Cryptocurrency FAQs — Everything you need to know about the cryptocurrencies, the crypto market and everything in between
- People are investing in cryptocurrencies for a variety of reasons, especially in India.
- However, the cryptocurrency market is not the same as the stock market, especially when it comes to having the same checks and balances to protect investments.
- Here are the answers to some of the most frequently asked questions (FAQs) about cryptocurrencies.
Here’s everything a first-time crypto investor should know before entering the crypto wild west.
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- What is cryptocurrency?
Refers to a digital currency, secured with cryptography to enable trusted transactions. Blockchain is the underlying technology, functioning as a ‘ledger’ or record of transactions made.
Hundreds of currencies are in circulation, such as Bitcoin, Ether, Monero, etc. Each is designed by one or more brilliant individuals, usually meant to run as a decentralised system so that no single entity can control it.
Cryptocurrency units are usually generated on the basis of an algorithm announced to everyone in advance, by ‘miners’ using powerful computers. Having expended a lot of time and electricity on ‘mining’, these miners can hold on to the units or sell to others.
- How is crypto stored?
Let’s look at a national currency like the rupee. It can be deposited in your name at a bank, or privately stuffed into a mattress at home far away from anyone’s eyes.
Similarly, a cryptocurrency can be held on your behalf by a company, usually in your wallet at a crypto exchange online. You could also hold it in without being affiliated to anybody, in a private cryptocurrency wallet.
- What is the purpose of cryptocurrency?
As indicated by ‘currency’, they were originally intended to be used in the same way as rupees and dollars are, as a medium of payment between people for products and services purchased.
Consider store reward cards, an alternative physical payment method that is denominated in their own units, and not in national currency. Similarly, cryptocurrency with its own units was meant to enable easy digital transactions online, at lower costs than what conventional banks charged.
- Is cryptocurrency used for illegal activities?
Initially with no government control, crypto became a useful tool to escape political censors and repressive regimes, which was an admirable goal. However, crypto eventually became known as a method of transacting for illegal substances on hidden parts of the internet.
Governments discourage such behaviour and made use of crypto’s built-in ledger to pursue criminals. With the extent of tracking that is now possible in 2021, it is safe to say that it is difficult to use cryptocurrency for crime. Bitcoin for instance, sees over 300,000 transactions daily on average, with crypto exchange trades accounting for over half of them in the last two years.
- How does supply and demand work in the cryptocurrency market?
Some cryptocurrencies like Bitcoin and Ether are designed to have a limited supply. By comparison, real-world currencies like the US Dollar do not have a hard limit on supply. When demand increases, the value of a supply-limited item is expected to increase.
That difference in supply, a high demand for crypto and new ways to profit from rising crypto, have led to a self-perpetuating cycle that drives up the exchange value of major cryptocurrencies.
- How to start trading in cryptocurrencies?
Fundamentally, a seller sells their currency to gain cash and a buyer buys expecting to hold the currency until its value increases in dollar/rupee terms.
In mid-August 2021, the total market value of all cryptocurrency exceeded $2 trillion, with Bitcoin alone making up 44% of that. As the graph above shows, a currency can start small and reach very high – but with a number of bumps along the way.
People with a lot of faith in the future of cryptocurrencies subscribe to a ‘HODL’ mindset, meaning ‘hold on for dear life’ to the roller-coaster they expect to ride. They buy and do not intend to sell anytime soon, even claiming that the value of one Bitcoin could rise from $50,000 today to $288,000 in a few years.
Others choose the day trading route – buy a currency, target a profit percentage as low as 2% and sell as soon as that target is reached – sometimes within hours.
- How to trade in cryptocurrencies in a safe way?
For beginners in the crypto market, experts advise investing only as much money as you’re willing to lose. The reason is, crypto trading marries the ‘irrational exuberance potential’ of a conventional stock market to the regulatory uncertainty of crypto.
Also, hackers have shown that anything financially valuable on the internet is a juicy target. However, crypto exchanges that hold user wallets try to stay safe by employing armies of security experts and paying ‘bug bounties’ to external consultants who identify vulnerabilities.
- What questions should I be asking about crypto?
The first question one may have to address is which currency to buy. The biggest one, Bitcoin, would be a good starting point to begin investing right away.
One could later branch into other coins and tokens as per observations/confidence. As with stocks, researching the cryptocurrency of choice is always helpful.
The second question is adopting a safe trading method. To begin with, a simple ‘buy and hold’ may be preferable. Long term investors could carry over the ‘rupee cost averaging’ (RCA) low-risk strategy from the stock market.
An example of RCA would be setting a budget of ₹1000 a month, and buying crypto for exactly that much regularly each month, regardless of price dips or peaks. After gaining confidence, many more strategies could be used.
The third question would be choosing a crypto exchange. Picking a well-known exchange backed by big names internationally, one that is likely to still be growing 2-3 years later could allow peace of mind that one’s investment is safe. CoinDCX and WazirX are both good starting points for Indian investors.
After gaining confidence, one could consider comparing exchanges on factors such as currency pairs offered, transaction costs, ease of transaction, security, leverage availability, futures, NFT purchases, earnings from DeFi lending, and so on.
- How do I make money by trading cryptocurrencies?
There are three things to be aware of when one is ready to take profits on investment. Like all business, trading in crypto has additional expenses to keep in mind.
First of all, exchange transaction fees that apply to all actions between infusing cash and exiting investments at a profit.
Secondly, unexpected movements in price could mean holding onto crypto for longer than initially expected.
Thirdly, taxes that fall due at the end of the year. Depending on income tax bracket, people may have differing minimum profit targets. Frequently forgotten until the end of the financial year, keeping this factor in mind could help one enjoy their gains in moderation.
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