You may not be ready to join the ranks of cryptocurrency investors just yet, but this innovative technology is very likely to change the future of financial markets and money in a significant way. A basic understanding of how cryptocurrency works is essential for any investor. Let’s go over why cryptocurrency moves the way it does, and how secure it really is.
Cryptocurrency - How Secure Is It?
Though volatile, cryptocurrencies are considered one of the most secure ways to store money. Note that this doesn’t mean they are safe investments that are guaranteed to retain their value, just that they are secure. A cryptocurrency may lose over 30% or more of its value overnight, but the odds of it being stolen or hacked into are very low.
Let’s understand why.
The concept of blockchain may seem complex, but let’s break it down. Blocks are files where transaction data is permanently recorded, like a ledger. Each block records data in hash functions with timestamps to help protect the data integrity. This ensures that the data cannot be overwritten, manipulated, or otherwise tampered with. Every cryptocurrency transaction is recorded and stored on a block that is then added to the blockchain.
What this means is that once a cryptocurrency transaction is made, it is encoded into the blockchain and cannot be changed or reversed easily. This is known as immutability. One would need to control over 51% of the network to force a change, and even if that were to happen, there are ways of securing the blockchain.
And this is not limited to transactions; any information can be stored on a blockchain, making it one of the most secure ways to store data.
Of course, this doesn’t make cryptocurrency 100% secure. As with any other network, there are weak links. In the case of cryptocurrency, the weakest link is the password used to secure one’s cryptocurrency “wallet.” Anyone who gained access to your wallet password could gain control over your cryptocurrency.
Why is Cryptocurrency so Volatile?
If there is one thing the Bitcoin crash proved yet again, it is that cryptocurrencies are, without a doubt, one of the most volatile investments available, particularly in comparison to the stock market. While the stock market has only dropped 20% to 30% on its worst days, cryptocurrencies can crash by as much as 30% to 70% every six months, or even more.
Does this make cryptocurrency a risky holding? Yes. But it doesn’t exactly spell doom for the cryptocurrency market, and here’s why.
Think back to the ‘dotcom bubble’ from 1995 to 2002. The internet was an emerging technology then, and investors speculated heavily on internet-related stocks in the late 1990s. When the bubble burst, companies like Amazon lost more than 90% of their market cap.
Did that spell the end of these companies? Not really. Amazon is up more than 15 times in the 20 years since the dotcom bubble, as are some other companies that were caught in the dotcom bubble.
New technologies tend to be volatile, particularly during their early days, but there is a difference between volatility and risk.
All products tend to have a 5-phase lifecycle: introduction, growth, mass adoption, saturation, and decline. Most cryptocurrencies are in the first 2 phases, which are characterized by extreme volatility and fast growth. This is one of the main reasons why cryptocurrencies are as volatile as they are, and why that isn’t necessarily a bad thing.
Changing Financial Markets
In mid-May, Bitcoin crashed 50% from its peak after a tweet by Elon Musk. This triggered the usual flurry of articles on how cryptocurrencies don’t have “real value” and how “Bitcoin is dead.” But far from signaling the end of cryptocurrencies, this was a big win for decentralized finance.
Think of it this way: imagine if the NASDAQ or Dow Jones Index had seen a crash of 50% in a few days. The world would grind to a halt; companies would go belly up, investors would lose their shirts, the government would start bailing companies out, and trading would stop.
But when Bitcoin dropped, there was no loss of liquidity. No broker or institution failed. Despite their volatility, cryptocurrencies work as a parallel financial system that could eventually replace the way banks, brokerages, and the traditional financial system function—unless it adapts and evolves.
Cryptocurrency - Investment or Speculation?
Despite the potential this technology holds, you may want to be careful investing more in cryptocurrency than you can afford to lose. Even the bigger cryptocurrencies like Bitcoin and Ethereum are speculative ventures at best, at least for now.
Aspire Planning Associates was founded to help you and your family achieve everything you aspire to. If you are struggling to balance your portfolio and need guidance with the investments best suited to your financial goals, get in touch to schedule a consultation with us today.
