Choosing the right cryptocurrency
There are so many cryptocurrencies available, some that seem to duplicate existing currencies and others that offer radically different benefits and drawbacks. How is a newcomer to know where to start; whether they want to invest or use a cryptocurrency to buy things? The guide that follows will help.
First, we’ll consider some of the factors that make a ‘good’ cryptocurrency, then we’ll consider the forces that drive prices, and finally we’ll examine whether cryptocurrencies are the future. By the time we’ve finished, would-be crypto investors should at least know what to look out for.
What makes a good cryptocurrency?
This is a tricky question to answer for two reasons. First, nobody can predict the future, so even the most encouraging looking cryptocurrency might end up failing. Second, what makes a cryptocurrency good depends on what you want to do with it.
If you are looking to invest in a currency, then you will want a coin that will hold – and increase – its value. On the other hand, if you want to use the cryptocurrency, then you will need one that is widely accepted, or is at least accepted by the retailers you want to use.
That usability is an important factor. The more uses a currency has, the wider its potential base of users, and the wider its user base, the greater demand. Demand, as in all economics, is crucial for driving price.
You will also want to look for a currency that is easy to acquire, whether through mining or buying. For some established currencies, mining is now restricted to those with access to expensive equipment, but buying them is still straightforward. For other, newer, cryptocurrencies, mining is easy but there are fewer in circulation for buyers.
It is important to investigate the community around a cryptocurrency as well. The code that underlies cryptocurrencies sometimes needs to be updated to take account of new developments and close gaps in security. The larger and more active the community, the more likely it is that these changes will be dealt with promptly and effectively.
The size of the community will also affect how widely it is supported by vendors and how easy it will be to find information and get help if you need it.
You need to look for a combination of all these things to help determine a good cryptocurrency. It’s worth considering the example of investors who advocate a ‘portfolio’ approach, which means spreading your risk by investing in different assets, with a mix of risk profiles. For cryptocurrency investors, a portfolio makes sense. Other users might want to consider a portfolio approach in the sense of adopting different currencies for diverse needs.
What drives cryptocurrency prices?
Cryptocurrency prices, like prices for traditional currencies or other tradable assets, are affected by numerous factors and those factors can interact in complex ways. At the root of the value of a cryptocurrency is supply and demand. Price goes up when demand exceeds supply and falls in the reverse conditions.
A rough rule of thumb for the strength of a cryptocurrency is its market capitalisation, known as ‘market cap’. In the world of shares, a market cap gives a rough estimate of the price of a company because it tells you the value of the company’s outstanding shares. That’s what it would cost you to buy the company, though the price of something is obviously not the same as its value.
Applied to cryptocurrency, the market cap is the price of all the outstanding coins. It is calculated by multiplying the supply of coins by the price per coin. Again, market cap does not necessarily equal value, but comparing the market cap of two cryptocurrencies is a better way to determine which is better priced than simply looking at the price of coins.
The difficulty of verifying a block of transactions and the energy costs involved in this mining process are both reflected in the price of a coin, as is its utility – a coin that has more uses, as mentioned above, will be more in demand and therefore prices are likely to rise.
Investors also pay attention to regulatory concerns and security issues such as thefts or claims that prices have been artificially inflated. These are all things that could worry investors, therefore driving demand down and leading the price to fall.
You’re probably already getting the sense that these things are hard to measure, but hardest to measure of all is perception. Investors are just individuals using their judgement and sometimes they will weigh-up the pros and cons of a currency and decide against it. There could be any number of reasons why they reach those decisions. Perhaps there has been a series of negative media coverage of a particular currency that has made them fear that a slump is coming, or perhaps they have seen prices change for some cryptocurrencies and expect others to follow a similar pattern.
Since cryptocurrencies are still new and many investors are still learning about them, these price fluctuations have been volatile for many cryptocurrencies. In some circumstances, volatility can breed more volatility. Investors, reacting to past price changes, take drastic action, which creates future volatility.
Are cryptocurrencies the future?
There are plenty of people who believe that cryptocurrencies are the future and will replace traditional currencies, shifting power away from central banks and governments. If this is the future it’s still some way away, with no cryptocurrency having established itself as a clear favourite even among those who are experts in the field. Also regulators are taking a very cautious approach to determining how cryptocurrencies can be used.
The decentralised nature of the internet is one of its strengths. The network was designed so that the removal of one, or even several, nodes would not cripple the remainder. Cryptocurrency is designed to work in a comparable way. As the financial crash of 2008 revealed, significant financial disruption in one country, for example, the United States, can have a knock-on effect that harms economies around the world. As a decentralised, peer-to-peer tool, cryptocurrencies are intended to avoid that.
However, their ability to do so in practice is debatable. The volatility of Bitcoin prices and allegations that the price increases were the result of market manipulation show that without a central bank in charge, catastrophic events can still affect the entire network.
Even so, there is little doubt that a technological currency is a natural fit for the modern world. Most of our money exists virtually in any case, so the idea that a virtual currency could replace traditional money and allow us to spend the same currency anywhere in the world, doesn’t seem that far-fetched.
Cryptocurrencies are also always-on, so that trading doesn’t cease when, for example, Wall Street closes for the night. This, too, seems like a more natural fit for our internet-enabled world.
If cryptocurrencies are the future then it is possible that we have not yet seen the winner. Indeed, one possible scenario is that governments will simply launch their own cryptocurrencies and convert their citizens to those. Certain countries might choose to get together and share currencies, while others might settle for making it easy to trade between currencies. It’s possible that it won’t be governments that do this but retailers. We could see an Amazon Coin or an Apple Coin that becomes a currency used by customers of those businesses.
There will be obstacles, however. Scientists have warned that the power demands of blockchain-based technology are unsustainable, so an alternative verification method might be needed if cryptocurrencies are to become truly global. Secondly, we’ve seen recently that networks can be compromised by attackers gaining control of more than 50 per cent of the network – something that was once thought unlikely. A currency with this kind of vulnerability clearly poses greater risks than traditional currencies, so this is a hole that will need to be closed before mass adoption is possible.
Finally, cryptocurrencies are still not trusted by many technology experts, so getting them beyond the tech world and persuading the average person to use them in place of traditional currency is clearly a long way from happening. There’s a very significant education exercise to be done before cryptocurrencies become mainstream.