About Those Objections to Cryptocurrency You May Have Heard…

There are a lot of reasons that someone may give for not thinking investing in or purchasing cryptocurrency or digital assets is a good idea. Here is a look at the most prominent objections a person may have to cryptocurrencies.

“‘Cryptocurrency’ doesn’t sound honest.”

When a lot of people hear or read the term cryptocurrency they may think of someone using it for something secret in a bad way or sinister purpose. However, it’s important to understand what the term actually means. The term cryptocurrency is made up of two parts: crypto and currency. Crypto, short for cryptography, is the computer technology used for encryption to help hide information and identities, as well as provide security. Currency is something that has a monetary value and can be used for the exchange of goods and services. Combined together, you get cryptocurrency, which is a form of currency that allows the identity of the owner of an account to remain private and for the transactions between two parties to also remain private. Cryptocurrency really is about a secure and private form of payment or transfer of monetary value.

“Cryptocurrency is used by criminals.”

Can cryptocurrency be used for criminal activity? Sure. But so can any other form of currency, including the U.S. dollar. Criminals and criminal organizations will use any means of funding their activities, not just cryptocurrency. In fact, research shows that illicit activity accounted for less than 1% of cryptocurrency transactions in 2020. And only 34% of that small portion (that’s 0.34% of all cryptocurrency transactions) was due to criminal activity, with the majority coming from scams. In 2021, criminal activity accounted for only 0.15% of all cryptocurrency transactions. Also, from 2017 to 2020, criminal economic activity was overwhelmingly conducted through traditional financial institutions.

“Cryptocurrency is a fad or it’s a fraud.”

I thought the same thing when I first heard about Bitcoin over 10 years ago. Even last year, as Bitcoin grew to a value of approximately $69,000, I felt the same way. Recently though, I began looking deeper into the technology behind it and the purpose of it, and began to realize it has real staying power. There are countries adopting Bitcoin or other cryptocurrencies as their national currency. El Salvador was the first, and other countries considering the move include Paraguay, Panama, Brazil, Mexico, and Argentina. Bills have been introduced in Arizona and California to make Bitcoin a legal form of payment for taxes and government services, and potentially a legal form of tender. There are countries that have already launched or are developing their own central bank digital currency (CBDC), which use the same cryptocurrency blockchain technology behind Bitcoin, Ethereum, and other current common cryptocurrencies. Some include:

• Dubai (Emcash)
• Venezuela (Petro)
• Estonia (Estcoin)
• Russia (Cryptoruble)
• Sweden (E-Krona)
• Japan (J-Coin)
• China (Digital Yuan)

The United States is also researching and investigating the possibility of its own CBDC.

Businesses are also beginning to accept cryptocurrencies as payment for their products and services. Some include:

• Tesla (Dogecoin)
• Microsoft (Bitcoin)
• Wikipedia (Bitcoin)
• PayPal (Bitcoin, Bitcoin Cash, Litecoin, Ether)
• Venmo (Bitcoin)
• Starbucks (Bitcoin)
• AT&T (various through BitPay)
• Overstock (various through partnership with Coinbase)
• Twitch (Bitcoin, Ether, Bitcoin Cash, Ripple, USD Coin, and more)
• Amazon (Bitcoin via Purse.io)
• Home Depot (Bitcoin via Flexa)
• Whole Foods (Bitcoin via Flexa)
• CheapAir (Bitcoin, Ether, USD Coin, Gemini USD, DogeCoin)
• NewEgg (Bitcoin)
• Namecheap (Bitcoin)
• Rakuten (Bitcoin, Ether, Bitcoin Cash)
• Expedia (Bitcoin via Travala)
• AMC Theaters (Bitcoin, Ether, Bitcoin Cash, Litecoin)
• And there are more…

Furthermore, the SEC has begun approving various ETFs and other investments that hold Bitcoin and other cryptocurrencies or invest in companies involved in cryptocurrencies and blockchain technology. There are also similar investments available in other countries.

Cryptocurrencies are also beginning to become more regulated. Regulation by governments increases the legitimacy of cryptocurrencies, and that regulation is likely to become more prominent. With many members of Congress and other branches of the government saying they do own cryptocurrencies, it’s unlikely that any regulations put in place will cause cryptocurrencies to go away as just a fad.

If cryptocurrencies were just a fad we would not be seeing this kind of adoption.

“There are too many coins.”

You’re absolutely right. There are a lot of different cryptocurrency options to choose from. In fact, as of 2021 there are over 12,400 cryptocurrency coins and tokens. However, the top two cryptocurrencies, Bitcoin and Ethereum, account for over 60% of the overall crypto currency market. The remaining eight in the top 10 each account for less than 5% of the market, totaling another 18.54% of the market. That means the top 10 cryptocurrencies account for over 78% of the entire cryptocurrency market. If you compare the cryptocurrency market to the U.S. stock market, there are about 6,000 companies on the New York Stock Exchange and NASDAQ. In 2020, there were also about 11,500 companies on the OTC (over-the-counter) markets. Those numbers don’t include the many mutual funds, ETFs, and other investments that are available on those exchanges. So there are actually less cryptocurrency coins and tokens than publicly-traded companies in the U.S., and that’s just the U.S. There are even more companies publicly traded in other countries. Cryptocurrencies, in general, don’t have borders, so those 12,400 cryptocurrencies are a global supply.

Fortunately you don’t need to know or think about most of the cryptocurrency coins and tokens that are out there. Typically, you’ll find the most prominent, well-known, and established coins and tokens in the top 100. You can also rely on a financial advisor, like Escient Financial, who is well-versed, educated, and experienced with cryptocurrencies to help you decide if investing in cryptocurrencies is right for you, and if it is, which investments might be best for you.

“Cryptocurrencies use too much energy.”

There’s no doubt that cryptocurrencies use a lot of energy. However, it’s important to consider the energy consumption compared to other users of electricity, as well as the source of the electricity that’s being consumed.

Bitcoin, as an example, is a global payment system, and as of 2021 uses 81.51 terawatt hours annually. The United States as a whole uses nearly 4,000 terawatt hours and China uses nearly 6,500 terawatt hours annually. Looking at the environmental impact, 62% of Bitcoin miners use hydroelectric power, 17% use wind power, 15% use solar power, and 8% use geothermal. 76% of miners use renewable energy as part of their electricity sourcing. 39% of miners’ total energy consumption comes from renewable sources.

The cost of electricity directly impacts the profitability of bitcoin miners, so it’s essential they find the lowest energy prices. Frequently that is renewable energy, which lowers the environmental impact of mining.

The traditional banking system uses over 250 terawatt hours annually, which is more than 3 times the energy consumption of Bitcoin. That places the energy consumption of Bitcoin far below the energy use and environmental impact of the traditional banking system.

Recently, many miners have relocated to Texas. The increase in the amount of cryptocurrency mining in Texas has actually helped the electrical grid there. Last year, the electrical grid in Texas experienced outages due to a lack of base power. With miners operating in Taxes, the power grid is able to increase the total load of the electrical grid, and when increases in the required power goes above a particular threshold the miners stop their operations to allow the electrical grid to supply the power to residents and business who are in need. The existence of miners in Texas has actually helped stabilize the electrical system there.

“It’s too volatile and risky.”

For short-term investments, you’re right. For longer term investments and for the potential utility of cryptocurrencies, things are more complicated.

First, let’s look at volatility. Volatility is the change in value of an asset, how quickly those changes occur, and how big those changes are over a period of time. Cryptocurrencies certainly are very volatile. It’s not unusual to see a 10% or even 20% change in the value of Bitcoin in a single day. However, Bitcoin is actually not the most volatile investment asset. A study found that in 2020 Bitcoin exhibited lower volatility than 112 stocks of the S&P 500 in a 90-day period and 145 stocks for that year.

Now, let’s look at risk. For a short-term investment, the volatility may present too much risk. After all, it’s not inconceivable that a cryptocurrency investment could decline in value by 30%, or even 50% in a relatively short amount of time. That’s exactly what happened when Bitcoin hit its all-time high of over $69,000 in November 2021 and gradually dropped down to approximately $33,000 only a couple months later. That’s actually more than a 50% drop in value. However, that’s not the first time that’s happened with Bitcoin, and it’s doubtful that it will be the last. In April 2021, Bitcoin hit nearly $63,000, but then dropped about 50% over the next few months before reaching that all-time high of over $69,000. If you’re an investor looking for a short-term investment, Bitcoin and cryptocurrencies are unlikely to be the right investment for you, unless you’re working on some special strategies.

As a long-term investment, however, cryptocurrencies have the potential to add a lot of value and potentially a lot of growth to an investment portfolio. For example, when Bitcoin first started to be tracked on exchanges in 2013, it was valued at about $100. Currently valued at nearly $44,000, that’s a 440 times (aka 44,000%) increase in value in only 9 years. There are few other investments that could have provided that kind of growth.

It’s important to keep in mind that there is no way for anyone to know what the future holds for any cryptocurrency investment. Cryptocurrencies surely are different than traditional investments and have very different risk characteristics. And past performance is not a guarantee of future performance.

There’s no question about the volatility or risk involved with investing in cryptocurrency and digital assets. In some cases, investing in cryptocurrencies could be compared to investing in a startup. These investments may not be right for everyone, and although a financial advisor can offer advice in either direction, it’s really up to each individual to determine if it’s right for them.

“Cryptocurrencies aren’t secure.”

The fact that cryptocurrencies are digital may make people think that it’s subject to hacking and other types of data breaches. While that is possible, it’s actually less likely than you think.

Cryptocurrencies are stored in digital wallets. To access a digital wallet there is typically a 12 or 24 word passphrase using the BIP-39 standard (there are other standards, but that’s the most common). A 12-word passphrase has 5,444,517,870,735,020E24 (the E24 means there’s 24 more zeros added on to the number) possible combinations. A 24-word passphrase has 29,642,774,844,752,900E63 possible combinations.  Just to understand how big that number is, it’s estimated that there are between 1,000,000,000,000,000E63 and 10,000,000,000,000,000,000E63 atoms in the observable universe.  There are actually more possible combinations of a 24-word passphrase than there are atoms in the observable universe. Even with only 5 words in the passphrase, it would take approximately 1,000 years to crack a digital wallet with today’s technology and none of the passphrase words known.  Utilizing the entire Bitcoin network to brute force a 12-word passphrase of a digital wallet would take approximately 317 billion years. Needless to say, without knowing most or all of the passphrase words, a hacker is not going to be able to break into a cryptocurrency wallet. The only stories of hacks of digital wallets have been due to social engineering or getting hold of files, documents, pictures, or paper that has the passphrase on it.

When it comes to cryptocurrency exchanges, some store at least some of the assets in cold storage wallets, and those can be pretty safe. Cold storage is a way of keeping the digital wallet that stores the private keys to access the assets from connecting to the Internet so that hackers would not even have access to it. However, some don’t indicate they use that kind of storage, and there have been stories of hackers being able to hack exchanges.

Many cryptocurrency and digital asset exchanges are not regulated and actually are not approved for use in the United States. It’s important to do your due diligence when selecting an exchange to transact with and purchase cryptocurrencies from. There are a number that are reputable and considered secure for safe use in the United States, and although they typically don’t offer FDIC or SIPC insurance or coverage, they may have their own insurance to cover possible breaches and theft. In fact, some of the biggest hacks of central cryptocurrency exchanges resulted in users being reimbursed for what had been stolen, including the infamous Bitfinex hack.

Regardless, the safest place for your cryptocurrency is a cold hardware wallet that you possess. Don’t type your passphrase in a file on your computer or take a picture of it. Write it down or use a steel passphrase backup storage, and place it where no one will see it or find it.

“There’s no legitimate source for the value.”

I have one word for you: fiat. Or more accurately fiat currency. What is fiat currency, you ask? Fiat currency is what most national currencies are these days, and that is a currency that is not really backed by anything except the promise of the government issuing it. That means a particular fiat currency has value simply because the government says it does. The U.S. dollar was once backed by gold and derived its value from gold, but in 1971 the United States severed the ties between the U.S. dollar and gold, turning the U.S. dollar into a fiat currency. At that time, many other countries did the same thing. Now, these fiat currencies do apparently have a legitimate source of value... the backing of the nation’s government. The government says the currency they print has value, and so the people and other nations accept that it does.

Also, it’s important to understand the relationship between value and price. Generally, something has value because someone or many people say it does. Sometimes it’s a single person or a company demanding a certain price for a product. For example, Tesla sets a price for a Model 3 or Ford sets a price for an F-150. In other cases, many people could be finding value in something and setting a price for it. For example, a painting or sculpture at an art auction. There’s a demand for something, and that something has value based on that demand and the supply. The price is dictated by the value, which is a product of the supply and demand for it. That’s similar to what’s happening with cryptocurrencies. Cryptocurrencies have a price that is partly based on their supply, the demand for that supply, and what people are willing to pay for it.

You may be asking, why do people find value in cryptocurrencies? That’s what upcoming articles will explain. Until then, if you would like guidance or advice on your financial situation, and how cryptocurrencies could play a role (including if they might be right for your or not), feel free to…