What to tell new friends about digital currency

Interest in crypto has grown since the bull market of 2017 and has increased further since 2021, which saw the non-fungible token (NFT) boom and Bitcoin (BTC) reach its highest price yet.

So, what can a crypto investor tell family and friends who are interested in cryptocurrency? Here are some common and important questions that one may come across regarding crypto and some appropriate answers with opinions from experts in the industry.

What is cryptocurrency?

One of the most common questions a crypto investor might get is what cryptocurrency is in the first place. Cryptocurrency is a digital currency that is designed to be used as a medium of exchange. This exchange can come in the form of peer-to-peer (P2P) payments and retail purchases.

Lucaz Lee, CEO of Affyn – a mobile-based metaverse platform – told Cointelegraph, “A cryptocurrency is a digital or virtual currency designed to act as a medium of exchange. It uses cryptography to secure and verify transactions, making it difficult for someone to make fake transactions or fake money.”

Lee continued, “Additionally, cryptocurrencies are decentralized and use distributed ledger technology, meaning no central bank or government controls them.”

Cryptocurrencies exist on the blockchain, which is a public ledger that records all transactions that take place, making it possible for anyone to see how money moves through the network. While anyone can see how much money a user owns and how it is spent. Users need a wallet to send and receive crypto, and these wallets use alphanumeric identifiers, which add a layer of anonymity to users.

What purpose does cryptocurrency serve?

The main purpose behind cryptocurrency is the ability for anyone to send and receive money through a decentralized P2P network. This works like a digital version of cash. For example, when users pay with cash, they pay directly to another person without having to go through an intermediary such as a bank or payment processor.

Cryptocurrency does this on a digital level, allowing anyone to transfer money directly to another person, entity or organization while retaining control of their money at all times. Lee agreed, saying: “Cryptocurrencies can be used as a medium of exchange or payment for specific services without intermediaries or centralized control. It removes the constraints of traditional finance, enabling the globe’s vast number of unbanked and underbanked users to access for financial services.”

Cryptocurrencies are also used as investment instruments, with users able to generate high returns due to limited supply, high volatility and high levels of speculation.

Lee added, “With each passing day, cryptocurrencies are becoming more attractive investment options. Certain variations also support opportunities to generate passive returns, helping investors expand and diversify portfolios.”

If crypto is not backed by anything, how is it worth anything?

Most cryptocurrencies are not backed by any traditional assets except for stablecoins such as USD Coin (USDC) and Tether (USDT), which have a large portion of their tokens backed by reserves of fiat money and bonds. Some people may wonder why cryptocurrencies have any value if they are not backed by anything.

First, much of the value comes from the utility of a cryptocurrency. The more a cryptocurrency is needed for a particular task, the more demand there will be for that cryptocurrency. Examples include the use of crypto as a store of value and use for special protocols in sub-sectors such as decentralized finance (DeFi) and NFTs.

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Igor Mikhalev, Partner and Head of Emerging Technologies at EY and Chairman of Decentralized Autonomous Organization at Blueshift – a decentralized exchange – weighs in on this question, telling Cointelegraph, “cryptocurrencies built well are worth more and more because they demonstrate the basic functions of traditional currencies: scarcity, medium of exchange/account and store of value. It is possible because of advances in the underlying technology, legislation and people’s general attitude towards it.”

It is also worth noting that fiat currencies such as the US dollar, euro and British pound are not backed by anything (hence the term “fiat” currency). Speaking about this, Mikhalev added: “The USD is not backed by real assets like gold and is only backed by people’s trust in the US as the issuer. So why wouldn’t we want to support, own and exchange currencies issued by other mission-driven collectives supported by their value and utility? This is the basis for the new decentralized economy.”

Giving his opinion on the value of cryptocurrency, Lee added: “Cryptocurrency is not backed by anything, but it is intrinsically worth something because people believe it has value. The market forces of supply and demand determine the price of a cryptocurrency.”

Speculation and investment also play a role in the value of cryptocurrency. If investors believe that the value of a coin will increase over time, they are more likely to buy and hold that coin, expecting to make a profit in the future.

Lee added, “the more people want to buy a cryptocurrency, the higher the price becomes. The more people want to sell the cryptocurrency, the lower the price. Blockchain technology has proven to be reliable and secure; consequently, many people believe in its longevity and invest therefore in cryptocurrencies.”

Can cryptocurrency replace real money?

Broadly speaking, no, as cryptocurrency is not regulated and there are many services, products and goods that will always need traditional cash. However, governments are looking at creating their own digital tokens known as central bank digital currencies (CBDCs), and there is growing use for decentralized cryptocurrencies.

“You can’t go into a Starbucks in America and pay with Swiss francs or pounds. Still, both of these are real money. Context matters.” Rockwell Shah, co-founder of Invisible College — a Web3 learning community — told Cointelegraph, adding:

“Similarly, the main cryptos are native currencies of their own digital nations. They have relevance in their own blockchain borders. If the use cases of cryptos are so compelling that people use them instead of traditional currencies even outside their digital borders, that’s great. Welcome to the free market.”

Lee also believes that the answer to this question is context-based. “The answer to this question is not a simple yes or no. It depends on the country and the corresponding economic system. In countries like Venezuela, where the government has mismanaged the economy and triggered high hyperinflation, cryptocurrency has become a way of life for many people.”

“Compared to traditional money, cryptocurrency is very new and its implications for society at large have yet to be tried and tested. Nevertheless, central banks are exploring the idea of ​​transitioning to digital currencies, known as central bank digital currencies,” he added.

Some experts believe that the underlying principles behind cryptocurrencies actually put them ahead of traditional currencies when it comes to adoption.

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“Remarkably, cryptos have already begun to outperform national currencies on the basic functions due to their democratic and transparent nature people lean towards. Together with the decline in trust in public/official institutions, this provides fertile ground for accelerated adoption,” Mikhalev said and continued:

“One can see this difficult (for traditional financial institutions) situation already today: The debate around the introduction of CBDCs (digital currencies at the national level) stops. Central, by nature, institutions do not want decentralization, as it will lead to their demise. It however, there is no going back. Once the technology is mature enough (and one could argue it already has), it will only take a major geopolitical event for explosive adoption to begin.”

Can cryptocurrency be hacked?

Blockchains themselves are largely impervious to cyber attacks. Lee spoke to this point:

“Blockchains, by design, are nearly impossible to hack because they are decentralized and rely on various security mechanisms. However, external variables such as hot wallets, centralized wallets, bridges, and even smart contracts can be hacked.”

Therefore, the best way to secure users is to secure their funds by storing them in a non-custodial wallet, which is a wallet that allows them to own the private keys and wallet seed. This way, an attacker needs to know the private key and the wallet seed to access their funds. When it comes to platforms, hackers usually resort to phishing attacks to try to trick users into giving away information such as passwords and login credentials so that the hackers can access their funds.

What makes cryptocurrency prices go up?

Speculation and supply and demand are some of the main factors that drive cryptocurrency prices. Most cryptocurrencies have a limited supply, and when there is a high demand for that coin (due to speculation about utility), the price usually rises in response.

Lee also believes that supply and demand is the main reason why the prices of a cryptocurrency increase, saying that “the price of all assets, including cryptocurrencies, is determined by supply and demand. When the demand for an asset exceeds the supply, it creates a price increase. Sometimes macroeconomic and geopolitical factors also affect crypto prices.”