Budget Girl’s note: My official recommendation for anyone wanting to build wealth and improve their financial situation is to use the bulk of their investing funds to purchase total stock market (or similar) index funds regularly and hold for the long term. Emerging currencies like crypto are exciting, but have serious risks and you should not invest anything you cannot afford to lose.
Budget Girl always is committed to financial transparency and seeks to clear the fog on some of the more obscured forms of investment. This article is an overview of the basic terms and functions of cryptocurrency so that you can be better prepared when considering whether to invest in this new financial platform.
Additional note: Crypto has taken a massive dive due to China announcing a ban on mining the currency. Crypto has had giant upswings and dives since its invention in 2009, and is still a very young platform.
Why should I care about Crypto?
In 2021, to many economists and Americans’ shock, cryptocurrencies like Bitcoin and Ethereum topped the charts of asset classes for percentage returns on investment (ROI).
- Bitcoin rose by over 100% from January 1st of 2021 to December 31st of 2021. It went from $32k to $69k in 12 months.
- Ethereum rose a shocking 600%, going from $775 to $4800 in 12 months.
Studies by the US Treasury showed that almost one-third of all Americans hold crypto of some kind and yet…there’s a fundamental piece of the puzzle missing.
While many people are invested in this asset class, almost none of them understand it, or could explain it, on a basic level. This has left a giant question hanging over most people’s heads:
What the Hell is Crypto?
Quite frankly, most online explanations are terrible. They dive too deep into the technicalities of Blockchain, bitcoin mining, and other buzzwords that mean absolutely nothing to someone outside of the space.
So rather than confuse you with complex explanations and big words, the goal of this article is to break down cryptocurrency and its basic thesis to the simplest levels.
Basic crypto terms explained
The core ideas behind the crypto industry existed for a long time before Bitcoin was first created in 2009. As far back as 1980, there are records of computer scientists and economists who proposed the core thesis of Crypto: a Decentralized, Disintermediated, Distributed, and Trustless system of value exchange.
This is precisely what Bitcoin and all other cryptocurrencies seek to achieve but what exactly do each of these ideas mean? There are four basic terms you need to understand.
There is no one person or group that controls the flow of value. This idea aligns heavily with that of a total democracy; all decisions about the currency are made by every single participant/holder of Bitcoin. There is no government to control the currency. This also means there is no central point of failure by which the network could collapse.
In traditional currencies, if you wanted to send money over the internet, you would need third-party organizations like Banks or companies like Paypal to facilitate your transactions. With Bitcoin, you can have uninterrupted peer-to-peer transactions.
Similar to Decentralized, Distributed means that the computing/work producing portion of the Bitcoin network is handled by thousands of different computers, rather than a handful of large servers and supercomputers. This again eliminates a central point of failure.
Similar to Disintermediated, Trustless means that there is no need for organizations or banks to facilitate trust between parties. Rather, this trust is created by the code that runs the Bitcoin network.
Phew! That wasn’t that bad, right?
So Bitcoin, at its heart, is built around the philosophy that currency shouldn’t be controlled by any key group. Instead, there should be no central points of failure, and decisions about the currency should be made by every holder of said currency.
How it Works
Bitcoin is just advanced code. When people refer to the Bitcoin “Blockchain” they are simply referring to the database that protects the Bitcoin network.
Bitcoin is similar to the internet in a number of ways; the internet has a large database that contains all the necessary info to keep the system running. Bitcoin does the same thing. The primary data that Bitcoin stores in the history of transactions. Every single transaction that takes place on the Bitcoin network is recorded and fact-checked to ensure the safety of funds.
Say, for example, that you were to send fifty dollars of Bitcoin to a friend. You and your friend would both connect to the Bitcoin network. You would initiate a transaction and confirm that you want this action to take place, similar to placing an online order.
The Bitcoin network would then record all the details on your end. Then send your money to whatever destination you had specified for your friend.
All transactions that take place on the Bitcoin network are processed and verified by Nodes. “Nodes” are computers that use their computing power to help run the code behind Bitcoin.
Your transaction is verified by thousands and thousands of these computers from all over the world. They work to help each other store the data and make it nearly impossible to hack, protecting your ownership.
The Pros and Cons
Is Crypto necessary?
Considering that there is no physical asset to guarantee your ownership (like a gold bar or physical cash paper), the legitimate question arises about whether it is even necessary for the currency to exist.
Modern fiat currency, otherwise known as day-to-day paper money, has functioned just fine for the past hundred years. So why change the system at all?
Both of these questions circle back to yet another question: Who owns your money? The answer is, of course, you… but do you really?
But do you own your money?
If a bank really wanted to or was forced to due to extreme financial crises, they can easily halt all withdrawals from an account, hundreds of accounts, or every single account in the bank. Read more about this unethical practice HERE, or look into the legislation of the Dodds Frank Act here.
This happens rarely, but it has happened. In the 1930s during The Great Depression, President Roosevelt gave an executive order shutting down all banks temporarily, effectively cutting off people from the money they owned.
Essentially, if a bank is in danger of collapse, it can freeze all withdrawals and use money in consumer accounts to sustain itself. Or if times get even worse, and banks collapse completely, they wouldn’t be able to pay out to their customers. While most citizens of the United States have never seen this happen, that is not the case in other countries. People from foreign nations have seen and continue to see the collapse of their currency and banking system. For example, the collapse currently taking place in Afghanistan.
The proposition of Bitcoin is this: when you own the currency, no bank or financial institution can freeze your finances or use it for their own benefit. The technicalities behind this begin to get a bit more complex, but this is the essential value proposition of Bitcoin.
The Volatility Issue
Despite some of the major benefits to Bitcoin and cryptocurrency, there are a number of deep issues within the industry.
While the goal is for Bitcoin to be a reserve currency that acts as an edge against inflation, it can often work much more like the stock of a company. Like any other industry, market collapses and falling asset prices affect the crypto industry. From mid-November to the end of January 2022, Bitcoin as a whole saw a price collapse from $69k to $35k in value (an almost fifty percent loss).
This massive volatility is one of the biggest issues in the crypto industry. Despite all of the idealistic hopes of Bitcoin and crypto becoming an actual stable currency, the reality is that this isn’t the case in 2022. Overall, the crypto market should be looked at more like an emerging market and/or an investment opportunity, rather than a good place to put all of your money. Had you put $1000 into Bitcoin in December of 2021, you’d have seen a thirty percent loss in that money.
No Going Back
Not only is the crypto market volatile, but transactions are often irreversible. One inherent piece of Bitcoin, as mentioned before, is that it allows direct peer-to-peer transactions. This means that once you send your money to another person, or commit your capital to some purchase, it’s almost impossible to get that money back.
In some extreme cases, such as accidental million-dollar transfers, the community has come together to refund and help individuals. Unfortunately, if you send $500 to the wrong location, there’s no getting it back.
With this issue in mind, individuals should tread carefully when they’re working with their cryptocurrency to avoid losing money. There is a learning curve to the crypto industry, and mistakes are bound to happen as everyone navigates this new space.
The cost of doing business
There has been a lot of talk in the media about being able to pay for cars, or other items with your crypto. Always do your research before trying to pay for a good with cryptocurrency, as many of those companies (including Tesla) who enthusiastically supported it have quietly shuttered those payment options. That’s also not the full story; did you know about “gas fees?”
Gas fees are charged when you do any sort of transaction on the blockchain. If you think spending $5 to pull $20 out of an ATM is bad, imagine spending $100 to send your friend $500. Gas fees are one of the most hated parts of crypto exchange and there is no cap on the cost.
If you have trouble remembering your passwords for websites, crypto might not be for you. It’s a very common problem that crypto owners get locked out of their “wallet” or crypto account because they lose their access information. People have lost thousands or even millions of dollars, including celebrities.
This type of problem is one of the reasons banking regulations exist in society, aka, when you have money at a bank, you have resources and people to contact to help secure your account.
If you purchase crypto through a trading platform like Robinhood, some account help may exist, but that platform has their own issues, like the class action suit following their trading shutdown following GameStop’s boom.
Crypto transactions require a lot of energy. A LOT.
A single bitcoin transaction requires around 1700 kilowatt hours of energy, which equals out to nearly two month’s worth of the energy required to run a standard American household.
Crypto has been blamed for contributing to climate change, using a large country’s worth of non-renewable resources and more, but they’re far from the only industry that uses a lot of energy or has a negative environmental impact.
Bitcoin’s entire system uses about half the electricity of traditional banking. And some researchers think miners could mitigate some of the issues and even help use more low-carbon energy moving forward. Read more on that here.
The long and short of it
The world of crypto is scary for a lot of people, and for good reason. It’s a new industry, and most people struggle to understand it. The market is volatile, and it’s easy to make a mistake and lose your money.
On the other hand, we’re watching a whole new industry blossom in front of our eyes. This means the opportunities that are emerging in this world are endless. It’s like the wild west – hundreds of opportunities exist, but you need to be savvy and understand the full scope of it to take advantage of them. (editor’s note: Also a reminder that for every person who made their fortune in the wild west, hundreds lost everything.)
I hope this article can help get you one step closer, and good luck on your journey!
Chase Guelette is a 17-year-old podcaster and entrepreneur. After starting his first podcast in March of 2021, he interviewed knowledgeable guests on topics ranging from personal improvement, finance, and investing. He is a part of the Teen Financial Freedom team and has recently started crypto-focused writing and podcasting. Still a high school student, Chase also works for his family business and runs a number of side hustles including a couch flipping and lawn care business.