Once people have covered their bases with their financial plans, some may like to take riskier bets. One option we’ve had a lot of questions about is cryptocurrencies and initial coin offerings (ICOs). So listen up…
You’ve read about it in the news. You’ve seen things online. Your friend Darren swears his cousin’s roommate’s sister in Finland made bank after putting £20 into bitcoin three years ago, and then lost the lot. So just what is all this crypto stuff?
Put simply, a cryptocurrency is a form of digital money that can be used to buy things. It uses secure communication techniques (cryptography – like in The Imitation Game) to process transactions and manage the amount of the cryptocurrency in circulation.
Transactions are typically recorded in decentralized ledgers (e.g. the famous blockchain), so no central authority controls the cryptocurrency or can alter the transactions recorded – unlike with dollars, pounds or euros, which are issued by a central bank. The software tends to be open source, which means anyone can look at it and ensure it does what it’s meant to. Notable cryptocurrencies include bitcoin, ether and litecoin.
An Initial Coin Offering (ICO) is an event where a company will release its own cryptocurrency with the goal of raising funds for its business. A certain amount of crypto-tokens will be released, which people can buy in exchange for another cryptocurrency.
A key departure from the more traditional Initial Public Offering (IPO) is that owning crypto-tokens does not typically mean an investor will own a part of the company (the way owning shares does). Instead, it simply means an owner can exchange tokens for other currencies. Investors hope that successful projects from the issuing company will cause the price others are willing to pay for their tokens to rise.
In some cases, it’s true that owning a large enough number of tokens may confer company voting rights. Either way, ICOs have been criticised by some (including the Chinese government) for their lack of regulation, which potentially encourages criminality and fraud. ICO fans respond that the initiative is simply a cheaper and quicker way to raise money.
Why Should I Care?
It’s the future, yo. Cryptocurrencies are being hailed by many as a revolution in the monetary system: a way of transferring borderless digital money in a secure manner, where everyone can see that the transaction has taken place and is legitimate. Plus, since no single party typically controls cryptocurrencies (though this could change as central banks and investment banks consider developing their own – it’s big in Japan), money can keep on flowing even if a part of the network is down.
It also means they can be used when other forms of money aren’t available, e.g. when you’re traveling to a country whose banks face sanctions. International payments can be made to any country for free, or subject to much lower fees than conventional bank transfers. Meanwhile, the underlying distributed ledger technology has potentially thousands of applications beyond cryptocurrency, from healthcare to vehicle registration.
Cryptocurrencies come with significant risks, however: for one, prices have been extremely volatile (just ask Darren’s cousin’s roommate’s sister). This is partly to do with them being a nascent phenomenon; questions remain over how people will use them, and how regulators will treat them. Also, since anyone with access to a token’s unique code can spend it, it’s possible for hackers to steal cryptocurrencies.
What Can I Do?
If you want to buy cryptocurrency, find an exchange that offers a “digital wallet” and the cryptocurrency you’re interested in, e.g. Coinbase and Gemini offer bitcoin and ether. Note that some services offer digital wallets only and not exchanges, which allows you to hold your cryptocurrency but not buy or sell it.
If you do take the plunge, you should ensure cryptocurrencies are only a tiny fraction of your wealth, as they can be volatile and carry high risks.