Cryptocurrency is one of the hottest topics on the market right now. And enthusiasm doesn’t seem to be dwindling. Almost daily, news cycles are dominated by talks of crypto in some form or another. And when it comes to this digital asset, there’s a lot to unpack. Steve Wyett, chief investment strategist at BOK Financial® answers some of the most commonly asked questions about crypto.
What are crypto assets?
A crypto asset is a digital asset that primarily utilizes cryptography, peer-to-peer networking and distributed ledger technology (DLT) as part of its value proposition. Crypto assets can be used as a means of exchange, to access resources/goods/services, execute smart contracts, represent ownership or exchange information without the intervention of a third party.
What is Bitcoin?
Bitcoin is one type of cryptocurrency—a type of crypto asset. It was developed to be used as a digital currency to facilitate online payments from one party to another without going through a financial institution. When Bitcoin launched in 2009, it became the first digital payment network that utilized blockchain technology.
What is blockchain?
Blockchain technology establishes the mathematics and algorithms required to validate, execute and record electronic transactions. Some things to know about this open-source software:
- Decentralized: The system does not require a central authority as its state is generally maintained through consensus across the network.
- Cryptographic: Every transaction is encrypted and decrypted to ensure secure communication.
- Distributed ledger: All data is simultaneously recorded, stored and accessible across multiple sites.
- Proof of work: A consensus algorithm that requires members of a network (miners) to expend effort solving a mathematical puzzle to validate and prevent anybody from gaming the system. The miner that solves the puzzle is rewarded with transaction fees or newly minted cryptocurrency.
- Immutable: Once a transaction is recorded, it is nearly impossible to change.
Blockchain is what many call a disruptive technological innovation. Beyond Bitcoin’s payment system, uses include smart contracts, supply chain management, central bank digital currencies, healthcare, energy, insurance, etc. However, it is important to note that an investment in crypto assets does not necessarily reflect a direct investment in blockchain technology.
Is Bitcoin the only crypto asset?
No. Since Bitcoin’s initial release, thousands of different crypto assets have been created. Given Bitcoin’s open- source code, most of the available cryptos are based on the Bitcoin code and almost all utilize blockchain technology in some manner. The technology, versatility and uses continue to evolve.
There are many terms used to describe crypto assets, and they are often used interchangeably. These include digital assets, virtual currencies, cryptos and cryptocurrencies.
Use of the term "currency" is somewhat misleading, though. The commonly accepted attributes of currency include accepted medium of exchange, endorsed by a government, serve as a store of value and function as a unit of account. And that doesn’t describe crypto assets.
The Commodity Futures Trading Commission classifies non-security tokens as commodities, and the Internal Revenue Service views them as taxable assets.
Below is a broad summary of crypto asset categories.
- Cryptocurrency is the native currency for a particular blockchain network and is used as a means of payment or exchange. One example is Bitcoin, which is the native currency for the Bitcoin payment network. Another example is Ether, which is the native currency used to pay for transactional fees (gas) and computational services on the Ethereum platform.
- Stablecoins are used as a means of payment or exchange. However, these coins are less volatile as they peg their value to an existing fiat currency, like the U.S. dollar. Examples include Tether and USD Coin.
- Utility Tokens give holders access to some type of utility (resources/goods/services).
- Non-Fungible Tokens (NFTs) are "one-of-a-kind" assets in the digital world that can be bought and sold like any other piece of property, but which have no tangible form of their own.
- Security/Asset Tokens are digital representations of fractional asset (e.g. company, crypto project, security, real estate, private equity, etc.) ownership or economic rights. Unlike the other tokens, these are backed by real assets with the intent of profiting.
Note: The attributes described above are not mutually exclusive—crypto assets can have multiple.
What is the size of the crypto asset market?
The entire crypto market cap is over $2.5 trillion1, as of October 2021. Bitcoin had a market cap of just over $1.18 trillion as of that date, representing approximately 46% of the entire cryptocurrency market. In January 2017, Bitcoin made up over 95% of the entire market. To put the current Bitcoin valuation into perspective, it has a market cap that is 288% higher than Walmart ($409 billion).
The next four largest crypto assets (and market caps) are Ethereum ($479 billion), Binance Coin ($79 billion), Tether ($71 billion), and Cardano ($71 billion). These top five cryptos represent about 75% of the entire market.
Who controls crypto assets?
For most cryptos, there is no governing central authority; security tokens are the exception. Crypto exchange and utility tokens generally are controlled by the structure established in the crypto’s white paper and/or consensus voting from the investor community (miners, owners, developers, etc.) who can make changes to rules, incentives, protocols, etc. This oversight may be controlled by a relatively small group and can result in changes to the crypto’s protocols for the network.
An example is the Ethereum 2.0 upgrade that changes the crypto’s consensus mechanism from a proof of work (Bitcoin’s process) to a faster, more energy-efficient proof of stake algorithm. Depending on objectives and specific governance structure, this could prove problematic for solutions built utilizing the previous technology.
How is the value of crypto assets determined?
Although Bitcoin has been around more than a decade, the crypto asset category is relatively new and speculation is one of the primary drivers of current valuations. Additionally, crypto asset prices are determined by supply and demand. In most cases, the number of tokens distributed is limited. If demand for a crypto is high, then the price will go up given the fixed supply and vice versa.
Many things can affect the price, including network growth, Dapp adoption, news, regulation, retail acceptance, ETF access, distribution schedule, etc. The value of utility tokens will also be influenced by the perceived value of the services provided. In addition, the valuation of a security token will primarily be driven by the underlying asset value.
What are some risks of buying crypto assets?
There are many different risks of owning crypto assets that should be considered before making an investment or purchase, including but not limited to:
- Financial loss. Investments in Bitcoin and other crypto assets are speculative and highly volatile, with wide price swings. Values are susceptible to sentiment, emotion, publicity and manipulation, any of which could result in the total loss of investment.
- Government regulation. Regulation around crypto assets has been limited, complicated and disorganized (security tokens less so). The lack of a regulatory framework and precedent makes dispute resolution unpredictable and potentially unavailable. Given the increased interest in these assets, the U.S. Treasury, Federal Reserve Bank, the Securities and Exchange Commission and regulators around the world have expressed the need for more regulation to protect consumers. New governmental regulation could impact the value of crypto assets.
- Cyber theft and loss. Platforms that buy and sell Bitcoin or crypto assets are subject to cybersecurity risks such as scams, hacking and theft. Like the platforms themselves, online digital wallets are also subject to cybercrime. Because cryptos exist in a digital world, where the link to ownership is tied to a password, a lost password likely results in the loss of the related assets.
- Continuous technological advancement. The crypto space is continuing to evolve. The market share of Bitcoin has dropped, as new cryptos have advanced the initial technology.
- No guarantee of safety to depositors. Unlike U.S. banks and credit unions that provide insurance to depositors, cryptos have no governmental backstops and transactions cannot be reversed.
- Not legal tender. Digital currency such as Bitcoin and other virtual currency products are not legal tender. Market adoption remains low due to regulatory concerns, technology shortfalls, market volatility and a lack of understanding, etc. Bitcoin and other virtual currencies have value simply because the community that invests in them believes they have value.
- Exiting the market. There can be timing and liquidity issues for investors seeking to exchange cryptocurrency to fiat currency.
What have the security regulators communicated regarding crypto assets?
The SEC and FINRA have commented on Bitcoin and other virtual currencies, including potential risks in recent news and Investor Alerts. Links to a few of these appear below: