In recent years, cryptocurrency has emerged as a transformative, intriguing, and immensely popular asset class.

If you’re a new investor eager to explore the world of crypto, it’s important to understand its basics, benefits and risks. Here’s a primer.

What is cryptocurrency?

Cryptocurrency is a digital asset that uses cryptography for secure transactions, independent of any central authority like banks or governments. The most well-known cryptocurrency is Bitcoin, but there are thousands of other digital assets available today, each with its own unique features and purposes.

Starting in the 1990s, many people tried to create digital currency systems, but they all failed. Satoshi Nakamoto — the pseudonym given to an unknown inventor or group of inventors — was the first to succeed. In 2008, Nakamoto created Bitcoin as an electronic peer-to-peer trading network. Since then, the world has seen an explosion of similar digital assets, which are often called cryptocurrencies because they can be used to purchase things, just like traditional currencies such as the dollar.

Bitcoin is still the most dominant player in the cryptocurrency market. As of mid-May 2023, Bitcoin held the largest share of market capitalization with over $500 billion of the approximate $1.20 trillion global cryptocurrency market capitalization.

The practice of using digital assets, or crypto, to purchase goods and services was established as early as 2012 by the open-source content management system WordPress. Other companies, such as Overstock and Expedia, soon followed suit. Now, many others, such as AT&T, Microsoft, and PayPal make it easy for customers to spend their digital assets by accepting them as a form of payment.

However, it is not difficult to understand why some merchants will not accept cryptocurrencies as payment. These assets can be surprisingly volatile, and values can plummet significantly even in one day. For example, consider some recent values for Bitcoin.

In dollars, the price of one Bitcoin rose from about six cents in 2010 to an all-time high of $67,567 on November 8, 2021. Then, the price quickly tumbled, falling 30 percent by the end of 2021, only seven weeks later. Investors quickly shifted their focus to safer assets, and volatility has continued.

Cryptocurrency benefits

Decentralization: Some cryptocurrencies operate on decentralized networks, removing the need for intermediaries like banks. This enables peer-to-peer transactions, eliminating some of the fees and delays associated with traditional financial systems. It also means that transaction data are not stored in a single location but hosted by millions of computers simultaneously and accessible to anyone on the internet.

Hypothetically, this means the data cannot be controlled by any single entity and has no single point of failure. However, in practice, most people hold their digital assets on one of the major platforms, like Coinbase, where things are highly centralized. To take full advantage of decentralization, you’d need to store your digital assets on a hardware wallet instead.

Security: Cryptocurrencies use advanced cryptographic techniques to secure transactions and user identities. This enhances security and reduces the risk of fraud or identity theft.

Global accessibility: Cryptocurrencies allow anyone with an internet connection to participate in the global financial system. They also provide financial services to the unbanked population, fostering financial inclusion and empowerment.

Potential for high returns: The crypto market has experienced significant growth, resulting in substantial returns for early investors. However, it’s important to note that this potential for high returns comes with increased volatility.

Cryptocurrency risks

Market volatility: These assets can be highly volatile, with prices experiencing rapid fluctuations. While this volatility can lead to significant gains, it also poses a considerable risk of losses. Investors must be prepared for price swings and potential market downturns.

Regulatory uncertainty: Digital assets operate in a regulatory gray area in many countries. Governments worldwide are still formulating regulations to govern this nascent industry. Changes in regulations can impact market sentiment and the value of cryptocurrencies.

Security concerns: While digital asset technology is typically secure, the surrounding infrastructure, such as cryptocurrency exchanges and digital wallets, can be vulnerable to hacks and cyber-attacks. Investors must adopt stringent security practices and choose reputable platforms to mitigate these risks.

Lack of fundamental value: Unlike most traditional investments, cryptocurrencies do not derive their value from underlying assets or earnings. Instead, their value is driven by market sentiment and speculation. This speculative nature can lead to unpredictable price movements.

Before you purchase any digital asset, do your research to fully understand the risks associated with the purchase. If you choose to proceed, it’s a good idea to invest only what you can afford to lose. And remember that when you sell these assets, you will realize a loss or gain and may owe corresponding income tax.

Of course, when we invest in cryptocurrency, we are hoping for a gain. But due to the nature of the asset class, we need to be prepared for a loss. In the future, mainstream views regarding digital assets may change, but for now, they are still considered speculative. As an investor, it’s important to treat them as such.

Teri Parker is a vice president for CAPTRUST Financial Advisors. She has practiced in the field of financial planning and investment management since 2000. Reach her via email at Teri.parker@captrustadvisors.com.