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Duration: 6:05

Contributor: Interactive Brokers

Level: Beginner

During the past decade, so-called cryptocurrencies have risen in prominence to become a prominent asset class with significant momentum.

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Study Notes:

The rise of cryptocurrencies has been driven by computer programmers who have implemented the vision laid out in a White Paper posted on Bitcoin.org in 2008 by Satashi Nakamoto. No one knows whether this individual actually exists, or whether the name is simply a pseudonym for a group of people. Nevertheless, the concept of a financial network and system devoid of national boundaries took hold. The result is the arrival of the leading cryptocurrency, Bitcoin but the movement has given birth to more than 2,200 so-called altcoins.

And while Bitcoin is the dominant force, it’s important not to think of these as competing digital coins, but rather as a legitimate approach to how individuals may perform financial, online and physical transactions in the future.

At the time of writing –

  • Bitcoin has a market capitalization of $891 billion with one Bitcoin trading at about $47,400. The number of Bitcoins in circulation stands at 18.8 million units, with daily trading volume of $30.3 billion.
  • By comparison, Tesla’s market cap is $757bn while Visa is capitalized at $491bn.
  • The second most valuable cryptocurrency by market cap is Ethereum at $407 billion.
  • Cardano, Binance Coin and Tether are valued at roughly $70 billion each.
  • Overall, there are currently 180 cryptocurrencies whose market cap is greater than a billion US dollars.  To put that in perspective, Ford is worth $52.6bn while FedEx and General Mills are worth $68bn and $35bn respectively.

Another well-known digital token is Dogecoin, which has a cult-like following using the Shibu Ina meme and popular with young adults. And while the story shows that this was made up by a program er one afternoon in just a couple of hours as a joke, its existence, popularity and penetration all illustrate an important backdrop to what cryptocurrencies are all about.

What are cryptocurrencies and how are they made?

Cryptocurrencies or tokens are small pieces of code that represent ownership of a digital concept, providing value to the owner.

A protocol or network enables owners to transact or pay other network participants without the need to go through a centralized banking system or government.

Records containing a precise history of cryptocurrencies, their creation, transfer and ownership are maintained by the use of what is known as a blockchain.

  • Using a form of blockchain, computer programmers or networks of programs create coins through a process known as mining.
  • They are not technically producing coins, rather they receive digital coins as a reward for providing computing power used collectively to solve complex algorithms in order to verify transactions and ensure the security of the network.
  • Think of cryptocurrency then as the output of a complex computing process that no one owns nor controls.
  • The function of the algorithmic programming is to solve complex puzzles designed to restrict the output of coins through time.

The principal of the blockchain ensures autonomy from governments, central banks and the banking system. This is important because onlookers are increasingly concerned about the potential erosion of traditional currencies.

Another buzzword you will hear nowadays is “fiat” currencies. This simply means that money is traditionally issued by a government or central bank and is backed only by its good faith in the international community. Many years ago, countries would issue currency backed by physical gold, and therefore the wealth of a country determined how much money it could print. And technically, although rarely tested, a holder could demand gold in exchange for the currency. Most countries abandoned the gold standard long ago.

Government policies, the level of interest rates (relative and absolute) and economic growth are factors that can drive inflation and determine the performance of a fiat currency.

Many crypto enthusiasts point to the independence of various blockchains and their freedom from political or institutional interference to justify why digital money cannot be subject to the devastation of inflationary pressures.

Unlike US dollars or euros, such digital tokens are not printed, but reside on a computer network. Cryptocurrencies are created within the framework of the protocol using free distributed software that anyone can download.

Digital exchange of cryptocurrencies or their payment between participants relies upon a cryptographically secured verification process.

Without regulation, the supply of cryptocurrency is a function of computing power, and no central bank, government or authority can influence the volume on record.

There are more than cryptocurrencies, each with its own distinct popularity, application possibilities and technology.

The crypto movement has been building for more than a decade and there is real money flowing into its advancement. An increasing number of corporations have started to accept not just common but also esoteric digital tokens as an acceptable means of payment in exchange for goods and services.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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Disclosure: Digital Assets

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