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What You Need to Know About Cryptocurrency

By Ankur Patel

Take a look at some recent headlines about cryptocurrency — they’re all over the place:

Bitcoin Rockets to New Highs as Tesla Takes It Mainstream.” “Bitcoin Retreats After Weekend Rally.” “Tesla's $1.5B Bitcoin Investment ‘A Sign Of Desperation’ From Elon Musk, Says Analyst.” “Bitcoin Investors: From Buying a Bentley to Losing It All.” “Bitcoin’s Big Moment: Mastercard Jumps on the Bandwagon.”

Here’s what we think you should know about it … and why it’s not part of your Ellevest investment portfolio.

Cryptocurrency and blockchain: The explainer

That root — “crypto” — means “secret” or “hidden.” In the context of cryptocurrency, it really means anonymous (or almost anonymous, depending on how the currency’s set up). Cryptocurrency is a form of money that a) isn’t issued by a central authority, like a government, and b) uses cryptography — the practice of storing and transmitting data for secure communication. Bitcoin is the best-known cryptocurrency, but definitely not the only one.

You might have also heard the word “blockchain.” In the context of cryptocurrency, that’s a public record of past transactions: Every time someone completes a transaction, it gets recorded in a “block” and added to the “chain” of transactions. Then the algorithms make sure the record can’t be altered.

Crypto and blockchain often go together, but they aren’t the same. One is a currency and the other is technology that supports the currency system. Think of it like this: With US dollars, you know how much money you have in the bank because the bank keeps track of it for you … and the government keeps track of how much money the banks have.

Instead of relying on banks and governments, cryptocurrencies use a blockchain. The full blockchain from the beginning of time is publicly recorded and unchangeable — which means everybody’s computer agrees on every single transaction that ever happened. All of that makes fraud pretty damn hard.

Blockchain technology is designed to decentralize the storage of data so it cannot be owned, controlled, or manipulated by a single party. Because it facilitates the process of recording transactions and tracking assets in a transparent, immutable fashion, it helps reduce costs, risk and fraud.Blockchains as a ledger system could be used for keeping track of anything from copyright protection to digital voting to businesses’ supply chains, which is why some people believe blockchain has the potential to disrupt a lot of different industries — not just crypto.

So, cryptocurrency = the money, and blockchain = an accounting system.

Why do people invest in cryptocurrency?

Investing in cryptocurrency may feel like investing in any foreign currency: You exchange your US dollars for that currency, hope that its exchange rate moves favorably, and, if it does, turn it back into US dollars so that you (hopefully) have more money than you started with.

The difference is that cryptocurrency isn’t tied to a country’s economy. It’s independent from any central authority, and its value moves wildly up and down — sometimes really fast. Its value fluctuates so much because it is dependent on supply and demand. As more people jump on the bandwagon and more accept its legitimacy, demand will increase, which will drive its price up. There are also unknowns that could cause it to go down, like regulatory actions (which the Biden Administration is starting to talk about) or lots of owners selling to lock in gains at once.

What’s been happening lately?

Elon Musk announced that his company, Tesla, bought $1.5 billion dollars’ worth of Bitcoin, and would start accepting payments in Bitcoin as well. That sparked a lot of interest, and other people started buying it, driving the price up. Meanwhile, the media began wondering whether big cities and other corporations could follow suit. (The consensus: Maybe, but widespread adoption isn’t very likely, because it’s too volatile — see commentary by Bloomberg and MarketWatch.)

This isn’t the first time that Musk has influenced the movement of cryptocurrency. In much the same way that a tweet by Musk helped send GameStop stock way up, a recent series of tweets by Musk sent the value of Dogecoin — a cryptocurrency that started as a joke, and Musk says he invested in as a joke — way up as well. (GameStop stock fell rapidly after its big rise, fyi).

Also in the news: The increased attention to Bitcoin’s price has recently brought more attention to its energy impacts. Bitcoin is a digital currency created using high-powered computers in a process called “mining,” which is intentionally time-consuming, competitive, and difficult — which means it uses a lot of energy. (It’s estimated to be some 22 million metric tons of carbon dioxide emissions a year and consumes more energy than Argentina.) The cost of that energy use? Well, besides the hit to the earth itself, it also leaves Bitcoin vulnerable to swings in public approval that could affect the supply-and-demand-driven price.

Investing vs. speculating

If you’re drawn to the thrill of the cryptocurrency chase and have money set aside just for risky purchasing that you’re prepared to lose, then by all means, have fun. But we believe that investing in a diversified investment portfolio, not speculating, has a greater chance of success in the long term than putting your money on any single “big bet.” That’s true whether it’s Bitcoin, or GameStop, or a new gold rush (there’s a reason Bitcoin production is called “mining”). Or any single company. Or any single type of investment, for that matter). One is investment, one is speculation.

On the other hand, the number of startup companies working on blockchain applications is growing fast. While bets on crypto are more speculative in nature, bets on blockchain technology are gaining the attention of serious investors.

We’re also a fiduciary, which means we’re legally required to act in your best interests. That’s why we don’t do things like try to time the markets, try to pick “winner” individual securities or sectors, or bet on factors like momentum or size when we choose investments for your portfolio. Because doing those things tends to lead to over-trading — which actually leads to underperformance. The majority of money managers who employ these tactics actually do worse with their money compared to the market overall.

It’s also why we don’t include cryptocurrency in any investment portfolios at Ellevest. We cannot — and will not — allow the outcome of your financial goals to be influenced by pure speculation.

Disclosures

© 2020 Ellevest, Inc. All Rights Reserved.

You may or may not have noticed that we linked to Forbes.com for recent headlines on cryptocurrency and how blockchains can be used to store information. FYI, Forbes (“Solicitor”) serves as a solicitor for Ellevest, Inc. (“Ellevest”). Solicitor will receive compensation for referring you to Ellevest. Compensation to the Solicitor will be $20 per membership activated. You will not be charged any fee or incur any additional costs for being referred to Ellevest by the Solicitor. The Solicitor may promote and/or may advertise Ellevest’s investment adviser services. Ellevest and the Solicitor are not under common ownership or otherwise related entities.

Information was obtained from third party sources, which we believe to be reliable but not guaranteed for accuracy or completeness.

The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.

The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.

Diversification does not ensure a profit or protect against a loss in a declining market. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Forecasts or projections of investment outcomes in investment plans are estimates only, based upon numerous assumptions about future capital markets returns and economic factors. As estimates, they are imprecise and hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Investing entails risk, including the possible loss of principal, and there is no assurance that the investment will provide positive performance over any period of time.

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Ankur Patel

Ankur is a CFA® charterholder with more than 15 years of experience working in investment and wealth management. As Ellevest's Senior Portfolio Manager, Ankur partners with our financial advisors to build and implement portfolios for our private wealth clients.