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Table of Contents: Best Things You Should know About Cryptocurrencies
When it comes to cryptocurrencies, one of the biggest challenges for investors is not to get caught up in the hype. Digital currencies have quickly taken a prominent place in the portfolios of many retail and institutional investors. At the same time, analysts continue to warn investors about the volatility and unpredictability of cryptocurrencies. If you decide to invest in the cryptocurrency market, it is important, as with any investment, that you do your research. Here’s what you need to know before you invest.
Since then, many cryptocurrencies have been developed, and the combined market value of bitcoin and cryptocurrencies continues to skyrocket, now estimated at around £2 trillion worldwide. After PayPal announced that it would support cryptocurrency payments, “crypto” is becoming more and more accessible to the public.
For kids raised in a digital world, the idea of non-physical currency is probably something they’ve already come across playing online games. Many youngsters are turning to crypto as a way to earn money, and a US summer camp for kids ages 5-17 is even offering an introduction to crypto. So what exactly is a cryptocurrency? What are the opportunities and risks? And what should parents keep in mind if their child is interested in crypto mining or investing?
Here is the list of the best things to know about cryptocurrencies
What is cryptocurrency?
Cryptocurrency is a digital or virtual currency that is protected by cryptography, making it nearly impossible to counterfeit or double spend. Many cryptocurrencies are decentralized networks based on blockchain technology, a distributed ledger maintained by a disparate network of computers. The hallmark of cryptocurrencies is that they are generally not issued by any central authority, making them theoretically immune from government interference or manipulation.
Why is ‘crypto’ so popular?
Some people believe that cryptocurrencies can replace conventional currencies within 5 years. Those involved in crypto claim that they are “democratizing” the currency by getting rid of reliance on banks. At first glance, anyone with access to a computer (and enough hardware) can “mine” cryptocurrencies, and at the current £34,000 worth of a bitcoin, anyone could become very rich. Cryptocurrency transactions are usually processed within minutes, unlike bank transfers, which can take several days. The person involved and the details of the transaction remain relatively anonymous.
What is blockchain and how is it connected to cryptocurrency?
Blockchain technology is a type of distributed ledger technology (DLT) that facilitates secure and verifiable peer-to-peer transactions without a centralized party. It is a unique and incorruptible database that constantly records and marks transactions (or “blocks”) in chronological order.
Each transaction must be verified through a process known as “consensus,” which requires multiple participants in the system to independently verify the authenticity of the output of the algorithm that creates the “block.” Once a new entry is agreed upon (confirmed) and made into the blockchain, it is “locked”, i.e. it cannot be changed; it can only be updated by adding a new entry as an attachment.
The most well-known use of blockchain today is to support cryptocurrency transactions like bitcoin, and while the two are often conflated and confused, bitcoin is just one of many potential applications of blockchain. Bitcoin is essentially a form of currency; Blockchain is a database that provides a single secure transaction.
What is ‘mining’ for cryptocurrencies?
One of the main ways to obtain cryptocurrency tokens is called “mining”. This assumes that your computer is performing the intense series of mathematical tasks required to validate a “block” on the blockchain, much like a card machine processes a transaction that you might make with your regular debit card. When your computer solves these problems, there is a chance that you will earn a cryptocurrency token, although this probability decreases as more people start mining cryptocurrency.
If this all sounds complicated enough, that’s because it is. To mine cryptocurrency, you need quite specialized hardware called an “asic” or “application specific integrated circuit”. The more money you spend on this equipment, the more efficient your mining process will be and the more cryptocurrency tokens you are likely to earn.
If you don’t want to mine, the most popular place to buy and sell crypto is Coinbase. PayPal recently announced that UK users will now be able to trade cryptocurrencies, although you will only be able to use them within the platform.
Does cryptocurrency represent inventory?
Organizations use cryptocurrencies as a medium of exchange or for speculative purposes. In these cases, the cryptocurrencies are clearly not inventory. In other situations, entities buy or mine cryptocurrencies with the intention of selling them in the normal course of business and may therefore be considered inventory. However, cryptocurrencies do not constitute “tangible personal property” and therefore do not meet the definition of stock under US GAAP.
How is cryptocurrency taxed?
The Internal Revenue Service has published very few guidelines for taxing cryptocurrencies. However, it issued a 2014 notice stating that cryptocurrency would be treated as property for federal income tax purposes. Depending on how a cryptocurrency is stored, it can be classified as business, investment, or personal property.
In addition to the nature of the earnings, it is important for cryptocurrency holders to keep track of their base. Every time cryptocurrency is used to exchange goods or services, a taxable transaction occurs. For example, events that are considered taxable events include the sale of coins for fiat currency, the exchange of coins for coins, purchases made with cryptocurrency, and the receipt of cryptocurrency for services. There are other complexities associated with the taxation of cryptocurrencies, and it is very important that individuals and businesses continue to monitor future recommendations.
How old do you have to be to trade or mine cryptocurrencies?
Technically, there is no age limit for trading or mining cryptocurrencies, although well-known sites like Coinbase and Paypal require users to be at least 18 years old. However, anyone of any age can mine cryptocurrencies. There are also ways to buy tokens that do not require you to be over 18 years old. For example, Purse.io has an age limit of 13+. The wallet allows you to transfer the value of an Amazon gift card to cryptocurrency tokens.
The risk of cryptocurrency scams
As with any form of currency, cryptocurrency carries financial risks. The value of even the most successful cryptocurrencies like bitcoin is volatile and failures are not uncommon. There have been stories of cryptocurrency trading addiction, but the biggest risk to young people comes from the growing number of cryptocurrency scams on the market.
The most common scam is when someone creates a seemingly valid new cryptocurrency and encourages people to invest in it. Once they take the money, the company will shut down and those who start the scam will walk away with the money. In fact, it is a financial pyramid scheme. An example of this is Theodex, which allegedly swindled investors out of $2 billion.
Similar scams include someone posing as a celebrity or online company and encouraging people to invest in what appears to be the next big cryptocurrency, claiming that the value should rise quickly. The higher the value, the more people invest. However, those who start the scam will cash out their tokens at their peak, causing the value of the coin to plummet and those who invested to suffer losses.
Since cryptocurrencies are unregulated, victims of fraud have little to no protection. The FCA (Financial Conduct Authority) is in the process of regulating cryptocurrency advertising.
If your child wants to start investing in cryptocurrencies, there is also plenty of financial advice available on various social networks, but remind them to be wary of advice that is not solidly backed. Just because someone has a large following doesn’t mean their advice is trustworthy.
environmental cost
You may not think of crypto as a particularly environmentally damaging industry. However, a large amount of energy is required to keep the blockchain running. As cryptocurrency tokens become more scarce and therefore more valuable, the more people use powerful mining hardware, the more CO2 is produced. Some cryptocurrencies use a different type of blockchain that doesn’t have the same environmental cost as it doesn’t rely on the same ever-increasing amount of energy from miners.
The bottom line
When it comes to cryptocurrencies, one of the biggest challenges for investors is not to get caught up in the hype. Analysts continue to warn investors about the volatility and unpredictability of cryptocurrencies. If you decide to invest in the cryptocurrency market, it is important, as with any investment, that you do your research. Think about why you are interested in this particular investment vehicle and familiarize yourself with cryptocurrencies and blockchain technology to be more prepared to determine if this type of investment opportunity is worth it for you.
Investments in cryptocurrencies and Initial Coin Offerings (ICOs) are very risky and speculative, and this article does not constitute a recommendation by Investopedia or the author to invest in cryptocurrencies or ICOs. Because each person’s situation is unique, a qualified professional should always be consulted before making any financial decision. Investopedia makes no representations or warranties as to the accuracy or currency of the information contained in this document. At the time of writing this article, the author owns Bitcoin and Ripple.
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