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Cryptoassets

The basics of cryptoassets

Sponsored by eToro

In a nutshell

  • High risk and volatile, so make sure you only invest what you can afford to lose

  • Bitcoin reached an all-time high in June 2021 and another all-time high in November 2021

  • The market nose-dived in early 2022 with cryptoassets like Luna reaching all-time lows, but some investors are optimistic about long-term growth prospects

What are cryptoassets?

  • 'Crypto' is a synonym of 'concealed’ and takes its name from the Greek word 'kryptos', which means hidden.

  • Cryptography is the study of secure communication techniques.

  • An 'asset' is basically a valuable thing, such as a stock or real estate, held by an individual or a business.

So – voila! Cryptoassets are cryptographic assets or currencies (i.e., Bitcoin).

How do cryptoassets differ from traditional fiat currency?

Key difference #1 – how cryptoassets are stored and distributed

Some of you might think of cryptoassets are like a chain of numbers or letters, and this might seem a bit peculiar since it’s not really something you can hold in your hands. Whereas physical money - at least in the form of cash - is easier for us to recognise. After all, it has been around since 1000 AD.

Cryptoassets are purely digital, stored on the blockchain and are not regulated by central authorities or backed by governments. That is different to traditional 'fiat' currency, like Pound Sterling or US Dollar, which are stored and distributed via central banks and governments.

Key difference #2 – how you make a transaction

Paying for a product or service via Bitcoin, Ethereum or other cryptoassets does not involve a third party (intermediary) like a bank. That means transactions are faster.

Key difference #3 - how the currency operates

Fiat currency is tied to a central banking system, which means the currency grows and contracts in alignment with the economy to attempt to keep prices stable. However, cryptocurrencies are not backed by any third party or organisation. They are created by a process known as ‘mining’, in which miners (computing systems) attempt to solve mathematical puzzles. The first miner to solve the puzzle receives the cryptocurrency.

Key difference #4 - volatility

It’s no secret that cryptoassets are much more volatile than traditional stocks and shares. The value of your investments can go up very quickly – but they can also fall very quickly too. If you don’t have a good plan, you could lose a lot of money if you’re not careful.

The FCA, sensibly, warns that anyone who invests in cryptoassets should be prepared to lose all of their money. That doesn’t mean you will lose your money – it just means you should be aware that there are risks attached to investing in an unregulated industry.

What are some common examples of cryptoassets today?

Bitcoin, Ethereum and Litecoin are among the best-known cryptoassets in circulation.

But none of these would exist without the creation of blockchain technology, which is like another version of the world wide web. 

Sorry, but what on earth is 'blockchain’?

Yes, the term ‘blockchain’ might sound a bit strange. But this is just the name of a shared database that stores data in blocks which, in theory, should be almost impossible to hack into. Think of it as a digital ledger of transactions that is transparent and visible to the public.

There are other forms of cryptoassets, like crypto tokens, hybrid tokens, and crypto commodities such as protocols, networks and storage. But for now, we will focus on the origins of cryptoassets and the rise of Bitcoin.

How can I buy cryptoassets?

  • Choose a reputable platform

  • Deposit money into the platform you intend to buy crypto with

  • Choose how you are going to store your crypto: Are you going to keep it in a hot wallet (online) or a cold wallet (offline)?

  • Some platforms, like eToro, will hold your crypto for you in a cold wallet.

How to reduce your risks when investing in cryptoassets

You need to create a portfolio that will help you successfully navigate changing market conditions, by reducing your risk of incurring big losses when the markets don’t go your way.

Diversify

When it comes to investing, especially with crypto, it’s good practice to diversify your assets in order to help mitigate your risk. Relying too much on a single crypto investment for returns can also lead to a lot of risk when it comes to loss. The same rules apply for traditional investments, too. Think of a freelancer relying on only one client for all their work. If that client's business closes, the freelancer’s entire source of income is lost. But having the same amount of work from ten clients significantly cuts your risk, because the chance of all ten clients' businesses closing simultaneously is much lower.

If you’re crypto-trading, set your stop-losses

What on earth is a 'stop-loss’?

We'll explain. When you make a stop-loss order, you choose to sell a cryptoasset automatically at a specified price when the value of the asset falls below a certain amount. This prevents you from incurring potentially much bigger losses if the value of the asset continues to fall further. In general, a stop-loss can be a great way for you to ensure that you do not lose more money than you initially were prepared to.

Be skeptical of what you read on social media

Many celebrities and influencers are aggressively promoting various cryptoassets, but don't just go with the flow. Do your research. Where did the cryptoasset come from? What is the true objective of this cryptoasset? Is the value being driven up purely by speculation? Is it listed on reputable and well-known platforms?

Cryptoassets - The Numbers

What are the largest cryptoassets by market cap?*

Bitcoin is, by some margin, the largest cryptoasset in circulation today by volume. The combined value of all the world's Bitcoins rose to a shade over $1 trillion by Nov 2021 - although the price can change abruptly (5-year performance: 900%). As of May 30th, 2022, Bitcoin's market cap was $582,769,152,998.

Ethereum is the second largest cryptoasset. Its total value rose to about $549 billion by November 2021, a sharp rise from roughly $70 billion a year earlier (5-year performance: 406%). As of May 30th, 2022, its market cap was $229,049,545,617.

Tether, a cryptoasset on the Ethereum blockchain, takes the third spot. As of May 30th, 2022, its market cap was $72,492,368,944.

USD Coin, a stablecoin pegged to the dollar, takes the fourth spot. As of May 30th, 2022, it had a market cap of $53,665,997,803.

Binance Coin, the native coin of cryptoasset exchange company Binance, takes the fifth spot. As of May 30th, 2022, its market cap was $51,540,687,914.

*By market cap, we are referring to ‘'The total market value of a cryptocurrency's circulating supply. It is analogous to the free-float capitalisation in the stock market”.

(data source: CoinMarketCap)

So how much has crypto grown in recent years?

Cryptoassets have gained value in recent years as more investors are seeing the value in their alternative to traditional fiat currency and the role decentralised finance could play in our modern world. Here’s a quick overview of the growth in market capitalisation (total value) of cryptoassets in the last ten years.

January 4th, 2012: $0.04 billion

January 4th, 2017: $21.05 billion (a 52,525% increase in five years)

January 5th, 2022: $2,348.38 billion (an 11,056.2%% increase in five years as of May 30th, 2022)

More about crypto:

How did crypto get started?

Well, it all started with the global economic crisis of the late 2000’s.

This has sometimes been dubbed the ‘giant reset’ which would inspire Satoshi Nakamoto - the name used to describe the person or persons who created Bitcoin - to come up with the world's first blockchain database. But, as we will describe later in this piece, some people dispute that it was the economic crisis which was responsible for the birth of cryptoassets.

The new digital currency that would sweep the world

In 2009, Bitcoin began to circulate on the internet. A new collection of computers - also known as 'nodes' or 'miners' - began storing Bitcoin's blockchain and code. The new currency was pioneered by 'peer-to-peer' technology, which enabled instant payments to be processed by Bitcoin miners (individuals and companies participating in the Bitcoin network).

By 2014, dozens of new cryptoassets were introduced to the market. Many went bust and into the dustbin of history, but one - Ethereum became one of the star players of the sector and a worthy competitor to the (still-much-larger by volume) Bitcoin.

But what was behind all this? What was the key driver of crypto?

Was the birth of crypto - months after the collapse of the subprime mortgage market in the autumn of 2008 - really a direct response to the financial crisis, or was this timing a mere coincidence?

We also know that Bitcoin's pseudonymous creator was working on a white paper in early 2007, many months before the financial crisis hit. But it's no myth that Bitcoin's creators were deeply unhappy with the global financial system as it stood in 2008.

So perhaps Nakamoto was just waiting for the right time. In 2009, at the height of the recession, they might have anticipated a flood of interest in alternative assets - following the stock and housing market crashes.

But this is still a mystery.

Truth be told - we’ll never know for sure what inspired the birth of crypto.

But what sort of impact could it have on the future?

Crypto enthusiasts argue that Bitcoin, Ethereum and the like have the potential to democratise the free market system by plugging the gaps left by the traditional banking system.

How might crypto create a better global banking system?

The hope is that Bitcoin and other cryptoassets could deliver to the world what mainstream banking has failed to do: transparent peer-to-peer-based transactions that can open up financial services to everyone.

Sorry, what are ‘peer-to-peer-based transactions?

This is when you pay and spend money on services without the need for a third party like a central bank to facilitate that exchange.

But who doesn’t have access to banking in this day and age?

Yes, in the UK or in other developed countries, it would be hard to believe that many people are excluded from banking services. How many adults do you know who have never owned a bank account? Chances are very few, or nil.

But, globally, 1.7 billion people are unbanked (have no access to a bank account).

That’s over twice the population of the US and EU combined!

So how might crypto help solve this problem?

Well, proponents of crypto say the speediness and seamless of crypto transactions - which require no 'middlemen' - could dramatically increase the number of borderless transactions to help spread free markets to underserved regions of the world.

Proponents also argue it can improve the banking system in other ways:

  • DLT (Distributed Ledger Technology) - can help corporations manage and share data more ethically.

  • Payments can become faster and cheaper than those offered by banks.

  • Loans and credit agreements could be available with lower interest rates and better security for the borrower.

  • Through decentralised 'blocks', sensitive information can be stored and shared more securely between financial institutions.

And if that’s not enough - crypto even gets a nod from the world's richest person.

Elon Musk, CEO and Founder of Tesla, endorsed the market last year when he revealed that Tesla would accept DOGE (Dogecoin, a cryptoasset) as a payment for merchandise. In May 2021, after tweeting this to his tens of millions of followers, the price of DOGE rose by over 50% in just one day (5-year performance: 1,964%). It has however fallen by 85% since (May 2022).

But what about the critics?

Crypto has its fair share of critics – one of the most vocal being Warren Buffet.

Despite being one of the world's most successful investors, he described crypto as a 'speculative asset' meaning that he sees the value of crypto investments as being driven by supply and demand rather than intrinsic value (real value) of products.

However, while that may be Buffet’s view, others would argue that as you can use crypto to make purchases for goods and services, then it very much does have intrinsic value.

As more people invest in cryptoassets, demand goes up while the circulating supply is restricted. For example, in 2021, when the price of Bitcoin rose to an all-time high, the demand for this asset exceeded the availability of new coins.

But Buffet likes to invest in undervalued stocks and assets that he perceives generate value. He also doesn’t like putting his money into anything he’s not that familiar with, so he may be a bit biased.

  • Sustainability and environmental impact

Bill Gates said he doesn’t invest in Bitcoin because of his concerns over the carbon footprint and the high amount of electricity required for the mining process. In 2021, during a live chat on the Clubhouse social network, he appeared to echo Buffet's view - saying he preferred companies 'that make products', like vaccines. He issued a disclaimer to anyone investing in crypto who doesn't have as much money as Elon Musk: ‘they should probably watch out’.

In recent years, smaller cryptoassets such as SolarCoin (SLR), Cardano (ADA), Stellar (XLR) have launched and are positioned as most energy efficient alternatives due to differences in the ways they are mined.

  • Volatility

Other critics of cryptoassets have argued that they are too volatile compared to traditional assets like stocks and shares. True: the stock market is more stable than crypto, although some individual stocks, particularly those in high-growth start-ups, can be very volatile too.

  • And is crypto leading to a greater concentration of wealth?

A few years ago, economists of the Project Syndicate not-for-profit international media organisation argued that blockchain had led to a greater concentration of wealth, rather than greater equality and a democratisation of the financial system. However, as we mentioned earlier, others argue it could open up banking services to regions that have been traditionally cut off from mainstream banking.

The bottom line: crypto is like marmite

Crypto is in its infancy and is extremely polarising. People either love it or hate it – although many more still don’t have the faintest idea what it is all about.

Disclaimer:

Cryptoassets are highly volatile and unregulated in the UK. No consumer protection. Tax on profits may apply.

This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation, and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.