Virtual currencies have been grabbing the headlines over the past few weeks, so here’s a guide to how they work and why I’ve invested in them.
You know how when you make payments through your bank or you get money in from someone, you see those transactions on your statement? It’s a list – or ledger – of money in and money out, possibly including bank charges and interest.
But what if you didn’t feel like doing these transactions through a bank? In fact, what if you were so angry at the destruction caused by some banks and governments during the financial crisis 10 years ago that you didn’t want any of your cash to go through their books, particularly if, as in the case of Cyprus, you felt they could take your money? In 2013, bank customers in Cyprus with more than £85,000 in savings had a large chunk of their money confiscated by the government.
That’s why, around the time of the financial crisis, some clever technology bods decided to create a system of money transfers that would circumvent banks, governments and any central authority. That’s how cryptocurrencies came into being.
What are cryptocurrencies?
Cryptocurrencies include the likes of Bitcoin, Dash, Ethereum, Litecoin, Ripple and Verge, to mention some of the top few of the thousand-odd that now exist in the ‘crypto-sphere’.
They work on ‘Distributed Ledger Technology’ (DLT), also known as ‘blockchain’, where that ‘bank ledger’ can be found on thousands of computers (soon to be millions) around the world, recording your transactions many times.
Having a bank ledger on lots of different computers makes it safer because you have many unconnected individuals dealing with it rather than one central authority that could take the law into its own hands. In theory, at least, this makes transactions fraud-proof.
For a start, the rules of cryptocurrencies insist that you can’t rub anything out. Again, this is to counter fraud: no one can do something and then say they didn’t do it.
Also, they’re called cryptocurrencies because the transactions are made secure by cryptography – puzzles – that can only be solved by computers working very hard. The people who run these computers, solving the puzzles, are called ‘miners’ and they earn digital ‘coins’ for doing the work.
Different cryptocurrencies work in different ways – for example, Bitcoin has a finite number of coins, is very inflexible and takes a lot of energy to ‘mine’. Others, such as Ether (Ethereum), are more flexible and cost less to ‘produce’. Ripple (or XRP) is not as decentralised as other currencies because it has no miners. Instead, transactions are powered through a centralised blockchain to make it more reliable and fast. So purists say it shouldn’t be counted as a proper cryptocurrency.
What is the blockchain?
Blockchain technology has many more potential applications than currency and financial transactions.
As it is decentralised and not subject to the whims of, say, a corrupt government, it is potentially a much safer way of recording transactions and social actions. It has the potential for use in areas such as:
- Births, marriages, deaths. These and many other registrations that are currently overseen by civil servants could be done more efficiently, accurately and honestly using distributed ledger technology.
- Education. Educational establishments could record classes taken and exams passed on blockchain and they could enable students to customise their learning with a network of instructors and educational materials around the globe. This has the potential to circumvent universities and colleges and enable people to pick their own tutorials and lectures from around the world.
- Medical procedures and history. If these are recorded on blockchain, then wherever you are in the world, medical professionals can pull out your records and see what can be done if you suddenly fall ill.
- Property transactions. Buying and selling houses could be carried out on blockchain, which could make many aspects of what estate agents and conveyancers do redundant.
- Voting. As no person, party or organisation can mess with the number of votes cast if they are recorded on blockchain, it could be a fraud-proof way of defending democracy, particularly in countries where vote-rigging is the norm.
The blockchain can be programmed to record virtually everything of value to societies, from birth certificates to social security cards, and anything else that can be expressed in code. This potential is why a lot of investors are more interested in putting money into blockchain technology than they are into cryptocurrencies.
What are ICOs?
Right now, every week there are new ICOs (Initial Coin Offerings) and ITOs (Initial Token Offerings – pretty much the same thing) offering new solutions based on blockchain, looking for investment. The majority are not worth considering.
ICOs can be seen as the third wave of the blockchain/cryptocurrency revolution. Speculators, hoping to ride the next bitcoin-like wave, are scooping up new coins, or tokens, in ICOs (and ITOs).
These are the ‘crypto’ version of IPOs (Initial Public Offerings). With an IPO, a company will float itself on the stock exchange to raise money from investors in return for shares.
With ICOs, it’s much, much riskier. Businesses – mostly just start-ups – go to the public for investment but in return they offer simply ‘tokens’, essentially no more valuable than air miles or Tesco Clubcard points.
These tokens are ‘coins’ that you can use within the ecosystem set up by that company or organisation or, in some cases, swap them for strong ‘fiat’ currency such as pounds or dollars. [Fiat money is currency that a government has declared to be legal tender, but it is not backed by a physical commodity.]
The tokens have no inherent value unless the business itself does well. If it does, then the rewards to the investor are exponentially great – in other words, your investment goes up very fast and very high (sometimes 100 times).
This ‘token’ idea isn’t just about making a quick buck on your investments, though, it’s a whole different philosophy of doing business.
“You take the idea of the coin in a blockchain and you abstract it out to anything, literally anything that can be turned into a token,” says Lex Sokolin, global director of fin-tech strategy research company Autonomous Research in London.
“For example, instead of having advertisers pay Facebook to reach you and me, advertisers can pay us directly, because we control tokens that can monetise our attention.”
The potential for the ‘tokenomy’ is huge as it can enable businesses – and even governments – to have direct engagement with their users, and bring more potential customers in, with rewards.
But being paid in tokens, which could shoot up in value and drop like a stone within 24 hours, is only for investors who are not easily seasick.
The Financial Conduct Authority (FCA) warns that these are “very highrisk, speculative investments” and as most ICOs aren’t regulated, there is no protection from the Financial Services Compensation Scheme or the Financial Ombudsman Service if something goes wrong.
Because these are early-stage projects, there is also a good chance you’ll lose your entire cryptocurrency stake, warns the FCA.
The FCA says you should fully research the specific project if you are thinking about buying digital tokens.
It adds that you should only invest in an ICO if you are an experienced investor, confident in the quality of the ICO project itself such as the business plan, technology, and people involved, and you’re prepared to lose your entire stake.
If the dotcom boom was the Wild West (and it was), the crypto boom is the Wild West on acid.
My blockchain investments
I wouldn’t describe myself as a speculator. Generally, I have a long-term view. I’m a ‘buy and hold’ kinda gal, but I have become fascinated with blockchain technologies and the slew of interesting cryptocurrencies and DLT-based businesses that have sprung up in the past year.
Most of my crypto-investments are in businesses that I consider have a long-term, rosy future, but I have made a bit of cash in short-term buying and selling recently, primarily with Ripple (XRP) – a relatively new cryptocurrency. I did that by buying CFDs (another very risky product) in Ripple on the eToro platform. I made $3,600 on a $1,000 investment in three months, which was good enough for me.
The platform’s trading fees are built into the trading spread. The main fees of interest are the withdrawal fees, which are $25 (£18.52 at the time of writing) per withdrawal.
I have also bought Ethereum, which I prefer to Bitcoin as it is more flexible and, I think, scalable.
But my main investments have been in some ICOs, which I did on the recommendation of Aditya Nagarsheth, who runs Red Pill Enterprises, a casual ‘friends and family’ syndicate that specialises in crypto. It charges a 20% fee, but it’s all unregulated (they’re getting regulated status soon.)
Through it, I have put money into three ICOs which have already gone up by at least 10 times in a couple of months. I’ll be interested to see how they do in the next couple of months.
Be warned: all the products mentioned above are very risky.
I don’t recommend that anyone invests in them unless they really know what they’re doing.
Only people who already have a decent chunk of cash in traditional investments, such as pensions, equities and property, should even consider dabbling in crypto.
You should only put in money that you can bear to lose, particularly when it comes to ICOs. These are like Venture Capital investments and even traditional VC investments have a very low success rate (about 2%).
“Only put in 1% or 2% of your liquid investment capital,” warns Mr Nagarsheth, as “the market is extremely volatile and it’s still very under-regulated”.
Even if your investments do well, it’s very easy for you, or the company you have invested in, to be hacked and drained of money. For example, in 2014, fraudsters hacked into the Tokyo-based Mt. Gox cryptocurrency exchange and helped themselves to $473 million in Bitcoin. The hack eventually led to the bankruptcy of Mt. Gox later that year.
This is why individual investors tend to be very cagey about what cryptocurrencies they have invested in – and where they are storing them – because it’s too easy for hackers to relieve them of their tokens.
Many now keep them in what is called ‘hardware wallets’ – ie, a USB key which, ironically, they often keep in a bank vault. If they keep the ‘tokens’ in a digital wallet they often go to extreme measures to hide the ‘private key’ that opens the online wallet, including splitting it in two and giving one part each to different friends or family members.
Does crypto have a future?
Blockchain technology is particularly exciting, and tech-savvy millennials are already buying into crypto as the currency of their futures.
However, it’s clear that we are in a cryptocurrency bubble now, like the dotcom bubble in the early 1990s. But, as with the internet bubble where companies such as Amazon, Apple, and Google came through the crash and went on to rule the world, so there will be crypto businesses that rule the waves later after the rest have crashed and burned.
The task for any savvy investor is to pick the long-term winners and not just try to make a quick buck.
The family of crypto investors
TV director Jeremy James*, 31, got into cryptocurrencies in December 2017. “I was quite mindful of diversifying my portfolio from the beginning,” he says. “I’ve got Bitcoin (£400), Dash (£300), Ethereum (£500), Litecoin (£400) and Ripple (£800). I’ve carried out all my transactions through eToro because it makes it easy. In some of the other exchanges, you have to trade with crypto, not pounds, which is complicated.
“I also copy a couple of successful investors on eToro, both of whom have money in traditional businesses as well as cryptocurrencies.”
Jeremy also introduced his siblings to cryptocurrencies. His brother David, who is 35 and works in finance, has invested £1,000 in Ethereum and £2,000 in Ripple primarily. His sister Sarah, 32, has put £400 into Ethereum and £400 into Ripple. She also invested in an ICO where she tripled her money.
“I try to be quite realistic about my investments,” says Jeremy. “I don’t necessarily think I’ll be massively rich out of this but it’s in the back of my mind that this is my big opportunity to make serious money in the way that I don’t see I will ever do through my job, living in London.
“It can be pretty addictive to keep checking the rates every day. It’s so volatile you feel you must keep looking. My Ripple holdings were £1,000 this morning, then it was £500 in the afternoon and then £700 in the evening and that’s just one day!
*Name has been changed.
Jasmine Birtles is a financial journalist and founder of MoneyMagpie.com.
My experience buying cryptocurrencies
By Edmund Greaves
I decided to buy a couple of very small holdings of cryptocurrencies in January 2018. I bought £10 worth of Bitcoin and £10 worth of Ether. Currently due to significant volitility, I have made a loss of £1,93 on Ether, and have lost £3.37 to Bitcoin.
I don’t have enough confidence to invest my life savings in cryptocurrency because of its volatility. A lot of my friends have also invested small amounts, just because it makes following developments a bit more interesting
How I bought my first cryptocurrency
I decided to buy cryptocurrency with an app called Revolut, which is UK-based and regulated by the City watchdog the Financial Conduct Authority. It also offers other services such as currency exchange and mobile only current accounts.
Revolut says trading through it is more cost-effective than other platforms as there are no hidden fees.
It applies a 1.5% mark-up during the exchange process.
The company offers trading in Bitcoin, Ether or Litecoin. Buying the cryptocurrencies was very straightforward. The major drawback to Revolut is that it costs £6.99 a month for the premium service, which includes buying cryptocurrency – although I have signed up for a free one-month trial.