The very real volatility of cryptocurrency has grabbed headlines recently, as investors have seen their funds in digital assets plummet. The price of Bitcoin (BTC) dove to one of its lowest levels since 2020, and more than $300 billion was wiped out by the crash.
Volatility is one aspect of cryptocurrency investing that you need to tell your clients about. However, it’s not the whole picture.
Some of your clients may have only heard the terms “cryptocurrency” or “digital assets,” yet they may not know what they mean or how they work. Others may have limited knowledge, and still others may have already invested in crypto and used it to buy goods and services. Because of those possibilities, it is best to ask your clients what they know about the subject and go from there.
- When clients ask you about cryptocurrency, they need to know the good and bad aspects.
- It is important to tell your clients that cryptocurrency can be a highly volatile investment.
- Clients should also know that cryptocurrency can be a secure payment form, accepted all over world by large and small vendors.
It is part of your job as a financial planner or advisor to present your clients with a range of investment options, evaluate these options, and explain how they may help or hinder clients from reaching their goals. Although some economists may disagree on the longevity of cryptocurrency, it’s likely to be around for years to come. Some experts believe that cryptocurrency may overtake spending with cash and credit cards within five to 10 years.
What Is Cryptocurrency?
A cryptocurrency is a decentralized digital currency that relies on cryptography for security. You can help your client understand that cryptocurrency can be used like traditional fiat currencies such as U.S. dollars and euros, as an investment, and to pay for everyday goods and experiences.
As of June 1, 2022, there are more than 19,684 digital currencies with a combined market capitalization of $1.31 trillion, according to CoinMarketCap. The largest by far is Bitcoin, released in January 2009 by the pseudonymous Satoshi Nakamoto.
The early digital products were easy to replicate, which was an inherent challenge to digital currencies until Bitcoin was introduced with safety measures in place. Now the use of cryptography and blockchain technology ensures that cryptocurrencies are nearly impossible to counterfeit or double spend, despite being digital.
6 Things That Your Client Needs to Know About Crypto
- How it works. Cryptocurrency is like fiat or traditional currency because you can use it to buy items and services. It’s different, however, because it’s digital-only. One simple way to spend cryptocurrency at retailers and vendors is through gift cards purchased through platforms like Bitrefill. Among the retailers that accept cryptocurrency through the third-party app are Starbucks Corp. (SBUX), Nordstrom Inc. (JWN), Best Buy Co. Inc. (BBY), Walmart Inc. (WMT), and Overstock.com Inc. (OSTK).
- How to start using it. You must create a crypto exchange account. You can purchase coins through an exchange such as Coinbase. You can buy crypto with traditional currency using debit cards or bank accounts.
- How to store it. Transfer it to a noncustodial crypto wallet to secure your funds. A wallet validates your transactions and keeps your secret private key information safe.
- Where can you use it? Crypto funds are always available anyplace in the world because they aren’t tied to a bank or a government.
- How safe is it? Cryptocurrency can be safer to use because you don’t need to provide personal information to a vendor, lessening the chances of identity theft or fraud.
- How stable is it? Not at all. Cryptocurrency is volatile, which can be good or bad. Let’s say you have $2,000 in your crypto account. The value can increase, meaning you have more in your account. However, if it dips in value—to $750, for example—there’s nothing you can do to recover the lost funds but wait it out, hoping that the value will increase. It may not.
With a noncustodial crypto wallet, you have control of your private keys, which in turn control your coins and can help prove that the funds are yours. With a custodial wallet, another company would control your private keys, and if that company goes bankrupt or gets hacked, your funds go with it.
What is a digital wallet?
A digital wallet (or e-wallet) is a software-based system that securely stores users’ payment information and passwords for numerous payment methods and websites. By using a digital wallet, users can complete purchases easily and quickly with near-field communication technology. They can also create stronger passwords without worrying about whether they will be able to remember them later. Digital wallets can be used in conjunction with mobile payment systems, which allow customers to pay for purchases with their smartphones. A digital wallet can also be used to store loyalty card information and digital coupons.
What is a distributed ledger?
A distributed ledger is a database that is consensually shared and synchronized across multiple sites, institutions, or geographies, accessible by multiple people. It allows transactions to have public “witnesses.” The participant at each node of the network can access the recordings shared across that network and can own an identical copy of it. Any changes or additions made to the ledger are reflected and copied to all participants in a matter of seconds or minutes. A distributed ledger stands in contrast to a centralized ledger, which is the type of ledger that most companies use. A centralized ledger is more prone to cyberattacks and fraud, as it has a single point of failure.
What is a blockchain?
A blockchain is a distributed database that is shared among the nodes of a computer network. As a database, a blockchain stores information electronically in digital format. Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions. The innovation with a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party. One key difference between a typical database and a blockchain is how the data is structured.
A blockchain collects information in groups, known as blocks, that hold sets of information. Blocks have certain storage capacities and, when filled, are closed and linked to the previously filled block, forming a chain of data known as the blockchain. All new information that follows that freshly added block is compiled into a newly formed block, which then also will be added to the chain once filled. A database usually structures its data into tables, whereas a blockchain—like its name implies—structures its data into chunks (blocks) that are strung together. This data structure inherently makes an irreversible time line of data when implemented in a decentralized nature. When a block is filled, it is set in stone and becomes a part of this time line. Each block in the chain is given an exact time stamp when it is added to the chain.
The Bottom Line
Clients may be hungry for information about cryptocurrencies, whether they plan to use them or not. As their financial advisor or planner, it’s your job to explain this relatively new form of currency, which has investment potential and a clear downside. Be ready with the facts.
Investing in cryptocurrencies, decentralized finance (DeFi), and other initial coin offerings (ICOs) is highly risky and speculative, and the markets can be extremely volatile. Consult with a qualified professional before making any financial decisions. This article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies, nor can the accuracy or timeliness of the information be guaranteed.