Part of the lure of investing in digital currency is the ease of entering the cryptocurrency market. Anyone can hop onto a cryptocurrency exchange, fund an account and begin buying and trading bitcoin, ethereum and other cryptocurrencies straightaway.
Once you've entered the crypto market, you'll want to measure and track your cryptocurrency investment's worth and liquidity over time.
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Cryptocurrency Value and Circulating Supply
Until 1971, the U.S. dollar was backed by a physical commodity: gold. Before that time, in theory, an American dollar was redeemable for its value in gold.
When President Nixon ended the gold standard, the U.S. dollar became a fiat currency, meaning it wasn't backed by anything but the government's creditworthiness. The issuing government also controls how much of a fiat currency is produced.
Cryptocurrencies are similar to fiat currencies in that they are not backed by a physical commodity. A cryptocurrency is a medium of exchange that isn't issued or backed by a government, central bank or central authority. The backing for virtual currency is blockchain technology. And the circulating supply comes from users, like those performing Bitcoin mining.
Is Your Digital Currency Legal Tender?
While bitcoin and other digital currencies are not legal tender in almost any country, they are not illegal to use or hold in most countries. In the U.S., the IRS now wants to know when you sell cryptocurrency, convert it into U.S. dollars or use virtual currency as a medium of exchange. That makes it clear that cryptocurrency's value is being officially recognized.
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Cryptocurrency Valuation and Volatility
Like any asset, the price of different cryptocurrencies is based on supply and demand. When there is high interest in the circulating supply, the price increases. If demand goes down, so does the crypto's price. The value of any cryptocurrency can change at any moment, depending on market demand.
The supply of Bitcoin, for instance, is capped at 21 million. It is estimated that there are only 2 million more to be mined, which is predicted to happen by 2140. This finite supply drove Bitcoin's price, which reached an all-time high of $68,000 in November 2021.
However, even the rarity of Bitcoin doesn't keep demand steadily rising. The price of Bitcoin recently fell below $40,000. Ethereum has risen sharply since its launch in 2015 but has experienced many fluctuations in the past year.
As a relatively new tradable asset, Ethereum, Bitcoin and all cryptocurrencies are very sensitive to volatility. Until cryptocurrency is stabilized by more widespread, legitimized use, its pricing and value will continue to experience fluctuations based on public sentiment and government regulation.
Take Elon Musk's poke at Dogecoin on Saturday Night Live in May 2021. Musk called the cryptocurrency a "hustle" – and Dogecoin dropped 36 percent by morning.
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Cryptocurrency as a Store of Value
According to blockchain and cryptocurrency expert Primavera De Filippi, the main function of Bitcoin (BTC) is a store of value. In other words, its strength isn't as a unit of payment or account but because, like gold, it is scarce and used to store value.
Legendary trader Warren Buffet disagrees, preferring productive assets that create something for the investor, rather than a more speculative investment like Bitcoin or other crypto with a value dependent upon a pool of people who buy it solely because they want to.
Corporate Finance Institute (CFI) defines something with a good store of value as "an item (that) can be held and converted into money in the future without a decrease in value."
As of now, due to volatility, perhaps Buffet's position describes cryptocurrency in the present, while De Filippi's vision looks to a more stable future.
Market Capitalization and Cryptocurrency
The market capitalization, or market cap, of cryptocurrency is the total dollar value of all the available coins multiplied by their price. This metric helps investors see value and growth potential.
Currently, all digital currency has a market cap of over $1.72 trillion, with Bitcoin holding the largest market cap of $702 billion and Ethereum at $319 billion. The remainder is split up among more than 9,000 other virtual currencies.
The market cap of an individual digital currency reveals the relative size and growth potential of different cryptocurrencies compared side-by-side.
SEC Regulation Cryptocurrency Exchanges
The U.S. Securities and Exchange Commission (SEC) goal is to protect investors, maintain fair markets and help investors make informed decisions. In a 2017 statement, the SEC warned of the lack of investor protection and increased potential for fraud in initial coin offerings (ICOs) and cryptocurrency trading platforms.
More recently, Gary Gensler, chair of the SEC, warned that crypto traded on DeFi platforms might be subject to SEC rules. Gensler stated his mission to ensure investor protection and uncover wrongdoing in cryptocurrency exchanges.
Your cryptocurrency investment isn't an SEC-regulated, protected financial product. The cryptocurrency market is rife with volatility and speculation. But there is a reason nearly half of millennials are comfortable having some crypto in their portfolios. Investing in digital currency is a high-risk, long-term option that may fit into a diversified investment portfolio.
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- International Monetary Fund: Crypto Prices Move More in Sync with Stocks, Posing New Risks
- Boston College News: Demystifying Cryptocurrency
- Federal Trade Commission (FTC): What to Know About Cryptocurrency
- Brookings Institution: 5 Myths About Cryptocurrency
- Investor.gov: Thinikng About Buying the Latest New Cryptocurrency or Token?
- Internal Revenue Service (IRS): Virtual Currencies
- Commodity Futures Trading Commission (CFTC): Digital Assets Primer
- CFTC: An Introduction to Virtual Currency
- MIT Sloan School: Blockchain Explained
- IMF: Making The Digital Money Revolution Work for All
- The Harvard Gazette: Taking the Crypto Out of Digital Currency
- Foundation for Economic Education (FEE): Everything You Need to Know about Dollar-Denominated Cryptocurrencies
- Corporate Finance Institute: Fiat Money
- Census.gov: Legal Tender
- IRS: FAQ on Virtual Currency Transactions
- Reuters: Dogecoin tumbles after Elon Musk calls it a ‘hustle’ on ‘SNL’ show
- CNBC: Warren Buffet: Bitcoin Is an Asset that Creates Nothing
- Berkman Klein Center: Primavera De Filippi
- Corporate Finance Institute: Store of Value
- Corporate Finance Institute: Market Capitalization
- U.S. Securities and Exchange Commission: Statement on Cryptocurrencies and Initial Coin Offerings
- U.S. Securities and Exchange Commission: Office Hours with Gary Gensler
- U.S. Securities and Exchange Commission: Statement on DeFi Risks
- Acorns: 12% of millennials think crypto is the best way to invest money they won’t need for 10 years or more