Cryptocurrency: The evolution of money, an investment, or both?
It seems everyone and their cat is talking about cryptocurrencies these days. You’d be hard-pressed to spend any conceivable amount of time on the web without hearing about them. Whether it’s the headline-grabbing rise (or fall) in the value of Bitcoin, or the IPO of the latest crypto exchange, cryptocurrency has captured the attention of many investors and it looks like it’s here to stay.
This blog discusses whether cryptocurrencies really are the next evolution of money, how they work and how they fare as investments. However, in order for us to begin discussing what cryptocurrencies are, we must first talk about what money is in the first place.
What is money?
Money has three primary functions, to act as a ‘medium of exchange’, ‘a store of value’ and a ‘unit of account’. We will explore what all of these mean in turn.
A medium of exchange
The first function of money is to serve as a ‘medium of exchange’. This is just a fancy term for any item that lets people buy products and services from one another. Over the course of human history, media of exchange have taken the form of shells, precious metals and rocks. More recently, it has been banknotes and coins.
Media of exchange are very useful in any large or sufficiently complex society because before the invention of money, people used to ‘barter’ – i.e. trade goods with each other directly. If you were an apple grower who wanted some beef, you would have to find a cattle grower and exchange your apples with them.
A store of value
The apples versus beef example above is a simple one, but multiply this scenario by thousands of goods, buyers and sellers and you can see how a barter based system might become tricky to maintain! What if you wanted some beef, but didn’t want an entire cow? Or, if the cattle grower wanted some apples not today, but a month from now? Enter the second function of money, to serve as a ‘store of value’. A store of value is an asset that can be saved and used to buy things in the future, while not losing said value.
A unit of account
‘But how many apples is an entire cow worth?’ I hear you ask. Well if I had a Dogecoin for every time I’ve been asked that question! This is why we need money to perform a third essential function – a ‘unit of account’. Anything that serves as a unit of account helps us ascribe a value to one thing so that we can gauge how much it is worth compared to something else. An apple is worth one coin, a piece of beef is worth two coins, job’s a good’un!
What are cryptocurrencies?
Cryptocurrencies are borderless, digital currencies. Bitcoin was the first cryptocurrency ever created in 2009, and is the most well-known, but cryptocurrencies you may have heard of include Ethereum, Dogecoin, Litecoin and Cardano.
Rather than being printed by the governments of various countries – like the Bank of England does in the UK – they are created using specialist hardware through a process called mining and stored on a decentralised network of computers called a blockchain.
Simply put, blockchain is a type of shared database that exists on a network of computers. Whenever someone transacts with a cryptocurrency, the database is updated across the network but cannot be changed. Blockchain technology offers secure, peer-to-peer transactions without the need for an intermediary like a bank.
Do cryptocurrencies serve as a medium of exchange, a store of value or a unit of account?
Cryptocurrencies are certainly gaining traction as a medium of exchange. Any two people with an internet connection can send cryptocurrency to each other via a cryptocurrency exchange. Also, as of June 2021, at least 10 major companies accepted Bitcoin as a form of payment, including Microsoft, Wholefoods and video game streaming service, Twitch, demonstrating that the use of cryptocurrency to buy real world products and services is making its way into the mainstream.
Bitcoin has been designed in such a way that only a finite number of coins will ever be created. In addition to this, the rate at which Bitcoins are being created is also decreasing over time due to the increasing complexity of calculations needed to mine them. It is estimated that the 21 million Bitcoins that will ever come into existence will not finish being mined until 2140. This fixed nature of Bitcoin’s supply is partially responsible for why it is seen as a strong store of value, much like gold.
What is less clear is whether cryptocurrencies function as a viable unit of account at this stage. Electric car company, Tesla, used to be one of the major organisations that accepted Bitcoin payments, but after Elon Musk’s stark warning in May 2021 that ‘Tesla has suspended vehicle purchases using Bitcoin’ followed by his concern about the ‘rapidly increasing use of fossil fuels for Bitcoin mining and transactions’, the value of Bitcoin crashed by at least 27% in one week, a drop in price it hasn’t since recovered from.
This crash in May 2021 is one of seven crashes Bitcoin has experienced of at least 50% since June 2011. This is far too volatile for some.
Do cryptocurrencies make a good investment?
There is no denying the huge gains that cryptocurrencies have made in recent years. Despite the volatility, over the past five years the value of Bitcoin has increased 63-fold, the value of Ethereum, 218-fold, and the value of Litecoin, 37-fold. This is compared to a 2-fold increase in the value of the 500 largest publicly traded companies in the United States (the S&P 500) and a virtual moving sideways in the value of the FTSE 100 (the UK’s 100 biggest publicly traded companies. However, there are a few age-old principles worth noting here.
It can be very difficult to make money on an investment that everyone is already aware of, due to the fact that this knowledge could push up the prices, meaning that you could end up buying when the market is already ‘up’. It can also be risky to put all your money into just one investment, as the lack of diversification will leave you exposed should that investment underperform. Lastly, wealth built through investing is generally a slow process, one that is measured in decades and years, rather than weeks and days.
Whatever your personal appetite for cryptocurrency investment is, make sure you fully research whatever you choose to invest into, aim to invest for the long term, and maintain a balanced and well diversified portfolio. For a continued and extensive discussion around the pros and cons to consider before investing in cryptocurrency, check out comparetheplatform.com’s three-part blog series ‘Should I invest in cryptocurrency? All my friends are doing it!’, parts one, two and three.
While the viability of cryptocurrency as an investment remains to be seen — most cryptocurrencies have been created within the past decade — it does look like cryptocurrency will have some part to play in the evolution of money.
There are a growing number of organisations that let you buy, sell and transact in cryptocurrency, and there were even reports in April 2021 that the UK government is exploring launching a cryptocurrency of its own. It is prudent to keep an eye on new technologies as they develop, lest we end up like Bill Gates in 1993, who, when asked about Microsoft’s position on the internet, responded: “The internet? We are not interested in it”.
Whatever your investment choices, you can use the tools and guides on comparetheplatform’s website to select a platform and investment style that suits you best.
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