Beginner’s guide to cryptocurrency
If you’ve only got a minute:
- A cryptocurrency is a digital asset that works based on blockchain technology.
- A blockchain is a decentralised, distributed ledger that records transactions across many computers in a way that makes it difficult to alter or delete previous transactions. This allows for a secure and transparent record of all transactions made.
- The value of cryptocurrencies is determined by demand, supply and utility.
- Consider carefully the security and reputation of the crypto exchange you use – the custodian should be in good financial standing.
- Cryptocurrencies should only form part of an overall portfolio of investments, given its high volatility.
In recent years, you might have heard of the terms “cryptocurrency” and “Bitcoin” in financial news or the investing world. What are they and should you invest in them? This topic may appear daunting but let us simplify it with an introduction to what could be the future of currencies.
What is a cryptocurrency?
A cryptocurrency is a type of digital asset that is supposed to function as a means of exchange, much like how the money in our wallets works. Unlike the money we use, cryptocurrencies allow for transactions online without a middleman, like a bank or a payment platform.
While fiat currency is issued by central banks, cryptocurrencies are typically not issued or controlled by any central authority or government. Rather, they are managed by blockchain technology - a decentralised, distributed ledger that records transactions across many computers in a way that makes it difficult to alter or delete previous transactions. This allows for a secure and transparent record of all transactions made.
Think about how many transactions you make online - from shopping to investing – and how every one of these transactions requires a bank or payment provider like Paypal. The blockchain allows for these transactions to happen without a middleman, and without the associated costs and complexity that comes with them.
Brief history of Bitcoin
Launched in early 2009 by an anonymous creator who goes by the pseudonym of Satoshi Nakamoto, Bitcoin is the largest cryptocurrency measured by market capitalisation. Only approximately 21 million bitcoins will ever be created, which explains its scarcity and high price. As of current records, almost 90% of all bitcoins have already been mined.
The bitcoin mining process rewards miners with a portion of bitcoin upon successful verification of a block. This process adapts over time. When Bitcoin was first launched, the reward was 50 bitcoins. As of 2022, miners only get 6.25 bitcoins for every new block mined. While this might not seem like much, the value comes up to around US$191,300 as the Bitcoin price was US$30,614 (as at30th Jan 2022) The reward will continue to halve every four years until the final bitcoin has been mined. Once all bitcoins have been mined, it is likely that miners will be incentivised to process transactions with fees.
While Bitcoin is the largest cryptocurrency by market capitalisation, other cryptocurrencies (often referred to as ‘altcoins’) have been sprouting up and garnering attention as well. For example, Bitcoin Cash focuses on solving the scalability issue of Bitcoin by allowing quicker processing of transactions at a lower cost – e.g. sending Bitcoin Cash to a recipient incurs far less transaction fees than sending Bitcoin. Beyond payments, the altcoin Ether is the native cryptocurrency of the Ethereum blockchain, which enables a variety of applications to be built through the use of smart contracts (programs stored on a blockchain that run when predetermined conditions are met, without the need for an intermediary) - such as gaming or decentralised finance applications.
What determines the value of cryptocurrency?
Put simply, a cryptocurrency’s value depends on 3 factors – its supply (scarcity), demand and usage (utility). Like many other things, its price is determined based on the market’s supply and demand.
There are several cryptocurrencies available now, with the most popular being Bitcoin. The value of Bitcoin is very volatile as it is a nascent market and many are not sure about how governments around the world would regulate it, or whether its usage will become mainstream one day.
As cryptocurrencies are basically currencies with no single authority that determines its value, there are several implications for those holding cryptocurrencies:
- Cryptocurrencies are not regulated by the Monetary Authority of Singapore (MAS) as they are not legal tender.
- There will not be any legislative protection should you lose money from dealing with digital tokens.
- There is no organisation deciding when to make more bitcoins, keep track of where they are or investigate fraud.
Investors will need to be mindful of the high volatility of cryptocurrencies before investing. Do note that Bitcoin prices fell by nearly 65% in 2022, its worst annual performance since its 73% decline in 2018. As such, investors should not invest money in cryptocurrencies that they need in the short term. In addition, cryptocurrencies should only form part of an overall portfolio of investments, given its their high volatility.
How do I buy or trade cryptocurrencies in Singapore?
The most accessible and common way to buy cryptocurrencies in Singapore is to set up an account on a cryptocurrency exchange. Before you start, you’d need to get a few things ready:
- Personal identification documents for verification
- Payment account/method, which includes credit cards and fund transfers
- Secure connection to the internet (public WIFI is a no-go)
- Phone for two-factor authentication
Bitcoin purchases through an exchange are typically held by the exchange. However, there is a need to ensure that your money is safe on the exchange. You should consider 3 main factors.
- Financial standing: The custodian should be in of good financial standing to minimise its risk of going bankrupt.
- Account segregation: All crypto holdings should be stored in segregated accounts. This means that clients’ funds are ringfenced and are not comingled with the service provider’s own holdings. By doing so, clients’ cryptocurrencies can be insulated from any potential insolvency risk of the service provider.
- Secure (cold) Storage: The exchange should use either a majority or 100% cold storage solution and take other relevant security and risk management measures to ensure the security of your cryptocurrencies from hacks/theft. Cryptocurrencies can either be stored via hot storage (i.e. storage that is connected to the internet, and thus more convenient to access) or cold storage (i.e. storage that is not connected to the internet and is thus more secure but less accessible). Cryptocurrencies stored in cold storage are less vulnerable to cryptocurrency hacks.
While storing with an exchange represents a custodial wallet solution, you may also wish to store your cryptocurrencies on non-custodial wallets (which also have hot or cold storage options). This removes the need to rely on a third party custodian and eliminates third party risk. However, it does require more effort on your part and would mean there is no ability to retrieve your private keys if they are lost. You can read more about cryptocurrency storage options here.
DBS Digital Exchange
With the DBS Digital Exchange, DBS leverages blockchain technology to provide an ecosystem for fund raising through asset tokenisation and secondary trading of digital assets including cryptocurrencies.
DBS uses 100% air-gapped cold storage technology, which reduces the risk of loss of cryptocurrencies to hacks. DBS also stores all crypto holdings in segregated accounts, which means that these holdings are ringfenced in the event of the exchange’s insolvency. These measures ensure the safety of client holdings.
Should I invest in Cryptocurrency?
As with any type of investments, ask yourself if it is aligned with your financial objectives, your financial health, and if it is worth the risk. This is because investing in cryptocurrency is highly speculative and the market is largely unregulated. So, invest with money that you don’t have an immediate need for.
The future of cryptocurrency remains a question mark for now. We do not know if cryptocurrencies will be widely accepted in the near future. While certain retailers in the United States are accepting Bitcoins as payments, other countries, like India, are looking at banning cryptocurrencies and fining anyone who owns them. Thus, you’d need to ask yourself the question – should cryptocurrencies not be accepted as widely as expected, would you be able to afford the loss of your investment?
It is prudent to first focus on your core investment portfolio using suitable tools and products from traditional asset classes like equities, bonds and cash. If you have spare cash after that and you understand the risks of alternative investments, you may wish to put some into cryptocurrencies. This approach would probably let you sleep with peace of mind and avoid putting all your eggs in one basket, instead of living with the stress of volatile movements associated with the cryptocurrency markets.
This article is part of a series of articles covering Digital Assets. If you enjoyed the read and want to learn about digital assets in greater detail, do check out the other articles in this series:
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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
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