Cryptocurrencies are with us for over 10 years, over that time we have seen some impressive growth in this field. Cryptocurrencies such as Bitcoin or Ethereum, or even some smaller contenders, can grow over 1,000% and more, in one year alone. These numbers are so high compared to the standard investment, to the point of making cryptocurrencies extremely attractive to buy, trade and hold. However, like all investment opportunities, we have to remember that cryptocurrencies may also be extremely volatile and require a level of technical understanding. Before experimenting with them, it is important that you do your research to understand this topic better.
Why cryptocurrencies are so volatile compared to standard Fiat-based investments?
To give you an answer we first need to understand what blockchain-powered digital assets are. A cryptocurrency is a decentralized way of holding money and can be done mostly anonymously (certain coins have a different level of privacy, and for example, Bitcoin is only pseudo-anonymous). Anonymity makes it harder for governments to track, seize, block and potentially avoid taxation.
Cryptocurrencies are also not issued or backed up by a central bank, or any other financial institution. That makes the value of the cryptocurrency to be created totally according to the law of supply and demand. Cryptocurrencies are not tied to fortunes, countries or linked to tangible assets or any form of reserves. All of that makes cryptocurrencies to be placed outside of regulated financial space and no central bank can influence crypto by changing global interest rates or use other regulatory measures to shape the price of crypto.
Because cryptocurrency is not yet fully financially regulated, it is more susceptible to currency manipulation as a crypto exchange purely sets its worth. Also, there have been numerous cases of hacking associated with cryptocurrencies. Please note that blockchain itself cannot be hacked – but satellite centralized crypto services, such as exchanges or online wallets can be hacked. Also, cryptocurrency exists purely electronically, it’s decentralized and usually anonymous – once you’ve sent your crypto to someone, and you made a mistake – there is usually no way for you to get your assets back, and you won’t have any way to communicate with the recipient at all.
Cryptocurrency mining (PoW) vs. Cryptocurrency staking (PoS)
Another fact worth noted is the idea behind the creation of cryptocurrencies. Until recently crypto assets were using mostly ng Proof of Work protocol, and new coins were created in the process of mining, where a computers (or dedicated hardware called ASICs) were performing a series of complicated calculations to unlock a new block – and miners for their efforts were rewarded with portion of cryptocurrency found in that block. Hardware mining required high investment costs in mining hardware. However, with the inception of Proof of Stake coins hardware mining is no longer required. Instead, everyone who owns certain PoS coins can stake their coins in a software wallet – the staking process will generate additional coins without the need of using any additional hardware.
With PoW based cryptocurrencies miners need to earn money to keep their business profitable. When the price of crypto was dropping miners, to keep on top of their business may want to sell a portion of their coins – and this act usually was a catalyst for even harder drops. PoS coins have no such drawback as no expensive hardware/maintenance/energy is needed to generate coins.
Investing in cryptocurrency can be an extremely attractive proposition. What we need to remember is the fact that with great potential comes great responsibility.
Happy investing!
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