Understanding the basics of bitcoin and cryptocurrency can be tough. This is a brief bitcoin and cryptocurrency 101, and learn about investing in them.
The rapid rise in the price of bitcoin and other cryptocurrencies has attracted the attention of investors, financial companies, regulators, and the media alike. While many have had their interest piqued, it can be challenging to understand the basics of bitcoin and other cryptocurrencies.
There are a few reasons for that. First, there is a lot of technical language involved, particularly if you’re trying to understand how the software works. Also, many cryptocurrencies are experimental open-source projects and there is disagreement about how they should evolve among developers, miners, and early investors who have large holdings, and therefore a lot of influence. Then there is the issue that the concept alone challenges many people’s conventional notions of money. Cryptocurrencies have been called everything from the future of currency to outright scams and Ponzi schemes.
In this article we will provide a brief overview of Bitcoin and cryptocurrencies, review how they are used, and discuss some risks to consider if you’re thinking about buying cryptocurrency-related stocks and ETFs.
Cryptocurrencies, also often referred to as coins, are digital currencies that are secured through cryptography, the enciphering and deciphering of messages in secret code or cipher. Many of them rely on blockchain technology—a distributed ledger of all transactions that is decentralized and unable to be changed under most circumstances as long as nobody controls more than 50% of the computing power on the network.
Unlike traditional currencies, they are not controlled by any central government or authority. In the case of some of them (Bitcoin, Monero, and Litecoin for example), the supply of new coins is controlled by a process called mining, a computationally intensive process where computers (mining nodes) compete against each other to secure the network by solving mathematical equations, collecting bitcoins as a reward if they are the first to create a new valid block, which is then broadcasted to the rest of the network and added to the blockchain.
Other coins are pre-mined, where the mining occurs before the public launch of the coin. Pre-mined coins are sometimes viewed in a negative light as they are often heavily promoted to increase demand and drive up the price, allowing developers to cash out.
Since many of them have been created as open-source software, they continue to evolve as developers work to implement solutions to address problems that arise. Some of the common problems include scalability and security issues.
From a market cap perspective, Bitcoin is far and away the largest. As of December 17, it accounts for $328 billion out of the total value of $598 billion across the 1,360 cryptocurrencies that coinmarketcap.com tracks.
With Bitcoin, the original developer Satoshi Nakamoto set out to create a “peer-to-peer electronic cash system”, according to the Bitcoin whitepaper. The whitepaper was written under what appears to be a pseudonym and there is much mystery around the original creator’s true identity. People that track the Bitcoin network’s early activity estimate that whoever Satoshi Nakamoto actually is holds roughly 1 million bitcoin, worth approximately $18.6 billion based on recent prices. To add further to the mystery, it seems a minimal amount, if any, of this bitcoin has been moved/spent.
One of the big innovations of Bitcoin was creating a system that did not rely on trusted third parties to process electronic payments; instead it relied on the consensus of the nodes on the network. It also created a currency where the supply could not be altered by any central bank or government. That might not seem like as big of a deal in a country like the U.S., but in places like Zimbabwe and Venezuela that have experienced hyper-inflation due to excessive money printing by corrupt governments, this is of greater concern.
Beyond bitcoin, according to data on coinmarketcap.com there are 27 other coins that have a market cap of $1 billion or more (as of December 17). Ether, Ripple, Litecoin, Dash, Monero, Zcash and IOTA are just a few examples.
The features and purpose of different coins vary. Several were created by developers looking to solve shortcomings of certain coins or provide additional features not present in others. For example, Bitcoin isn’t fully anonymous. The ledger can be viewed by anyone and the flow of funds can be traced to and from different Bitcoin addresses, although there is no private information linking you to your Bitcoin address. Other coins have been developed to provide full anonymity.
Here are some of the basic, non-technical terms you’re likely to come across as you read about cryptocurrencies:
There are some merchants that accept bitcoin and other cryptocurrencies directly from a user’s wallet. Even though some of them have very high prices, they are divisible into very small fractions. Bitcoin, for example, is divisible down to a “satoshi”, which represents 0.00000001 of one bitcoin.
Some companies have created ATMs where you can use U.S. dollars and other fiat currencies to buy bitcoin and sell them to get cash. There are also companies that have created debit cards where you can convert bitcoin into dollars and use just like you would any other debit card.
Other cryptocurrencies have more specific uses and are used to pay for services on a certain network. For example, Ether is the digital currency used for operating smart contracts on the Ethereum network.
While you can’t purchase cryptocurrencies directly through regulated exchanges, there are ways for investors to get exposure to these markets. It’s important to acknowledge these are higher-risk investments and the cryptocurrency-related aspects of these companies could comprise a minimal part of their overall business.
One way is to research what kind of equipment miners are using. Several semiconductor companies such as Nvidia (NVDA) and Advanced Micro Devices (AMD), produce chips used in the mining process. There are also different companies that accept bitcoin as payments. Microsoft (MSFT) and Overstock.com (OSTK) are two examples, and e-commerce platform Shopify (SHOP) allows merchants the option of accepting them as a payment. Square (SQ) also recently announced it would allow a small number of users to buy and sell bitcoin on Square Cash.
There are several U.S. fund companies that have filed papers with the SEC to list bitcoin ETFs, but none of these products have been approved so far. Investors might also come across the Grayscale Bitcoin Investment Trust (GBTC), an open-ended trust. It is a highly speculative investment and, historically, the product has traded at a high premium to its net asset value. If you are thinking about investing in this product, there are other unique risks to consider. You can learn more about them by reading Grayscale’s FAQ and disclaimers.
For traders with a high risk tolerance, both the Cboe and CME recently rolled out bitcoin futures. If you’re looking to learn more about those products, start with this article on The Ticker Tape.
First and foremost, these are experimental products with short trading histories and it’s important to understand there are extremely high risks with the potential to lose money if you choose to invest in cryptocurrency-related equities, and ETFs if they become available.
While it might not be possible for governments to regulate cryptocurrencies directly, they can regulate exchanges and third-party wallet providers, making it more difficult to use them. This could drastically alter the dynamics of supply and demand and limit their potential use.
Another thing to consider is your personal risk tolerance and how you’ve handled major corrections in the past with your other investments. Cryptocurrencies can be extremely volatile and cryptocurrency-related securities can experience similar price swings. If you don’t think you can psychologically or financially withstand double-digit percentage swings in a short period of time, you should probably steer clear.
To read more about risks, both the SEC and FINRA have issued statements providing their views on cryptocurrencies and initial coin offerings:
The CFTC also has a bitcoin information page that you might want to check out as well.
Remember, there’s nothing wrong with sitting on the sidelines and watching everything play out until cryptocurrencies have matured a bit more. Don’t let the fear of missing out drive you to take on too much risk and make emotional decisions with your money. In light of the unique aspects of these new currencies, it’s a good idea to do an extensive amount of research.
Have questions about bitcoin futures? Check out the TD Ameritrade Bitcoin Futures Page.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, leverage risk, credit risk and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.
Futures trading is speculative, and is not suitable for all investors. Please read the Risk Disclosure for Futures and Options prior to trading futures products.
Futures accounts are not protected by the Securities Investor Protection Corporation (SIPC).
The risk of loss in trading stocks, options, futures and forex can be substantial. Clients must consider all relevant risk factors, including their own personal financial situation, before trading.
Futures and futures options trading services provided by TD Ameritrade Futures & Forex LLC. Trading privileges subject to review and approval. Not all clients will qualify.
All investing involves risk, including loss of principal.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 TD Ameritrade.