Digital Assets:
What Are They and Why All This Attention?
Digital assets are here to stay and the magnitude of their growth is hard to determine. Defining digital assets is highly complex and it is difficult to evaluate the future impact of our financial markets and our environmental energy sources (via data mining). However, let's just start with a primer introducing some "digital asset" terms and a few frequently asked questions.
View our recent webinar "A Primer on Digital Assets" to learn more about Digital Assets and Cryptocurrencies - what it was, where it is and where is it heading?
What do you mean by DIGITAL ASSETS?
In financial services, digital assets exist as binary data, which are self-contained, uniquely identifiable, and have a value/use case. Broadly, this phrase can refer to any asset that is stored digitally (e.g., a PowerPoint slide deck, JPEG picture file, MP3 podcast episode, Bitcoin (BTC)).
What is CRYPTOCURRENCIES and how is it different from Digital Assets?
Cryptocurrency is digital money powered by blockchain. There are thousands of digital currencies today, such as Bitcoin, Dogecoin, and Ethereum that can be used to buy and sell goods and services online. Cryptocurrency is unregulated, lacking oversight from agencies like the Securities and Exchange Commission and FINRA. While all cryptocurrencies are digital assets, not all digital assets are cryptocurrencies.
What is BLOCKCHAIN?
Blockchain is the underlying technology that supports many digital assets. Think of it as a "distributed ledger," or a specific type of database that stores information in chains of "blocks." No individual or group is in control of the entirety of the blockchain. The Bitcoin Blockchain consists of a link of blocks, each holding information on:
1) A Bitcoin transaction
2) The individual block's identity
3) The identity of the previous block.
What are TOKENS?
Other crypto assets leverage non-native blockchain (the network another coin runs on), intended to represent a different asset to be used as a store of value and/or for trading. These assets are fungible, meaning they can be replaced with another identical asset of the same value (e.g., Tether, USDC).
What is MINING?
Mining is the technology that supports the creation of cryptocurrencies. A new "block" of code creates a new crypto coin. Mining requires considerable computing power to execute the complex formulas to solve and create a new block. This process also verifies recent transactions along with the blockchain.
What are NON-FUNGIBLETOKENS (NFT's)?
NFTs are digital proofs of purchase for items such as art, baseball cards or digital music. NFTs are stored and traded on computer networks using the same technology that powers bitcoin and other cryptocurrencies.
CENTRALIZED FINANCE (CEFI) vs. DECENTRALIZED FINANCE (DEFI)?
The original concept of Bitcoin set out to decentralize the Traditional Finance (TradFi) system. However, many crypto transactions are taking place on 'CeFi' platforms, where centralized governing bodies oversee and regulate users' digital assets. By contrast, 'DeFi' platforms allow direct peer-to-peer transactions, with self-executing trades using blockchain, without third parties. CeFi Exchanges (CEX's) include Binance, Coinbase, and Gemini versus DeFi Exchanges (DEX's) Uniswap and Sushiswap.
How do I purchase cryptocurrency?
There are a couple of ways to purchase cryptocurrency, but the simplest and least expensive method is through an online cryptocurrency exchange. After establishing an account, you have the ability to transfer in cash and purchase the cryptocurrency of your choice.
Exchanges allow you to buy, sell, and hold cryptocurrency, but the user experience, fees, and identification requirements vary based on the particular exchange. Some of the most popular exchanges are Coinbase, Gemini, and Kraken. In addition, traditional online brokers, such as eToro and Robinhood, as well as fintech and technology companies, like Square and PayPal, are beginning to offer these services.
What is a crypto wallet?
Just as a traditional wallet can store your physical cash, crypto wallets are where you can store your digital assets. You can hold your crypto wallet through an exchange account, custody wallet, or outside of the exchange. While your wallet can be internet-connected ("hot" wallet), the alternative is to store your wallet on a device that is not connected to the internet ("cold" wallet), which is the most secure way, designed for longer-term holdings.
Are wallets capable of being hacked?
Unfortunately, yes. This demonstrates the importance of thoroughly researching where you both trade and store your digital assets. In the case that you are hacked, there is no FDIC insurance to protect you. However, if you have a large position, you can purchase individual crypto-insurance and many exchanges finance their own insurance plans -- but there is still a risk of loss, as the insurance coverage is typically capped and not guaranteed.
Why would I purchase a security?
There are a variety of different reasons investors are turning to cryptocurrency. Some believe it will retain its purchasing power over time and act as a hedge against traditional fiat money. Those who are more speculative are looking to make money off the volatility. Others want to be part of the emerging ecosystem and use it as an alternative to traditional currency—as a means of transacting vs. investment.
Can you trade cryptocurrencies 24/7?
Yes, many cryptocurrencies trade 24/7.
Are cryptocurrencies used for illicit or illegal activities?
They can be. Cryptocurrency operates on a decentralized network that lacks a central authority, and it is possible to exchange cryptocurrency without registering under an identity. The checks and balances can occur because the blockchain publicly records every transaction. While names are not assigned to addresses, you can trace activity back to a crypto exchange, which knows the end user. The estimates of how many transactions occur for illegal activities vary. (Source: NY Times article Jan 2020)
Have more questions regarding digital assets? Contact BakerAvenue to speak with one of our advisors.