What are cryptocurrencies?
Cryptocurrencies are digital currencies. They are a decentralised form of payment that is seen as an alternative to “fiat” money (paper money that can be printed into infinity by central banks).
Cryptocurrencies are secured by cryptography (such as using blockchain technology) that ensures the security and transparency of transactions.
Cryptocurrencies can be used for payments for online purchases that can be made without going through an intermediary, such as a bank. Whilst the primary use of cryptocurrencies is as a source of payment, they are also extremely popular as an asset for trading and investing.
There are thousands of cryptocurrencies available to own
There has been enormous growth in the popularity of cryptocurrencies in the past decade. This has led to an explosion of available cryptocurrencies.
Numbering in the low hundreds in the early 2010s, their number soared to over 10,000 in February 2022. The number has since reduced slightly but is still around 8650 cryptocurrencies worldwide.
Bitcoin is the largest and most popular traded crypto asset. Other widely traded cryptocurrencies include Ethereum, Tether, Binance coin and XRP.
Ways to own and trade cryptocurrencies
You can hold cryptocurrencies as a form of payment. You can also buy and sell them as an asset for investment or speculation.
Here is how to be exposed to cryptocurrencies:
- Join a crypto exchange – By joining a crypto exchange you will then be able to hold cryptocurrencies in a wallet. You can then use cryptocurrency to make online payments, or just hold them. However, this is not without its risk. Exchange fraud (such as with the crypto exchange, FTX), and issues surrounding cybersecurity and hacking are significant risks to consider.
- Through a broker – Trading cryptocurrency is popular through financial brokers that offer exposure to cryptocurrency CFDs. However, some regulators (such as the FCS) have restrictions on leveraged cryptocurrency trading and it is only available in certain jurisdictions.
- Crypto funds – Investing in cryptocurrency Exchange Traded Funds. Several ETFs invest in assets of cryptocurrencies and blockchain technology.
The pros and cons of trading cryptocurrencies
Here are a few pros and cons that need to be considered before investing in cryptocurrencies.
Pros:
- Add diversification – Cryptocurrencies are another asset class that adds another string to the bow of a portfolio. They can help to increase the diversification of investments.
- Increase the risk profile of a defensive portfolio – The volatility of a highly speculative asset class such as cryptocurrencies can be a positive as they can help to increase the risk and potential for returns.
- Trade crypto whenever – Cryptocurrency markets never close. They are truly a 24/7 market which means you can trade whenever you like. By contrast, although forex markets run 24 hours per day, they are still closed at the weekend, making them a 24/5 market.
Cons:
- Significant volatility – Whilst adding volatility can be a good thing for a portfolio, having too much exposure to cryptocurrencies can be a high-risk strategy for investments.
- Elevated risks of a lack of regulation – Cryptocurrency is classified by regulators such as the UK’s FCA as “very high risk, speculative investments”. They are also not regulated investment products, meaning that there is no regulatory compensation scheme to cover fraudulent losses.
- Cyber risk – Hacking is a very real threat to holding cryptocurrency in a crypto wallet on an exchange. As the FTX scandal also shows, how much can you trust the exchange you are holding your cryptocurrency with?
