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What is cryptocurrency?
Put simply, cryptocurrency is digital money.
Think of it like a type of software. Like software, cryptocurrency only works on computers. But unlike software, cryptocurrency does not have a backend that allows its creators to change or manipulate it.
Instead, it is decentralized. This means unrelated and often anonymous individuals around the world control cryptocurrencies by running software on their computers.
These computers are called nodes.
Since cryptocurrency assets are decentralized, no one is protecting or carrying out crypto transactions. Instead, every cryptocurrency exists on a blockchain, which is like an accounting ledger that records every transaction that has ever happened.
Is cryptocurrency secure?
When you use a credit card backed by standard currency to buy something online, it works because multiple corporate entities have agreed to accept that payment. The transaction is secured by the trust between banks, corporations and payment technologies like Visa or Mastercard.
Unlike government-maintained currencies, which run on trust between governments and financial institutions, cryptocurrencies are maintained by cryptography – the science of maintaining and sending information that has been secured against outside third parties.
Because of this, cryptocurrencies can’t be counterfeited.
How do digital wallets work?
Cryptocurrency users hold crypto in password-protected digital wallets, like MetaMask or Trust Wallet. But because it’s decentralized, if you lose your password, no bank representative can help you retrieve your cryptocurrency. That’s why you may have heard about would-be Bitcoin billionaires who can’t access their investments.
Digital wallets are also anonymous, which means no person or government can necessarily discover that you own this wallet or the assets inside.
This makes cryptocurrency permissionless, which means that no one can stop you from using it in a transaction.
This is why governments and institutions like the International Monetary Fund have warned against widespread cryptocurrency adoption.
Governments can regulate cryptocurrency with things like taxes, but can’t control it like national banking and currency systems. So, bad actors – including terrorists, criminal syndicates and anyone trying to hide their personal assets – can exploit that lack of oversight to move money around surreptitiously.
What is crypto mining?
Additionally, certain proof-of-work cryptocurrencies are minable. This means that powerful computers can be set up to solve cryptography puzzles, which involve verifying actual transactions on the blockchain.
Whoever solves the puzzle first mines a certain allotment of new coins.
The enormous computing power and electricity consumption required for crypto mining provide a work value to the underlying cryptocurrencies.
What is crypto staking?
Proof-of-stake cryptocurrencies work by giving users the ability to deposit their crypto in specified wallets where their tokens will be used to verify other transactions on the blockchain.
By depositing, or staking, the coins, instead of selling them, users can collect interest on their savings through verified transaction fees.
How does cryptocurrency gain value?
Just because cryptocurrencies aren’t issued by a government doesn’t mean they are imaginary. Their value is based on supply and demand – what a token is worth depends on how much crypto users think it’s worth.
Strict limits on the amount of a cryptocurrency in circulation maintain a token’s value. Governments can’t create more Bitcoins, for example, and increase spending while decreasing value.
So as interest in cryptocurrency grows but the crypto supply remains constant, the token’s value shoots up. This is a primary draw for cryptocurrency investors. It’s also what makes crypto a high-risk investment.
Governments and central banks try to keep national currencies stable. They don’t want them to gain or lose too much value relative to other currencies.
Cryptocurrencies, on the other hand, tend to gain and lose value rapidly with users’ interest. Their volatility makes them extremely risky investments, but also capable of offering high returns.
Investing in cryptocurrency
Stories of Bitcoin billionaires may tempt investors to put 100% of their investment cash into cryptocurrency, but certified financial planners and nearly every personal finance book out there argue against such a high-risk move.
If you put all your eggs in one basket – so to speak – one bad investment can cost you everything.
“A military member needs to understand that this investment has risks that other assets don’t have,” said Kirk Kinder, certified financial planner at Picket Fence Financial. “If a military member put 10% of their portfolio in crypto, would they be ok with it going to zero? If not, then pull back the percentage.”
Investment brokerage AJ Bell released a survey of financial planners this year finding that though only 4% of professional investment advisors encourage their clients to invest in cryptocurrencies, about 36% of their clients already own crypto assets.
Of seven financial advisors and planners who spoke with The Military Wallet, four recommended allocating no more than 5% of your total investment portfolio to cryptocurrency. Two recommended staying away from the investment altogether.
Rick Raybin, CEO and founder of Lifetime Capital Group, said he finds cryptocurrency’s investment risk unnecessary for most people. “The hype doesn’t regale you with stories of losses, lost passwords or hacked accounts and other forms of theft,” Raybin said.
“At best, the cryptocurrencies are an extremely volatile, new, currency about which not enough is known to warrant adding it to investment accounts,” said Barry Korb, a certified financial planner at Lighthouse Financial Planning.
Jim Crider, CEO of Intentional Living FP, is more optimistic about cryptocurrency’s investment potential. He said he proactively pursues conversations about cryptocurrency investment with the families he advises, and most of his clients allocate about 10% to 20% of their portfolios to cryptocurrency.
“While there are countless cryptocurrencies out there, we are not allowing ourselves to be sidetracked by altcoins and only focus on Bitcoin,” Crider said, citing they pioneer crypto’s longer track record.
What is the future of cryptocurrency?
Analyst opinions are largely positive on two of the most valuable cryptocurrencies.
Shervin Pishevar, the cofounder of Sherpa Capital, forecasted that Bitcoin will hit $100,000 by the end of 2021. Mark Yusko, the founder of Morgan Creek Capital, estimates that Bitcoin will reach $400,000 in the longer term by comparing it to the value of the gold market.
Likewise, though Ethereum (the second most valuable cryptocurrency) currently hovers near $3,000, a team of analysts at Britain’s Standard Chartered bank recently released a price target for the smart contract coin between $26,000 and $35,000.
However, as more governments begin to regulate cryptocurrencies, their value could decrease. The Internal Revenue Service requires cryptocurrency investors to report their transactions. The IRS taxes your profits just like capital gains from 0 to 37%, depending on how long you held the asset and how much you profited.