Cryptocurrencies, also known as digital currencies or altcoins, are a relatively new type of asset. They are decentralized and do not have oversight by any outside authority, unlike fiat currencies such as the dollar or euro. The first popular one, Bitcoin, was created in 2009, and now has hundreds of competitors, such as Ethereum and Ripple. While these payment methods were first viewed primarily as an anonymous way to transfer funds, they are now more mainstream thanks to increased global acceptance.
Digital currencies are usually created, or “mined”, using powerful computers to solve difficult algorithmic puzzles. There is an electronic ledger which tracks when a new coin is created. The ledger also has a record of the location of each coin as it is transferred from person to person, but the actual name of the person who owns the coin is not listed. Individuals can also buy altcoins through peer-to-peer networks where the price is set by an agreement between the parties.
Ancient cultures such as the Egyptians, Greeks, and Romans created easily portable coins that could be exchanged for goods and services. However, consumers soon realized that government backed money could easily lose or gain value based on the policies of those issuing the credits.
For example, let’s say the value of a single unit of a country’s currency was originally worth 0.2 percent of the total value of a country’s net worth. Then government decides to create twice as many coins to pay its debts, without increasing the country’s productivity. Each coin is now worth only 0.1 percent of the country’s total net worth, leading to an immediate loss in its value and buying power. This loss of value and subsequent rise in the price of goods and services is called inflation.
Governments can also influence the value of a currency by making it harder or easier to borrow money. They do this by changing the interest rate that the country’s national bank, normally referred to as a Central Bank, uses to lend money to retail banks. When interest rates are higher, these retail banks can offer better returns, and foreign investors buy more of the country’s currency, once again increasing its value. On the other hand, lower interest rates reduce investment and cause the currency’s value to drop.
For those interested in cryptocurrencies, the ability of a government to influence the value of the local currency is problematic. If the country runs into economic difficulties, or has a political upheaval, those in charge can easily take control of the local money.
Depositors in several European countries learned this the hard way during the recent global recession, when pensioners were forced to turn over all or most of their retirement funds to the state to help with budget shortfalls. Because cryptocurrencies like Bitcoin were not held in banks under government control, these funds were kept safe from seizure.
The rise of online trading has allowed investors to profit from price movements in cryptocurrencies, without having to physically purchase the underlying altcoin. Many CFD brokers are even letting clients trade cryptocurrencies like Bitcoin against exotic assets such as oil or gold.