Cryptoassets are underpinned by distributed ledger technology (DLT). A ‘distributed ledger’ is a digital database of transactions that is implemented across a network of computers and has no central administrator. Because the data in the database is stored across the network and not in one location, the network is said to be ‘decentralised.’
The key advantage of a decentralised network is that any transaction that takes place on the network is recorded in multiple locations at the same time. This means there’s a much higher level of security compared to a ‘centralised’ ledger, where data is stored in only one place.
‘Blockchain’ is the most well-known form of DLT. This is the technology that a lot of major cryptoassets are based on. With Blockchain, transactions are grouped into ‘blocks’ that are chained together and cryptography is used to secure and verify every transaction. The advantage of Blockchain is that all transaction data is public meaning that anyone can see it. This makes it pretty much impossible to forge a transaction on the network.
What are the main uses for cryptocurrency?
Cryptoassets have a number of uses. These include:
- Payments. Some cryptocurrencies such as Bitcoin, Bitcoin Cash, and Litecoin are designed to work as a medium of exchange. This means that they can potentially be used to pay for goods or services, or to transfer money to someone.
- Smart contracts. Some cryptoassets such as Ethereum and Cardano are designed to facilitate smart contracts. Smart contracts are digital agreements that can be used to settle complex transactions and allow movement of funds under predetermined conditions.
- Investments. Increasingly, investors are viewing cryptoassets as an asset class. One appeal of cryptoassets from an investment point of view is that they tend to have a low correlation to traditional asset classes such as equities and bonds. This means that they can potentially be used for portfolio diversification.
The difference between a fiat currency and a cryptocurrency
A fiat currency is a currency that is issued by and backed by a government. Examples of fiat currencies include the US dollar, the British pound, and the Euro.
A cryptocurrency, by contrast, is a digital currency that is not issued or backed by any government. Examples of cryptocurrencies include Bitcoin, Bitcoin Cash, and Litecoin.
While governments can potentially manipulate fiat currencies by increasing or decreasing supply, they cannot manipulate cryptocurrencies as they are not controlled by any central authority.
How to invest in cryptocurrency
In the UK, there are several ways you can invest in cryptocurrency. One way to invest is through a crypto broker such as Coinbase, Kraken, eToro, or Gemini. These brokers offer access to a wide range of different cryptoassets.
To invest in cryptocurrency through a broker you will need to open an account first. This can sometimes take some time as you will need to complete some identification checks.
With some brokers, such as eToro, you need to deposit funds into your account before you can invest in crypto. However, with others, such as Coinbase, you can pay for your cryptocurrency with a credit card.
An alternative way to invest in crypto is through a FinTech company such as Revolut where you can invest in crypto with as little as $1. Currently, Revolut offers access to over 50 different cryptocurrencies.
It’s worth pointing out that in the past, it was possible to use Contracts for Difference (CFDs) to trade cryptocurrencies without buying the underlying assets. However, in early 2021, the UK’s financial regulator, the Financial Conduct Authority (FCA), banned crypto derivative trading in the UK meaning it’s no longer possible to trade crypto CFDs.
The FCA’s ban on cryptocurrency derivatives includes exchange-traded products (crypto ETPs) meaning that UK investors cannot currently invest in crypto exchange-traded funds (Bitcoin ETFs) such as the ProShares Bitcoin Strategy ETF.
Where to buy cryptocurrency
In the UK, the main ways to buy cryptocurrency are through a:
- Cryptocurrency exchanges: for small-medium sizes crypto trading
- Cryptocurrency brokers: for large and complex crypto transactions
- Cryptocurrency trading accounts: buy and sell cryptocurrency online
Is cryptocurrency a good investment?
Cryptoassets are considered to be high-risk, speculative investments. They are much higher risk than traditional asset classes such as stocks, bonds, and real estate.
The reason cryptoassets are high risk is that they tend to be very volatile. While their prices can rise explosively at times, their prices can also fall dramatically. It’s not unusual to see the price of a cryptocurrency fall by more than 20% in a single day.
This volatility can be seen in the price of Bitcoin during the first half of 2021. Between January 2021 and April 2021, the price of BTC rose from around $30,000 to above $60,000. However, over the next few months, it then fell back to around $30,000.
Had you invested at the start of 2021 when Bitcoin was trading near $30,000, you could have potentially doubled your money in just a few months. However, had you invested in April near the $60,000 mark, you would have seen your investment halve in value over the next few months.
Given their volatility, financial experts generally recommend not investing more than 5% of your overall investment portfolio in cryptoassets.
It’s worth pointing out that while cryptoassets are risky, studies have shown that they can potentially improve a balanced portfolio’s returns over the long term.
In 2020, analysts at Fidelity compared the performance of a standard 60/40 equity/bond portfolio with the performance of some 60/40 portfolios that contained a small amount of Bitcoin (1% to 3%).
Fidelity’s analysts found that the portfolios with Bitcoin exposure generated higher returns over the long term than the standard 60/40 portfolio, without a significantly higher level of risk. Interestingly, the portfolios with Bitcoin exposure had a higher Sharpe Ratio than the standard portfolio meaning they delivered better risk-adjusted returns.
|5-year average return||Annualised volatility||Sharpe Ratio|
|Balanced 60/40 portfolio||6.83%||11.67%||0.59|
|Balanced portfolio with 1% Bitcoin||7.98%||12.04%||0.66|
|Balanced portfolio with 2% Bitcoin||9.11%||12.54%||0.73|
|Balanced portfolio with 3% Bitcoin||10.24%||13.16%||0.78|
Source: Fidelity. Returns to 30 September 2020.
This research suggests that cryptocurrency could potentially play a role in a well-diversified investment portfolio.
Advantages of buying crypto
Advantages of buying crypto include:
- The potential for big returns. In the past, cryptocurrency has generated strong returns for investors at times. For example, in 2017, Bitcoin generated a gain of around 1,320%.
- Enhanced portfolio diversification. Crypto tends to have a low correlation to other assets such as stocks and bonds. This means that it can potentially be used to help diversify an investment portfolio.
- The ability to make payments. Some cryptoassets can be used for payments. For example, with Bitcoin, you can send it to friends and family. You can also pay for some goods and services with it.
Disadvantages of buying crypto
Disadvantages of buying crypto include:
- The potential for big losses. While crypto can generate big gains at times, it can also generate big losses. In 2018, Bitcoin lost nearly 75% of its value.
- Growing regulatory scrutiny. At present, financial regulators around the world are taking a close look at cryptoassets. This means that there is a high level of regulatory uncertainty. In some countries, crypto has been banned by regulators.
- Most retailers do not accept crypto. In the UK, no major high street shop currently accepts cryptocurrency as payment. This means you must convert your crypto to cash before you can pay for goods or services.
Popular cryptocurrencies for trading
Some of the most heavily traded and discussed cryptocurrencies are:
- Bitcoin (BTC) – Bitcoin is a digital currency that is based on blockchain technology and can be sent from user to user on the global Bitcoin network without the need for intermediaries such as banks. It was launched in 2009 by Satoshi Nakamoto (a pseudonym) and designed to be an alternative to traditional fiat currencies.
- Ethereum (ETH) – Launched in 2015, Ethereum is a programmable blockchain technology with smart contract functionality. When people talk about trading Ethereum, they’re actually talking about trading ‘Ether’ – a tradable token designed to fuel the Ethereum ecosystem.
- Binance Coin (BNB) – Binance Coin is a cryptocurrency that’s used to pay fees on the Binance cryptocurrency exchange. Binance Coin was initially based on the Ethereum network, however, it’s now the native currency of Binance’s own blockchain, the Binance chain.
- Tether (USDT) – Tether is a cryptocurrency with tokens issued by Tether Limited, which is controlled by the owners of crypto exchange Bitfinex. Tether is a ‘stablecoin’ – a type of cryptocurrency that’s designed to be stable so that it can be used as a medium of exchange. Tether is designed to always be worth USD $1.00.
- Solana (SOL) – Solana (SOL) is a cryptocurrency coin that runs on the Solana network. Solana is a blockchain platform that aims to provide high transaction speeds at a low cost without sacrificing decentralisation. Like Ethereum, Solana can support smart contracts.
- Cardano (ADA) – ADA is the native cryptocurrency of Cardano – a public blockchain platform designed to run various applications such as smart contracts and decentralised applications (DApps). This platform was launched in 2017 as a competitor to the Ethereum blockchain. The key advantage of the Cardano platform is that it’s much faster than Bitcoin in facilitating peer-to-peer transactions.
- XRP (XRP) – XRP is the token of Ripple – a payments company that provides solutions for global money transfers. Ripple operates RippleNet, which is a network of banks, payment providers, and other financial institutions that uses a single application programming interface (API) to make the process of moving money around the world faster and cheaper.
- Polkadot (DOT) – DOT is the native cryptocurrency of Polkadot – a platform that enables cross-blockchain transfers of any type of data or asset. It’s designed to achieve high degrees of security and scalability by uniting multiple blockchains.
- USD Coin (USDC) – USD Coin is a stablecoin that is supposedly pegged to the US Dollar. Each USDC is backed by one US dollar or asset with equivalent fair value, which is held in accounts with regulated US financial institutions.
- Dogecoin (DOGE) – Dogecoin is a cryptocurrency that was originally created in 2013 by two software engineers as a joke. It is designed to be a light-hearted alternative to traditional cryptocurrencies such as Bitcoin.