Cryptocurrency is not for everyone. The simple reason is that you should never invest in anything you do not understand, and for a long time to come, most people will not have the foggiest idea how crypto works. That hasn’t stopped millions getting involved and many have lost and made fortunes, and often both.
Crypto – I hesitate to call the market “cryptocurrency” because the arena has gone well beyond currency – is a tiny market. With a total market cap of perhaps $300bn, the total market size is less than a single company like Tesla. To me this is a benefit because the tiny market cap belies the likelihood that the next generation – and definitely the generation after that – of giant enterprises will rise from this sapling of an industry and become tomorrow’s trillion-dollar entities.
The cornerstones of this infant colossus are Bitcoin and Ethereum. Bitcoin is money and Ethereum is a decentralised computer dematerialised by the arcane magic of cryptography onto the internet: a science fiction dream, now a reality. Any investor however novice should hold a little of both, if only as a gateway investment to get a taste of what this emergent revolution is all about.
There are two families of crypto: currencies and tokens. Both depend on blockchains which have currencies as their engines.
Currencies can be split into two species: ‘proof of work’ (PoW) and ‘proof of stake’ (PoS). You might also want to consider another taxonomy of private and public with a coin like bitcoin – a ‘public’ coin which is free for all to operate – and Ripple, which is blockchain-operated, controlled and maintained privately like say the Visa credit card system.
If you wanted to dig deep, you could grid coins out along these two dimensions, but for me I only consider proof of work coins for investment. Proof of work coins are open for anybody to administer and maintain and this, in most cases, is called ‘mining’. Mining is a process where anyone with a high-powered computer can compete to register the new set of transactions on the blockchain and get paid a reward for doing so. As with most things crypto, there are multiple layers and complications but for most, ‘mining’ is an activity that is the most user-facing aspect of blockchain operations and miners and their computers drive this process. It’s actually quite fun if you are nerdy but if you want to invest in coins this is a very complicated way of going about it; it’s like owning a cow because you want cheese. It’s far easier to go to the store and just buy it; in this case, by using an exchange such as Coinbase. As far as I’m concerned, proof of stake coins, which operate on a ‘one coin, one vote’ basis remind me too much of oligarchy systems to appeal. We all know what oligarchs do to the little guys and I don’t want to put my capital into that dynamic.
Tokens hang from certain blockchains. Ethereum is the king of this space and this was why Ethereum exploded into the number two position in the hierarchy of crypto behind Bitcoin. Anyone can create a token and it can represent whatever you wish it to and with a little computer program called a ‘smart contract,’ which operates on the blockchain, it can achieve infinite things. Tokens can be traded on exchanges or via smart contracts on the chain itself. Imagine you have a smart contract that predicted tomorrow’s Tesla price, which would make its prediction if you gave it some of a particular token. That token would be worth a lot. The way the Ethereum blockchain, Ethereum’s currency, smart contracts and Ethereum-issued tokens interact produces a virtuous circle of value that drives the value of Ethereum and its tokens. This Ethereum ecosystem drove the original ICO wave, a kind of wild west dotcom boom, because tokens can act as securities. It is now driving the DeFi boom, a wave of financial service offerings where smart contracts are acting as financial institutions like, for example, online banks (with just computers and no staff). DeFi is exploding in the same way as ICOs erupted into the world and this development is turning the token idea into a gateway for some of the most incredible or risky (or both) financial and software developments currently emerging.
You can certainly quickly make a small fortune from a large fortune with crypto and with DeFi and tokens this is even more the case. Yet there are – and will be – huge opportunities for investment in tokens, but it is at the extreme horizon of risk and it is not for the novice.
Bitcoin is the starting point for investors, then Ethereum. Junior coins need the next level of skill to dabble with. Tokens are yet a further distance into the wild frontier and then at the edge comes DeFi where beyond the horizon are the yield farmers and their insane conniptions.
This is a journey worth making slowly and carefully because there are massive returns to be made if the very many financially lethal pitfalls are avoided. Basic rules of investment apply; diversification is a must, scepticism is a necessity and lots of research and study is vital.
Make no mistake, crypto is no cakewalk, but it is without doubt the future.
Disclosure: I am/we are long BTC-USD, ETH-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.