What Are Cryptocurrencies? Pros And Cons In Investing Money Through Cryptocurrencies

What are Cryptocurrencies? Essentially, cryptocurrencies and tokes form the so-called cryptoassets.

You can imagine cryptoassets as some umbrella term, spanning around cryptocurrencies and the so-called tokens.

What Are Cryptocurrencies?

A cryptocurrency, crypto-currency, or crypto is a digital currency that functions as a medium of exchange via a computer network and is not reliant on any central authority, such as a government or bank, to uphold or maintain it.

Individual coin ownership records are stored in a digital ledger, which is a computerized database that uses strong cryptography to secure transaction records, control coin creation, and verify coin ownership transfers.

Understanding this breakdown of cryptoassets helps you to understand the entire universe of cryptocurrencies better.  It also shows you that cryptocurrencies themselves are just one part of the story.  Lastly, in this video, we will also briefly talk about hybrids, which combine features of both, cryptocurrencies and tokens.

What Are Cryptocurrencies

Cryptoassets

Before we look at cryptocurrencies themselves, let’s speak about the term cryptoassets for a moment.  The crypto market has changed significantly over the last few years.  Two of the most notable developments are the massive growth of the number of so-called private tokens issued on existing platforms to raise funds and the emergence of so-called stable coins. 

These trends have caused various regulatory authorities, standard-setting bodies, and industry professionals to shift their focus and expand their vocabulary from cryptocurrencies to the broader term of cryptoassets.

A cryptoasset can be described as a type of private asset built on cryptography principles, which forms part of its perceived value.  This includes two consecutive types of cryptoassets, namely virtual currencies, and tokens.

Cryptocurrencies

It’s finally time to talk about cryptocurrencies themselves.  Cryptocurrencies or coins, such as Bitcoin and Litecoin, are those cryptoassets designed or intended to perform currency roles, which means to function as a medium of exchange, a store of value, and a unit of account.  They are intended to constitute a peer-to-peer alternative to government-issued legal tender.

Cryptocurrencies can be characterized in numerous different ways, and we will look at two of them.  In particular, we will look at private versus sovereign coins and stable or backed versus non-stable coins.

Private versus sovereign coins

Let us first talk about Private versus sovereign coins.  The emergence and growing popularity of cryptocurrencies and their underlying technology have inspired various central banks to investigate whether it would make sense to issue their digital currencies for wholesale purposes or as a complement for physical banknotes coins. 

These digital currencies are commonly referred to as central bank digital currencies or CBDC.  Simply put, a CBDC is a digital asset or a digitalized instrument issued by a central bank for payment and settlement in either retail or wholesale transactions.  Since a central bank issues, it is a central bank liability – it could be described as a sovereign coin.  On the contrary, non-central bank digital currencies that are decentralized can be described as private coins.

Stable coins versus non-stable coins

Now let’s talk about Stable coins versus non-stable coins.  The first wave of cryptocurrencies, which began with Bitcoin and hundreds of subsequent Bitcoin clones, are de-facto considered by their users as something of value.  They do not represent any underlying asset, claim, or liability, making them prone to high price volatility.  They are what could be called traditional non-backed cryptocurrencies.

The highly volatile nature of traditional non-backed cryptocurrencies makes it very hard for them to truly perform currency roles and become more widely adopted.

Several cryptocurrency advocates have recognized that the severe price volatility of the first wave of cryptocurrencies is a major hurdle for their acceptance as a means of payment and store of value.  They have tried to address the issue at hand by introducing so-called stablecoins. 

A stablecoin is a subcategory of cryptocurrencies, typically linked to another asset’s price or a pool of assets.  By these means, a stablecoin is designed to maintain a stable value.  Like traditional non-backed cryptocurrencies, stablecoins are intended to perform the roles of currency.

Traditional non- backed cryptocurrencies are generally decentralized and do not have an identifiable issuer or at least not an institution that can easily be held accountable by or towards the coin’s users.  Stablecoins, on the other hand, typically represent a claim on a specific issuer or underlying assets or funds or some other right or interest.  They are, in other words, backed by something and not just perceived to be something of value.  Examples of stablecoins already in circulation are Tether, Multi-collateral DAI, and Gemini Dollar, among several others.

What Are Cryptocurrencies

Tokens

And then, there are Token.  On the other hand, tokens are those cryptoassets that offer their holders certain economic or consumption rights.  They are digital representations of interests or rights to access certain assets, products, or services.  Tokens are typically issued on an existing platform or blockchain to either raise capital for new entrepreneurial projects or fund start-ups or develop innovative services.

There is currently more than one category of cryptocurrencies.  There is also more than one category of tokens.  Tokens can take on different forms with various features.  Since their conception, different approaches have been developed to classify and define them.  Generally speaking, most regulatory authorities tend to distinguish so-called investment or security tokens from so-called utility tokens:

  • Investment Tokes: Let us first talk about Investment Tokes.  Investment tokens, which are sometimes also referred to as security tokens or asset tokens, are those tokens that typically provide their holders’ rights in the form of ownership rights or entitlements that are similar to dividends.

Investment tokens are generally issued for capital raising, for example, through an initial coin offering.  They show similarities to traditional debt and equity instruments.

A well-known example of an investment token is Bankera’s BNK token, which grants its holder a right to a weekly commitment to be paid out in the cryptocurrency Ether.

  • Utility Tokes: Secondly, there are Utility Tokens.  Utility tokens grant their holders access to a specific application, product or service often provided through a blockchain-type infrastructure.  They typically only provide access to a product or service developed by the token issuer and are not accepted as a means of payment for other products or services.

Some examples of utility tokens include Golem and Filecoin, which facilitate access to a specific service: Golem grants access to computing power and Filecoin to data storage.

Like investment tokens, utility tokens are also issued to collect financial resources, usually to fund the issuer’s application, product, or service development.  However, unlike investment tokens, their main purpose is not to generate future cash flows for investors but to grant access to the issuer’s application, product, or service, and at the same time, create a user base.

Hybrids

Besides cryptocurrencies and tokes, there are also hybrids.  While it is theoretically feasible to draw a clear dividing line between cryptocurrencies and tokens, it is not always easy to categorize a cryptoasset in practice.  This is because cryptoassets can exhibit features of more than one category.  Cryptoassets that embody such a combination are commonly referred to as hybrids and raise particular regulatory challenges.  An example of a hybrid token, more specifically an investment-utility hybrid, is Crypterium.  Crypterium is used to pay transaction fees when using the issuer’s services, gives the right to discounts for future services, and gives a right to revenues.

Before we finish this lesson, it is important to understand that this taxonomy is not carved in stone.  This is, after all, a snapshot of what is out there now.  The crypto-market continues to evolve, so what holds today may require an update in the future.

Final Thoughts

Despite their name, cryptocurrencies are not necessarily considered to be currencies in the traditional sense, and while various categorical treatments have been applied to them, including classification as commodities, securities, and currencies, cryptocurrencies are generally viewed as a distinct asset class in practice. Owners put up their tokens as collateral in a proof-of-stake model. In exchange, they receive authority over the token in proportion to the amount staked.

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