Cryptocurrencies have been available to buy and trade for over a decade now, and it’s clear they’re more than just a passing fad. But many people are unclear about precisely what they are, how they work, what you can use them for, and whether the stories of people getting rich on “crypto” are actually true.

What are cryptocurrencies?

Cryptocurrencies, of which Bitcoin is the largest and best-known, are digital currencies that can circulate without the need of a central monetary authority, like a bank or government.

You can buy and sell cryptocurrency via an exchange (of which there are now many). Individual units of crypto, often referred to as coins or tokens, are held on a trading platform, or in a digital wallet. While they aren’t accepted as payment in the vast majority of places, you can sometimes use them to buy goods and services online, or trade them for profit.

The value of crypto is purely determined by market forces generated by the people who want to buy and sell them. They have the same value in each country and there are no exchange fluctuations, which makes person-to-person transfers around the world easier.

The Financial Conduct Authority (FCA), describes crypto as “very high risk and speculative"

How does it work?

Most cryptocurrencies are supported by an open-source technology known as blockchain. This enables digital property to be transferred between internet users and keeps track of who owns what.

Blockchain is a type of database that essentially holds a public ledger of every crypto transaction that has taken place. It’s supposedly tamper-proof, and according to supporters of cryptocurrencies, is more secure than traditional payment mechanisms.

Different cryptocurrencies are created using different methods, but one of the main methods is ‘mining’. Miners are people with the computer power to solve complex mathematical puzzles that can verify and log the authenticity of transactions on the network. As a reward, miners are paid with newly created cryptocurrency.

For some cryptocurrencies, like Bitcoin, there is a finite limit to the number of coins that can ever be mined. As more of those coins enter circulation, it gets harder to mine them, as the puzzles become increasingly complex. Mining computers require a huge amount of energy to process such complex puzzles, and environmentalists warn that the rise of crypto could significantly impact the world’s attempts to reduce its energy consumption.

To find out more, a short video by the Bank of England explains how it works.

How have cryptocurrencies performed?

Cryptocurrencies are extremely volatile. So much so, that the UK’s financial watchdog, the Financial Conduct Authority (FCA), describes them as “very high risk and speculative”, with an added warning that anyone investing in crypto assets should be prepared to lose all of their money.

For instance, in June 2012, one Bitcoin was worth just a few pounds before reaching the heady heights of £50,000 in November 2021. But today, just 9 months later, it’s worth nearer £20,000. It’s a similar story across the various other cryptocurrencies in circulation, with some recording even more spectacular rises and falls.

Having heard ‘get rich quick’ stories from those early adopters (everyone knows one), many people have been tempted to invest. But investing now is a bit like playing roulette. You could make significant returns if you’re lucky, but equally, you could lose everything.

In 2021 over two million people in the UK own cryptocurrency, but their median holding was £300

How is crypto regulated?

Outside of the blockchain environment, cryptocurrencies are not regulated, and some countries, such as Turkey, have even banned crypto payments completely.

In the UK, if you buy crypto assets and things go wrong, you’re unlikely to be able to turn to the Financial Services Ombudsman Scheme (FSCS) for assistance.

Should I invest in crypto?

In 2021 the FCA estimated that over two million people in the UK own cryptocurrency, but their median holding was £300.

You are unlikely to find a qualified financial planner who advises you to invest in crypto, and the vast majority will tell you to steer well clear. It’s volatile and unregulated – an investor’s nightmare.

However, people that are prepared to lose all of the money they put in may still decide to buy a small stake and see what happens, on the basis they may be one of the lucky ones.

Life Landscaping® from Amber River

Are you seeking advice about building an investment portfolio as part of your financial plan? An Amber River financial planner won’t advise you to invest in crypto, but they will advise you on how to build a fully diversified investment strategy that matches your attitude to risk, and helps you achieve your life goals.

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