Cryptocurrency Basics
According to the Oxford English Dictionary, a cryptocurrency is “a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority.”
Before we go any further into what crypto is, let’s review the meaning of some crypto terminology that often comes up when we discuss cryptocurrencies.
Bitcoin
The first and most popular cryptocurrency. First created in 2009, it was the first cryptocurrency to be widely adopted.
Blockchain
This is the technology that most crypto assets (including currencies such as Bitcoin and Ethereum) are maintained on, a sort of digital ledger system that maintains the records of crypto asset ownership. Simply put, a blockchain is a list of all transactions, a record of every purchase or sale of a crypto asset.
Digital Tokens
A type of crypto asset that can be traded and tracked on a ledger. There are several different kinds of digital tokens (utility tokens, security tokens and non-fungible tokens) that provide the owner access to a service, voting rights on a blockchain project, or ownership of a unique asset.
Ethereum
The second-largest cryptocurrency (by market capitalization) after Bitcoin. It was first launched in 2015.
NFT
This is a “non-fungible token”, a kind of crypto asset that provides ownership rights to an asset (e.g., digital artwork, virtual event tickets, video game items, etc.).
What is cryptocurrency?
Cryptocurrency is intended to work like a digital or virtual currency and facilitate the sale, purchase or trade of goods between two parties. It can also be saved, retrieved and exchanged at a later time. Unlike traditional currencies, cryptocurrencies are not issued or backed by a government or a central bank. Instead, they’re managed by peer-to-peer networks of computers running free, open-source software. Cryptocurrencies and their transactions are secured on a blockchain. Each cryptocurrency blockchain manages the entire chain of custody of the crypto asset.
Because cryptocurrencies are not issued by a government or central authority, it’s possible to transfer value without the need for a bank or payment processer, no matter who you are or where you’re located.
One of the earliest cryptocurrencies to gain widespread knowledge was Bitcoin, first created in 2009, but there are many other cryptocurrencies today, including Ethereum, Litecoin, Tether and BNB.
There have been other cryptocurrency developments in recent years, including the emergence of “stablecoins”, which maintain a stable value. Their intent is to make it easier to use cryptocurrencies as a form of payment in day-to-day purchases of goods and services and have generally been less volatile than traditional cryptocurrencies.
At this point, there is little exchange of cryptocurrencies used in everyday transactions (purchase of goods and services); rather, cryptocurrencies are currently largely being used as an investment, a method to store and secure wealth.
What are the risks associated with investing in cryptocurrencies?
Simply put, cryptocurrencies are considered a high-risk investment for a few reasons, which we’ll cover here.
Volatility
The value of a cryptocurrency can be very volatile, with prices fluctuating widely, and it’s not always clear why the volatility is taking place. You could lose some, or all, of your investment. More traditional investments (stocks, bonds, mutual funds, etc.) tend to have an underlying asset, even if it is the expectation of a company’s future earnings. Cryptocurrencies have no underlying asset.
Crypto fraud
In addition to being highly volatile, crypto assets can also be vulnerable to fraud, manipulation and cyberattacks.
The nature of crypto means investors could fall victim to investment fraud in a number of ways. For instance, a fraudster may claim they will use your money to buy cryptocurrencies, and then cut off all communication once you’ve sent them money. Scams could include fake investment products, false websites claiming to sell packaged investments, and fraudulent cryptocurrency exchanges.
BC Securities Commission
It’s best to be on the safe side. Before you invest, check the registration of any crypto asset trading platform. Checking their registration may help to protect you from possibly fraudulent individuals and companies.
Security and Access – private keys
You may have heard stories about investors who are not able to retrieve their crypto assets because they’ve misplaced their key or password. This is true, and it is a risk for anyone holding crypto assets, including currencies; they only exist on the blockchain. The only way you can access your crypto asset is by knowing the private key.
When you purchase a crypto asset, you are not buying a physical item. There is nothing that you can download or file to prove that you own it. Instead, the assets are held in a digital address on a blockchain and managed through a digital wallet, a technology that helps you manage your asset keys.
A digital wallet can be hot (which is connected to the internet) or cold (which is offline). A cold wallet is often considered more secure because it’s not connected to the internet, but if it’s lost or destroyed, anything stored in it (including your private keys) is also lost.
NOTE: Always keep your crypto private key in a secure place. If it is lost or stolen, you won’t be able to gain access to your crypto assets.
How can I invest in cryptocurrencies?
You can invest directly in cryptocurrencies through a crypto asset trading platform. There are many platforms out there, but it is recommended that you choose a platform that is registered in Canada. That way, the platform will have to comply with Canadian securities laws. Canadian Securities Administrators has published a list of registered crypto asset trading platforms, those seeking registration as well as platforms that have been banned.
Alternatively, you can also invest in cryptocurrencies without investing directly in the crypto assets themselves. Current options include a crypto exchange-traded fund (ETF), blockchain fund or mutual fund. You can also invest in the stocks of companies within the blockchain and cryptocurrency industries, which gives you exposure to cryptocurrencies without investing in them directly.
Other resources
If you’re looking to invest in cryptocurrencies, it’s a good idea to know what you’re getting into. For more information, we recommend the OSC’s crypto learning module or the BC Securities Commission’s article How to start investing in Crypto…or not.
The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters.