The Basics: What You Should Know About Cryptocurrency

There has been much debate recently about the rising popularity, skepticism, excitement, and long-term future for cryptocurrency (or “crypto”), a digital currency that can be used to buy goods and services. Here are some common questions about crypto that we address for our clients; we welcome a conversation if you are interested in learning more.

What is Cryptocurrency?

Cryptocurrency is a type of digital currency that generally only exists electronically. There is no physical coin or bill unless you use a service that allows you to cash in cryptocurrency for a physical token. You usually exchange cryptocurrency with someone online, with your phone or computer, without using an intermediary like a bank.  There are many different cryptocurrencies, and new ones are continuously being created.[i]

Where do you store cryptocurrency?

Unlike traditional currency which is stored via a financial institution, cryptocurrency is stored in a digital wallet online, on your computer, or on an external hard drive (cold storage).

How is cryptocurrency different from typical currency like US dollars?

According to the FTC, there are important differences between cryptocurrency and traditional currency. Cryptocurrency accounts are not backed or insured by a government like US dollars deposited into a bank account. The US dollar money supply is controlled by the Federal Reserve which it digitally debits and credits to major banks. Then when banks loan out new balances to the broader economy it puts more dollars in circulation. Cryptocurrencies have their own mechanisms coded into them for creating money supply, such as “mining” and “minting.” Also, cryptocurrency values can change often, even by the hour and is based on many factors including supply and demand.

How many cryptocurrencies are there?

According to CoinMarketCap.com, a market research website, there are more than 10,000 cryptocurrencies traded publicly.[ii] Some of the most popular cryptos are Bitcoin, Ethereum, and Tether.

How was cryptocurrency started?

While there are many answers to this question, some in the technology field would point to a few key developments, including the development of public key cryptography in the 70s, decentralized services in the 80s, and technologies born from the cypherpunk movement in the 90s and 00s.[iii] What we do know is that the technology appears to be here to stay.

What is a blockchain?

A blockchain is a type of database, a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems. Unlike a typical database, blockchains store data in blocks that are linked together. New data that is entered becomes a block, and once that block is filled with data it becomes “chained” to the previous block. Blocks are chained together in chronological order. Some blockchains are decentralized, Bitcoin’s for example, which means that no single person has control, data entered is irreversible, and transactions are permanently recorded and viewable to anyone.[iv]  This allows people to trust the blockchain protocol rather than a centralized authority to settle transactions. Not being controlled or administered by any single entity is part of what many people find appealing about the system.

Why are cryptocurrencies so popular right now?

There is much discussion and debate about why cryptocurrencies like bitcoin are popular now. Some investors say that crypto – and also its blockchain infrastructure – is the way of the future and are trying to buy them now under the presumption that they will be more valuable in the future. Many believe that the internet should have its own native currencies that can be used to buy and sell products such as art and gaming items in a digital economy.  Others say that by having an alternative decentralized global rules-based cryptocurrency to the fiat monetary systems used by governments, it may prove as a long-term store of value helping to protect against inflation. Some investors have no interest in the long-term future of the currency and want to “cash in” on its popularity now.

Is cryptocurrency legal?

Yes, cryptocurrency is legal in the United States and falls under the regulatory scope of the Bank Secrecy Act (BSA), though its use is essentially banned in some countries like China. There are many scams around crypto and managing custody of crypto funds can be complicated, so be wary and do your research before considering an investment.

Is cryptocurrency regulated?

Cryptocurrencies and blockchain-related financial services companies are regulated by a number of federal and state agencies, including the SEC, the Commodity Futures Trading Commission, the U.S. Treasury Department and Federal Reserve, among others.[v] Investors have been outspoken about the complexity in understanding the regulations.

Expanded regulation may be on the near horizon. In July 2021, Federal Reserve Chairman Jerome Powell spoke about the Fed’s interest in regulating stablecoins and the potential for a central bank digital currency (CBDC), while testifying before the U.S. House Committee on Financial Services.[vi] This would essentially lay the groundwork for future centralized regulation by the Fed. Also, the Infrastructure Bill recently passed by the Senate, includes a section that would add regulations identifying a “broker” as someone who is “responsible for and regularly providing any service effectuating transfers of digital assets on behalf of another person.” If signed into law, anyone classified as a broker would be subject to the same tax reporting requirements as traditional financial brokers.[vii] 

Are they considered a good investment in 2021?

Cryptocurrency relies heavily on speculation and is considered a volatile buy. We recommend doing lots of research and consulting with your financial advisor before considering an investment. 

Private Ocean’s investment philosophy requires us first to understand a security’s intrinsic value, and secondly to establish that we are buying in at a fair price, before including it in our client’s portfolio. As of this writing, cryptocurrency does not meet these conditions. For more information, we recommend reading our Investment Chairman, Fred Dopfel’s, piece on cryptocurrency.

Private Ocean is a West Coast-based wealth management firm deliberately structured to give clients the intimate experience of a small firm while harnessing the power, depth and discipline of a much larger one. Formed in 2009, the firm has locations in San Rafael, San Francisco, and Seattle. 

John Thiel, MBA, CFP® is a financial advisor at Private Ocean. He is inspired to help people reach their financial goals by helping them make informed decisions that lead to long-term, meaningful steps throughout their lifetime. He holds a Certified Financial Planner designation and received an MBA from California Lutheran University.

Sources:

[i] What To Know About Cryptocurrency and Scams, Federal Trade Commission. Obtained August 9, 2021.

[ii] Royal, James PhD, and Kevin Voigt. “What Is Cryptocurrency? Here’s What You Should Know,” July 23, 2021, Nerdwallet.com.

[iii]Before Bitcoin Pt.1 — 70s “Public Key Saga,” March 24, 2018, Medium.com. 

[iv] Conway, Luke. “Blockchain Explained,” Obtained August 9, 2021. Investopedia.com.

[v] Matthews, Chris. “U.S. is ‘behind the curve’ on crypto regulations, says SEC Commissioner Peirce,” April 7, 2021. Marketwatch.com.

[vi] Little, Kendall. “Fed Chairman Says U.S. Might Need More Crypto Regulation. Here’s What That Means for Investors,” July 15, 2021. Time.com.

[vii] https://www.vox.com/2021/8/8/22615679/1-trillion-dollar-infrastructure-bill-cryptocurrency-policies-digital-rights

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