Cryptocurrency Q&A — The basics – Wells Fargo Investment Institute

Understanding Cryptocurrency
by Global Investment Strategy Team
Key takeaways

  • Cryptocurrencies are part of a new technology platform that we anticipate could launch the next digital era.

What it may mean for investors

  • Investors should not casually dismiss what cryptocurrencies (crypto) represent and what the technology can do.

This report reviews the most coarse, basic questions we have received on cryptocurrencies. The questions tend to center on how they work, why interest is growing, and common investor fears. It is written for the crypto novice, not the adept. For those concern in more depth and detail, we will be writing batch of those in the future. We caution investors not to casually dismiss cryptocurrencies or get lost looking for accurate definitions. We believe it is about what cryptocurrencies represent and what the technology ( presently ) can do. We view the engineering as a new means of transacting business.

What are cryptocurrencies?
Cryptocurrencies originated as a newfangled kind of currentness in 2009. They are not physically minted or printed, like a dime or a $ 20 charge. Cryptocurrencies are digital, which means that they entirely exist electronically. Using them as a currentness requires a digital device such as a chic phone, tablet, or computer .
Where did cryptocurrencies come from?
The first cryptocurrency, Bitcoin, was launched in 2009. It was created by Satoshi Nakamoto to become a modern kind of daily currency change, but strictly digital .
When you say “digital currency”, is this the same thing as me paying with my credit card or paying bills online?
No, these are unlike things. When an individual uses a U.S. citation card, pays a U.S. circular on-line, or uses other virtual payment methods, they are likely paying with U.S. dollars. The U.S. ’ s money and deposit system is based on U.S. dollars .
How are cryptocurrencies different than traditional money, such as U.S. dollars?
Cryptocurrencies are quite different than the traditional money we use today, but this is not inevitably because they are digital. U.S. dollars, in fact, are largely digital today, with only 16 % physically circulating. The three independent differences between traditional money and cryptocurrencies are how they are 1 ) used, 2 ) created and controlled, and 3 ) secured. Chart 1 illustrates in three double panels .

  • Use (first panel)
    traditional money — Typically comes in both electronic and physical forms. Cryptocurrencies — Exist electronically entirely. Exchanging them requires a digital device such as a chic call, tablet, or computer .
    Cryptocurrencies — Exist electronically only. Exchanging them requires a digital device such as a smart telephone, pill, or computer .
  • Creation and control (second panel)
    traditional money — Created, tracked, and controlled by governments. This is called a centralize system, and it is the way most countries operate with money. Governments control all aspects of their money systems, from printing money ( whether physical or digital ) to creating deposit rules and setting interest rates to tracking imposter .
    Cryptocurrencies — The huge majority are created outside of government-led money systems. They are built on a singular set of technologies which create, track and control the rules surrounding the currentness. Cryptocurrencies reside on a global network of computers, accessible to anyone and everyone interested. This is called a decentralized system .
  • Security (third panel)
    traditional money — Centralized politics money systems are secured by locking out likely bad actors. only approved government-backed institutions ( banks, fiscal institutions, etc. ) have access .
    Cryptocurrencies — Decentralized money systems are secured by inviting everyone in to check on one another because they trust no unmarried assurance .

What’s the difference?
What's the difference?
source : Wells Fargo Investment Institute, June 28, 2021 .
How many cryptocurrencies are there?

today there are more than 9,000. The market capitalization of the industry has grown from literally $ 0 in 2009 to $ 1.3 trillion today. Bitcoin is presently by far the largest at $ 600 billion, accounting for 45 % of the industry .
Why has interest grown among investors?
We believe the fundamental engineering could launch the adjacent digital era. It presently transacts in a wide-eyed range of digital value ; from money ( cash ), stocks, artwork, songs, policy, land titles, and tied votes. The engineering may bridge our physical and digital worlds like nothing before it, and countless industries could be disrupted .
What much confuses raw investors is having currency in the diagnose “ cryptocurrency ”. “ Digital assets ” may be a more appropriate mention for an diligence that transacts in all manner of digital measure .
Can you explain what the technology does?
The basic technology platform is designed to store and transact in digital data, or digital measure. The platform is unique in that computer code strictly enforces the rules, which cuts out much human sagacity. The technology platform is outdoors and transparent, yet has been secure and individual. The four key ingredients are : 1 ) cryptocurrencies, 2 ) blockchains, 3 ) cryptanalysis, and 4 ) decentralization. We will begin and end with cryptocurrencies. While each cryptocurrency is built a snatch differently, it by and large works like this :
A slice of digital value is created, called a cryptocurrency. The cryptocurrency is stored on a digital ledger, called a blockchain. All cryptocurrency transactions are tracked, stored, and fused inside the blockchain. This brings us to what has been the first samara security feature — removing a transaction from a blockchain can be extremely unmanageable, which has made fraudulently obtaining currency similarly unmanageable .
Another authoritative security feature has been that blockchains are unfold for anyone interested to see and scrutinize. It is a security system that invites everyone in to check on one another because it trusts no individual authority ( this is identical unlike than the centralized way most things are secured today ) .
A third base key security feature of speech of the platform has been that most blockchains are decentralized, which means that they are not held in one central location or controlled by one entity. Copies of the blockchain are spread across a global network of computers, a community of sorts, where anyone concerned can keep a copy .
fourth, individual privacy is protected using “ cryptanalysis ”. While open residential district check is necessity to keep the digital daybook accurate and crystalline, no one would use the system if individual privacy was not protected. To fix this, each individual transaction on a blockchain is candy-wrapped in cryptography. Cryptography, which basically means clandestine spell, has been used for centuries to protect personal messages and communications. Digital cryptanalysis keeps person identities hidden and the cryptocurrency accessible only between the mean parties. Accessing the cryptocurrency requires removal of the crypto sugarcoat wrap. To do this, a proofread of identity is needed, called a digital signature. This proof of identity is not something that can be influenced by a bad actor. A digital key signature is unique to the individual owner, and it is protected by a long passcode ( 12 random words ) known alone to the owner .
last, how cryptocurrencies are designed, and ultimately valued, can help secure the platform besides. The more valuable the cryptocurrency, the more participants want to join. This typically leads to more computers checking and validating transactions, and a stronger computer science network ( called hashing power ) more immune to attack .
Can you give us an example of how cryptocurrency may be used?
We anticipate that there are countless physical assets that could be transformed into digital assets. Take house deeds and title indemnity, for exercise. In the future, home buyers may not receive a physical act but a digital one. It would come in the form of a cryptocurrency, or cryptodeed, which could be held in the owner ’ second private digital wallet. Buying or selling the home would probably require the owner ’ s personal digital touch to transfer the deed. This cryptodeed could be recorded on the public county blockchain for all to see. The city could regularly update allow contractor shape and property liens, which a new home buyer and mortgage lender could view before making an offer. Title insurance is but one industry that we believe could be transformed by this engineering platform that is open and diaphanous, even has been sensible to a customer ’ s private information and secure .

Common fears and risks

What reasons have investors given for not wanting to own cryptocurrencies ?
In October 2020, Bloomberg conducted a view of 500 high-net-worth ( HNW ) investors on crypto investing. Chart 2 highlights the circus tent six answers that they received. This list is identical stopping point to the main fears we have heard .

  1. Not a regulated market. This has generally been the case with cryptocurrencies. The fear is understandable as future regulation is an unknown. We believe being overly fearful may be unwarranted as global regulation continued to expand in 2020, yet the industry was the best performing major asset class. Additional regulation, for such a young asset class, can mean a clearer regulatory path, which was likely one of the key reasons institutional interest grew in 2020.
  2. Volatility of cryptocurrencies. We believe cryptocurrencies are new and highly volatile. If they are all that an investor owns, volatility can be a serious problem. Mix in this volatility with a diverse set of assets, however, and volatility may be useful. Cryptocurrencies were the best-performing major asset class in the past decade.
  3. High potential for fraud. Fraud does occur in the space. Of the 9,000+ cryptocurrencies in existence, we would not be surprised to find that a high percentage of them eventually fail, whether that be from fraud, scams, or lack of adoption. The industry has been prone to sweeping boom and bust cycles, too. Like other emerging fields though, high failure rates do not necessarily mean that the industry will not survive. In fact, we suspect that the technology and the industry winners may thrive, not just survive.
  4. Don’t know enough about it. Our aim is to change that. That said, we understand investors’ concerns. The space is new, highly technical, and not easy to understand.
  5. Risk of specific cryptocurrencies to no longer exist. This is another legitimate worry. As we stated under reason number three, a high percentage of cryptocurrencies are likely to fail.
  6. Hacking risk. Millions of dollars in cryptocurrency thefts have been reported through the years. In 2020 alone there were more than 120 reported attacks. Not all hacks are created equal, though. Most hacks do not happen on the blockchains themselves, which is critical to the survival of the industry. Many thefts have usually been due to users not securing their cryptocurrencies properly in their digital wallets or picking the wrong exchanges to store them. As the space matures, we expect that security options and investors’ understanding of how to best secure their digital assets will as well.

Chart 1. Top reasons not to invest in cryptocurrencies


Chart 1. Top reasons not to invest in cryptocurrencies
source : Bloomberg Research Survey of high Net Worth Investor Attitudes Toward Crypto Investing, October, 2020/Wells Fargo Investment Institute
Are cryptocurrencies used for illegal activities?
sometimes yes, like in the holocene Colonial Pipeline hack. But perspective is needed. All forms of currency have thoroughly and badly actors, so the more pertinent question may be, how act cryptocurrencies stack up versus early forms of currency in illegitimate trades ? Recent data shows that a very small percentage of cryptocurrency transactions are illicit or illegal. In fact, illegitimate action represented 2.1 %, or approximately $ 21.4 billion, of all cryptocurrency transaction volume in 2019 and just 0.34 %, or $ 10.0 billion, in 2020. By comparison, closely $ 29.0 billion of credit card fraud occurred in 2019 alone. And according to Harvard professor Ken Rogoff in his book Curse of Cash, most of the $ 1.4 trillion in physical U.S. dollars circulating around the earth are used to finance nefarious clandestine economies.

If cryptocurrency owners are anonymous, won’t they eventually be used more and more for illicit activities?
They could, but again we caution patience. The jury is still out on this debate. On the one hand, transactions on a blockchain are frequently pseudo-anonymous. This means that when an individual transacts on a blockchain, a bunch of numbers are shown ( a digital wallet address ), not a private mention. For very early investors, this can be a strong privacy feature as linking one ’ south digital address to their physical identity can be unmanageable .
We anticipate the growing popularity of cryptocurrencies, however, has the potential to slowly degrade this privacy have. The largest digital exchanges in the U.S. are beginning to ask modern investors for recognition under the Know Your Customer fiscal regulative framework. We believe this may make it easier to link a digital address with a physical identity. As more and more new investors buy cryptocurrencies from earlier owners and as transactions are connected in blockchains, one could envision a day when cryptocurrencies become the among some of the most traceable form of currency around the ball. death month, the Colonial Pipeline hackers learned this the hard way .

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