Welcome to the world of internet money
At the most basic level, cryptocurrencies can be thought of as internet money. It is money. But it only exists online.
That means you won’t get any notes or coins to rattle around your pocket, but the concept should not be as unfamiliar as it sounds.
If you have ever collected Tesco Clubcard points, Nectar points or air miles, you have essentially collected some kind of currency that doesn’t look much like the money you put in a piggy bank. These tokens are created from nothing; spirited into existence when you either earn them or buy them.
All of these are digital “currencies”, which you can exchange for products, but it’s worth remembering this:
If the company issuing them suddenly went out of business, the coins would be worthless. If Tesco closed down, your Clubcard balance is irrelevant. If your airline was permanently grounded, there’s no point in having air miles. If Nectar shut up shop the points would be useless.
Up to a point, the same can be said of conventional banks and money. If a bank goes out of business, you might lose your money or, at least, have difficulty accessing it. Though there are safeguards, this is exactly what happened to some people during the 2008 financial crisis.
How cryptocurrency is different
Cryptocurrencies—the best known of which is bitcoin—are similar to supermarket points, air miles or other reward points, but they don’t rely on any person or business for their value.
To stop the problem of a central authority (like a bank or a supermarket) disappearing overnight, most cryptocurrencies embrace a concept known as decentralisation.
Bitcoin has no central organisation. There’s no central bank and no government behind it. It just exists. Transactions in bitcoin are validated by the people on either side of the deal, rather than by a separate entity, and complex mathematics are used to ensure that validations are accurate. [See “Blockchain”]
What would happen if bitcoin’s inventor disappeared? That happened, and bitcoin went on to reach $20,000 in value without its originator, the mysterious Satoshi Nakamoto.
Why is that so good?
Cryptocurrencies have huge potential. They could do for the world monetary system what the internet has done for communication and information sharing.
Imagine a world where you could instantly send physical money from one part of the world to another without massive fees. Cryptocurrencies like nano, ripple and OmiseGO are working on solving that problem right now—and there’s no bank getting in the way to complicate things.
Similarly cryptocurrencies could revolutionize contracts (ethereum), verification (VeChain) and monetary transfer, and in the process make a lot of people very rich.
The mainstream has recently caught on to what smart investors have known for some time: this technology is extremely valuable and owning a bit of it is a very clever idea.
Normally when opportunities like this come up, the general public are excluded from the biggest gains. When the first dot-com companies arrived in the 90s, most of those were funded by accredited US investors.
But anyone, anywhere in the world can invest in cryptocurrencies. It’s the first time ever that anyone can play.
What’s the catch?
Cryptocurrencies are a great opportunity that comes with substantial risk. The technology isn’t quite there yet, but isn’t far off. There will be winners and losers.
Firstly, because there’s no central bank, there’s no way to get a refund when something goes wrong. If you lose control of your cryptocurrency wallet, you lose control of your money.
The combination of a multi-hundred billion dollar market and lack of regulation attracts bad people. If someone creates a cryptocurrency, potential buyers need to be very aware that there’s not a whole lot of regulation to help you out of a hole if things go wrong.
That might sound somewhat scary, and that’s because it is. Cryptocurrencies are a very high risk asset. In fact, they’re so high risk that you should never ever put any money into them that you might need to see again. That’s just smart investing.
But it’s also worth remembering that though governments and banks tell us that cryptocurrencies are used in criminal activities, both governments and banks use physical money when they break the law. HSBC laundered so much physical money for Mexican and Colombian drug cartels that the Mexican cartel used special boxes specifically designed to fit as much cash as possible into the teller booths.