambling in the hopes of a big payout.
“It’s for speculators and gamblers,” says Henry Kim, a cryptocurrency expert and an associate professor at the Schulich School of Business at York University in Toronto.
“The general feeling is that of the tens of thousands of cryptocurrencies out there, there are probably at the very most about a dozen that ought to be of interest right now and actually go beyond pure gambling and speculation.”
Kim explains that those investing in crypto are betting on the fact that at some point the cryptocurrency they have invested in will gain intrinsic value.
This could come from the technologies that underlie the crypto, like for Ethereum (perhaps the other most notable cryptocurrency) which is connected with a heavily-used blockchain technology.
Another is Decentraland’s crypto, MANA, which is connected with a metaverse as its legal tender, so if this metaverse concept catches on then MANA could be worth something.
How did we get here?
What made cryptocurrency so attractive at its onset was the idea of it being less regulated and therefore less susceptible to manipulation or interference from centralized financial institutions (i.e. no taxes or bank fees). There was also the idea that it could cut out the so-called middle man for loans and investments, which could enable more Peer-to-Peer (P2P) investing.
But, the current reality is that you can’t easily take crypto to the local grocery store and use it to buy a loaf of bread. The only country that currently recognizes crypto as legal tender is El Salvador. And the lack of regulation has left it open to considerable price manipulation.
This raises questions about the intrinsic value of any cryptocurrency, one of the reasons for the significant swings in value.
Bitcoin, for instance, hit US$69,000 in July 2021, but then went on a wild ride, sitting just under US$39,000 by early February 2022 after dropping below US$33,000 a week prior, showing just how volatile this asset class can be.
At the moment, crypto is being treated more as an asset class than legal tender – although many investment professionals take issue with that categorization, because, they argue, Bitcoin has no utility or intrinsic value (two qualities assets must have).
Returns at any cost
The fear of missing out (FOMO) is also a huge driver for investment in crypto, as many are worried they’ll miss their chance to get in on the action. Bitcoin, in particular, is gaining in popularity and price due to its rarity. There are only so many Bitcoins to be mined in the world (21 million to be exact) with 19 million already mined.
This FOMO is fueled by stories about people like Eddie Zillan, the teenager from Ohio who, back in 2015, used his birthday and Bar Mitzvah money to buy crypto and is now a millionaire.
Proponents of blockchain, the technology that underlies cryptocurrency, feel the excitement around the overall sector is justified.
“Blockchain is the first digital medium for value and will upend many industries, starting with financial services. Bitcoin is just the beginning,” says Alex Tapscott, managing director at Ninepoint Digital Asset Group and author of Blockchain Revolution.
“This asset class is foundational to the next era of economic progress and prosperity.”
The technology, he added, provides a way to gain exposure to many new use-cases and opportunities, from decentralized finance to NFTs (non-fungible tokens), new forms of money and more.
“Crypto assets are the building blocks for new kinds of organizations called DAO’s (decentralized autonomous organizations) that will soon replace companies in many parts of the economy.”
Risk and reward
While supporters of blockchain see the technology as a whole being a legitimate catalyst for disruption in the field of financial services, that doesn’t mean it will usher in a whole new way of mainstream investing.
“I think it goes without saying that you don’t (want to) put too much money into this,” adds Kim.
And for the time being, the significant risks that come with this type of investment mean research and a thorough assessment of one’s own risk tolerance remain crucial.
“But I do believe blockchains will enable us to digitize all of those assets, so ultimately an investor could find themselves buying a crypto asset (for example a digital share or digital bond) without even knowing it.”
Digital asset definitions
Cryptocurrency: An asset that only exists in a digital or virtual format and is secured by cryptography or encryption to avoid counterfeiting or double-spending.
Bitcoin: Perhaps the most recognized cryptocurrency in the world, Bitcoin was developed by Satoshi Nakamoto, who put a maximum limit of 21 million on the supply of this digital asset. It can only be acquired through “mining.”
Crypto mining: Like precious metals, cryptocurrency must be “mined.” This process is done by solving complex mathematical problems that are released virtually at a certain time. Whichever computer––and by extension, whoever owns that computer––solves these problems then receives a certain amount of that cryptocurrency and/or transaction fees.
Blockchain: A blockchain is a database that stores its data in digital blocks and is heavily encrypted. In the case of cryptocurrency, a blockchain refers to a publicly distributed virtual ledger that records all the transactions related to a particular cryptocurrency.
NFTs: These are “non-fungible tokens” (hence NFT) meaning they are not interchangeable or, in other words, they cannot be replaced or traded for anything. Anything digital––like a picture, tweet, song or video––can be an NFT. Owners of NFTs do not have copyright ownership of the digital asset, but they do have the right to resell it.