Cryptocurrencies offer several advantages when compared with traditional banking, money transfers, and fiat currencies.
Privacy. Many cryptocurrencies are designed with privacy in mind and obscure the identity of the sender and receiver of cryptocurrency funds. Only cash provides similar anonymity.
Decentralization. Cryptocurrency owners use a wallet to access their currency and receive or send funds from a specific wallet address that uses a secret key for access. Some also use an exchange to store currency, although the practice brings additional risk. The record of the currency exists on the blockchain with a copy stored on every full node, a computer that keeps a ledger locally and syncs with other computers online. Your money isn’t in a single bank, or even several. The decentralized nature of cryptocurrency ledgers makes cryptocurrencies less vulnerable to seizure or localized risks, like fires or hardware failures. The data isn’t just stored off-site, it’s copied worldwide to all full nodes.
Scarcity. Bitcoin has a fixed supply. Over 17 million Bitcoin are in existence. However, only 21 million Bitcoin will ever exist. It’s built into the code for the currency. The fixed supply gives Bitcoin and other cryptocurrencies similar characteristics to gold, silver, or other precious metals that have historically been used as money. Unlike U.S. Dollars, British Pounds or any other fiat currency, after the full supply is in circulation, the supply will never grow, devaluing the currency’s buying power.
Smart Contracts. Some cryptocurrencies have a unique feature that can’t be duplicated with fiat currencies. Ethereum is among the best examples with its robust support for “smart contracts”, essentially programs that live on the blockchain and can be used to manage transactions as well as many other uses, some of which we may not have yet imagined. At a base level, these contracts can be used to replace arbiters or escrow services. The smart contract can manage the details of a transaction, only releasing payment when predefined conditions are met.
Cost of Transfers. The cost associated with cryptocurrency transfers can be a pro or a con, depending on the type of currency, the type of transfer, and the speed of the transfer. Bitcoin, for example, can become prohibitively expensive if you need fast clearance for a transaction. Costs are less problematic for less time-sensitive transactions. Other types of cryptocurrencies, such as Ripple, are fast and inexpensive to transfer, leading to increased adoption of Ripple-based transactions and related technology by financial institutions.
Cryptocurrency Disadvantages
Cryptocurrencies come with a list of considerations that can help investors make safer investments. It’s fair to say that there is no safe cryptocurrency at this early stage, but with careful planning, you can assemble a portfolio that limits your risk while still providing you the opportunity to exit the trade if needed.
Market Adoption. Awareness for Cryptocurrencies is growing, but most of the focus has been on Bitcoin. Relatively few retailers accept cryptocurrencies for payment, but there are a few. Overstock.com announced in 2017 that they would accept cryptocurrencies as payment. Payments will be limited to Bitcoin, Ethereum, Litecoin, Dash, and Monero, giving the other 1,500+ cryptocurrencies the cold shoulder. Pizzaforcoins.com accepts over 50 cryptocurrencies, allowing cryptocurrency owners to buy pizza from local establishments and have it delivered. Market adoption of cryptocurrencies for payment has been slow and options continue to be limited but the cryptocurrency market can change quickly.
Obsolescence. As many as 1,000 cryptocurrencies have failed already, with more currencies sure to follow. The most common type of failure is at the Initial Coin Offering (ICO) or shortly thereafter, with many coins finding a crowded market for coins with similar characteristics to existing offerings, causing skepticism among investors. In some other cases, the ICO itself was just a cash grab, with the founders running off with investor funds. Currently, ICOs are unregulated.
Abandoned Cryptocurrency Projects. Most of the investment money for cryptocurrencies is focused on a relatively small group of coins. Without investor interest, projects can get abandoned, leaving investors with essentially worthless digital coins.
Regulation Risk. As it pertains to cryptocurrencies, regulation risk has two sides. In the U.S., cryptocurrencies are not regulated at a federal level, leaving states the option to introduce rules and regulations regarding cryptocurrencies or the blockchain technology that serves as the backbone for cryptocurrencies. On the other hand, some investors and finance experts have expressed concern over future regulation for cryptocurrencies, which could cause a drop in demand or eliminate demand altogether.
Liquidity Risk. Investors and lesser-known cryptocurrencies may find fewer buyers, creating challenges when looking to exit a position.
Volatility Risk. Few investment classes can rival cryptocurrencies when it comes to price volatility. Prices can rise or fall dramatically in a single day, making or breaking fortunes.
Third-party Risk. Mt. Gox, a Bitcoin exchange based in Japan, and the leading exchange worldwide in 2014 was hacked, leading to a loss of nearly half a billion dollars in Bitcoin. In total, an estimated 850,000 Bitcoins belonging to investors went missing, ultimately forcing the exchange into bankruptcy.
Secure Keys. Cryptocurrencies are often kept in a digital wallet, which is secured by a long code or a long series of words. Unlike your bank account or investment account, there is no recovery process available if you lose your password. Without your password, your cryptocurrency wallet and its contents are no longer accessibl
