Cryptocurrencies are a relatively new phenomenon that have taken the world by storm. There are now thousands of these digital assets, with more appearing every day. So should you buy into the hype and invest in cryptocurrencies, or steer well clear? Here’s our brief guide to the key facts you need to know.
What is cryptocurrency and how does it work?
Cryptoassets or cryptocurrencies are “cryptographically secured digital representations of value or contractual rights that can be transferred, stored and traded electronically”, according to HMRC’s definition.
This basically means a cryptocurrency is a digital asset that can be traded and used to pay for things. It’s not based on any actual asset, so there’s no intrinsic value; the value is determined by supply and demand – essentially, it’s only worth what a buyer will pay. This makes cryptocurrencies speculative, unpredictable and hard to accurately value.
Peer-to-peer transactions
What’s different about cryptocurrencies is that they are not overseen or controlled centrally, and they operate on an open network. Transactions are conducted peer-to-peer rather than being run by a bank or other authority.
They use ‘distributed ledger technology’ (the best-known type is blockchain) to keep a public record of all transactions. It’s a way of synchronising and sharing data globally through a decentralised database, and is meant to prevent double-spending of cryptocurrencies.
Cryptocurrencies are legal, but they’re not legal tender. In the UK, you may have to pay tax on them because they are not eligible to be held in tax-free wrappers such as ISAs.
How many cryptocurrencies are there and what are they worth?
Depending on whether you include failed ones or not, there are around 5,000 to 7,000 cryptocurrencies in existence. Bitcoin is the largest cryptocurrency, with a market cap of around $600bn, followed by Ethereum. Other popular cryptocurrencies include XRP, Tether, and Litecoin. The top five cryptocurrencies currently account for more than 80% of the market.
How to buy, spend and trade cryptocurrencies
There are lots of startups offering ways to trade cryptocurrency, but you might be sceptical about trusting your money to a brand new name. More established platform Revolut, which was set up in 2015, now allows users to invest in currencies like Bitcoin, Ethereum and Stellar.
What are the risks?
There are lots, since the whole sector is kind of like the Wild West. Scams are rife, and the currencies themselves are volatile, but that doesn’t seem to be putting off consumers, and cryptoassets are gaining mainstream acceptance. Back in October, a decision by PayPal to allow its US customers to buy, sell and hold cryptocurrencies including Bitcoin, Ethereum, Bitcoin Cash and Litecoin from 2021 signalled that the use of digital currencies is becoming much more commonplace. However, not everyone is on board with the mainstreaming of crypto money.
UK financial regulator the FCA has stated: “there is growing evidence that cryptoassets are causing harm to consumers and markets”. It recently delivered a blow to the cryptocurrency space by banning cryptocurrency derivatives and exchange-traded notes being sold to retail investors from January 2021.
Translated, this means it’s banning the sale of products based on cryptocurrency prices, but you’ll still be able to buy the cryptocurrencies themselves. The FCA pointed to the difficulty consumers face in working out the real value and risks in these products, and noted the presence of market abuse and financial crime in the secondary market for cryptoassets.
How to choose a cryptocurrency
If you’re still convinced you’d like to dip a toe into crypto, you’ll need to decide which currency you would like to buy. There’s a tonne of information online so start by reading some guides and user reviews. Usually, there will be a white paper for each cryptocurrency when it launches, explaining what it is aiming to do.
Look also at the strength of the user community, the quality of the tech and team behind the cryptoasset and, of course, the currency’s price performance to date. Will it have longevity? What do you think will drive future price movements? If in doubt, start small with one of the more established cryptocurrencies like Bitcoin – read our guide to it here. Keep your wits about you and, before you buy, make sure you educate yourself about cryptocurrency scams.
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
Image Source: Getty Images
About the Author
Hannah Smith
Hannah is an award-winning journalist with a background in the trade press. She writes about finance, asset management and business for Shares, Citywire, FE Trustnet, and interactive investor.
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