3/18/24:Why Do People Invest In Cryptocurrencies?

Cryptocurrency (or “crypto”) is a digital currency that can be used to buy goods and services or traded for a profit. Bitcoin is the most widely used cryptocurrency.

By Andy Rosen 

Why do people invest in cryptocurrencies?

People invest in cryptocurrencies for the same reason anyone invests in anything. They hope its value will rise, netting them a profit.

If demand for Bitcoin grows, for example, the interplay of supply and demand could push up its value.

If people began using Bitcoin for payments on a huge scale, demand for Bitcoin would go up, and in turn, its price in dollars would increase. So, if you’d purchased one Bitcoin before that increase in demand, you could theoretically sell that one Bitcoin for more U.S. dollars than you bought it for, making a profit.

The same principles apply to Ethereum. “Ether” is the cryptocurrency of the Ethereum blockchain, where developers can build financial apps without the need for a third-party financial institution. Developers must use Ether to build and run applications on Ethereum, so theoretically, the more that is built on the Ethereum blockchain, the higher the demand for Ether.

However, it’s important to note that to some, cryptocurrencies aren’t investments at all. Bitcoin enthusiasts, for example, hail it as a much-improved monetary system over our current one and would prefer we spend and accept it as everyday payment. One common refrain — “one Bitcoin is one Bitcoin” — underscores the view that Bitcoin shouldn’t be measured in USD, but rather by the value it brings as a new monetary system.

Why is Bitcoin still popular?

Since its inception, Bitcoin has been regularly derided as dead, worthless or a scam, in part because its price is prone to meteoric rises and dramatic falls. Most recently, when Bitcoin’s price rose to $60,000 in 2021 before collapsing to around $17,000 in 2022, many experts and investors said it wouldn’t recover from this burst.

But it did, hitting a series of record highs in early 2024. As of this writing, the cryptocurrency is up about 250% from a year ago.

The latest surge in price can partially be attributed to approval by the SEC of spot Bitcoin ETFs in Jan. 2024. This gave some of the largest asset managers in the world (think Fidelity and BlackRock) a way to offer their clients exposure to Bitcoin, making it easier for those clients to hold Bitcoin in accounts such as IRAs and taxable brokerage accounts.

But Bitcoin’s 2024 price rise is also due to other factors. Every four years, something known as “Bitcoin halving” occurs. The last halving occurred in 2020, when the reward for mining bitcoin was slashed in half from 12.5 to 6.25. In 2024, that will happen again, cutting the mining reward from 6.25 to 3.125. With fewer Bitcoins entering the market, its possible scarcity could drive up the price, leading to investor speculation today.

What’s more, the surge in interest rates in 2022 that pummeled growth stocks may have had a similar influence on Bitcoin; investors tend to prefer security over volatility during times of uncertainty. But as talk of interest rate cuts in 2024 circulates, some investors may have more appetite for risk assets like Bitcoin, leading them to get back in now.

And lastly, there are still Bitcoin enthusiasts who preach that looking at Bitcoin through the lens of fiat currencies like the U.S. dollar or Great British pound is missing the point entirely, and that its true value lies in being a new monetary system.

But, if there’s anything about Bitcoin that appears to be predictable, it’s that it will continue to be volatile. In the relative short-term, both camps are likely right: Bitcoin will rise and Bitcoin will fall. But at the moment, it appears the Bitcoin bulls are winning out.

How does cryptocurrency work?

Cryptocurrencies are supported by a technology known as blockchain, which maintains a tamper-resistant record of transactions and keeps track of who owns what. The use of blockchains addressed a problem faced by previous efforts to create purely digital currencies: preventing people from making copies of their holdings and attempting to spend it twice

.

Individual units of cryptocurrencies can be referred to as coins or tokens, depending on how they are used. Some are intended to be units of exchange for goods and services, others are stores of value, and some can be used to participate in specific software programs such as games and financial products.

» Dive deeper. How does Bitcoin work?

How are cryptocurrencies created?

One common way cryptocurrencies are created is through a process known as mining, which is used by Bitcoin. Bitcoin mining can be an energy-intensive process in which computers solve complex puzzles in order to verify the authenticity of transactions on the network. As a reward, the owners of those computers can receive newly created cryptocurrency. Other cryptocurrencies use different methods to create and distribute tokens, and many have a significantly lighter environmental impact.

» Learn more: How Bitcoin mining works

For most people, the easiest way to get cryptocurrency is to buy it, either from an exchange or another user.

Why are there so many kinds of cryptocurrency?

It’s important to remember that Bitcoin is different from cryptocurrency in general. While Bitcoin is the first and most valuable cryptocurrency, the market is large.

There are more than two million different cryptocurrencies in existence, according to CoinMarketCap.com, a market research website

. And while some cryptocurrencies have total market valuations in the hundreds of billions of dollars, others are obscure and essentially worthless.

If you’re thinking about getting into cryptocurrency, it can be helpful to start with one that is commonly traded and relatively well-established in the market. These coins typically have the largest market capitalizations.

Thoughtfully selecting your cryptocurrency, however, is no guarantee of success in such a volatile space. Sometimes, an issue in the deeply interconnected crypto industry can spill out and have broad implications on asset values.

For instance, in November of 2022 the market took a major hit as the cryptocurrency exchange FTX struggled to deal with liquidity issues amid a spike in withdrawals. As the fallout spread, cryptocurrencies both large and small saw their values plummet.

Are cryptocurrencies financial securities, like stocks?

Whether or not cryptocurrency is a security is a bit of a gray area right now. To back up a little, generally, a “security” in finance is anything that represents a value and can be traded. Stocks are securities because they represent ownership in a public company. Bonds are securities because they represent a debt owed to the bondholder. And both of these securities can be traded on public markets.

Regulators are increasingly starting to signal cryptocurrencies should be regulated similarly to other securities, such as stocks and bonds. But this take is receiving pushback; scholars, legal firms and some of the biggest players in the crypto industry have argued against this, claiming the rules that apply to stocks and bonds, for example, don’t apply as broadly to cryptocurrencies.

The Securities and Exchange Commission has set its sights on the sector generally. The agency has raised concerns about activities including crypto staking, and well as the operations of some large crypto companies.

» Learn more: What’s happening with crypto regulation?

Whether the SEC will treat cryptocurrencies, or specific types of cryptocurrencies, as securities will be at the forefront of crypto regulation, and could have major implications for the asset class in the near future.

Pros and cons of cryptocurrency

Cryptocurrency inspires passionate opinions across the spectrum of investors. Here are a few reasons that some people believe it is a transformational technology, while others worry it’s a fad.

Cryptocurrency pros

• Some supporters like the fact that cryptocurrency removes central banks from managing the money supply since over time these banks tend to reduce the value of money via inflation.
• In communities that have been underserved by the traditional financial system, some people see cryptocurrencies as a promising foothold. Pew Research Center data from 2021 found that Asian, Black and Hispanic people “are more likely than White adults to say they have ever invested in, traded or used a cryptocurrency

• .”
• Other advocates like the blockchain technology behind cryptocurrencies, because it’s a decentralized processing and recording system and can be more secure than traditional payment systems.
• Some cryptocurrencies offer their owners the opportunity to earn passive income through a process called staking. Crypto staking involves using your cryptocurrencies to help verify transactions on a blockchain protocol. Though staking has its risks, it can allow you to grow your crypto holdings without buying more.

» Another option: Learn about decentralized finance (DeFi)

Cryptocurrency cons

• Many cryptocurrency projects are untested, and blockchain technology in general has yet to gain wide adoption. If the underlying idea behind cryptocurrency does not reach its potential, long-term investors may never see the returns they hoped for.
• For shorter-term crypto investors, there are other risks. Its prices tend to change rapidly, and while that means that many people have made money quickly by buying in at the right time, many others have lost money by doing so just before a crypto crash.
• Those wild shifts in value may also cut against the basic ideas behind the projects that cryptocurrencies were created to support. For example, people may be less likely to use Bitcoin as a payment system if they are not sure what it will be worth the next day.
• The environmental impact of Bitcoin and other projects that use similar mining protocols is significant. A comparison by the University of Cambridge, for instance, said worldwide Bitcoin mining consumes more than twice as much power as all U.S. residential lighting

. Some cryptocurrencies use different technology that demands less energy.

Governments around the world have not yet fully reckoned with how to handle cryptocurrency, so regulatory changes and crackdowns have the potential to affect the market in unpredictable ways.

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