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What is cryptocurrency and should you invest in cryptocurrencies?

Know how cryptocurrency works
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As lunch time in the canteen became IPL fever for everyone, Rahul asked Atul if he knew anything about cryptocurrency. After about 2-3 overs, crypto was advertised in every match. Are they reliable? Do they generate serious returns? Should I consider them for investment?

While Atul wasn’t very helpful to Rahul about any of these questions, let’s shed light on some of your questions about this new phenomenon that everyone wants to know about.

What are cryptocurrencies?

Cryptocurrencies are one of a kind eCash or a digital currency designed using blockchain technology for use only on the Internet, Unlike traditional currencies such as the rupee or dollar, You will not see physical coins or currency notes for cryptocurrency, Just like you keep currency or money in your bank account and view it in internet banking, You can keep these cryptocurrencies in your virtual wallet Or the account tagged on your email account and mobile number. You can access them through mobile, computer or laptop as long as you have internet.

While central banks and governments control Fiat currencies like Indian Rupee or US Dollar, Cryptocurrencies are decentralized and linked to each other as peers by hundreds and thousands of computers and running on free, open-source software., Since they are decentralized and not limited by national borders, anyone who has internet access can use cryptocurrencies.

Some of the most popular cryptocurrencies today that you may have heard about are Bitcoin, Ethereum, Litecoin, Dogecoin, etc.

How does cryptocurrency work?

Perhaps a decade or two ago, you would have handed over Rs. Now, you can pay for your purchases by swiping your credit/debit card or sending money by scanning the UPI QR code.

In the crypto world, everything is completely digitized that when you transact, bitcoin (or other cryptocurrency) is transferred from your digital account or wallet (or email address) to the seller’s account upon entering your credentials. (or email address). Every time you transfer bitcoin (or any other cryptocurrency), the transaction record is added to the public registry of transactions for the currency (in this case bitcoin) by a network of computers called nodes that operate on this cryptocurrency platform. The value of the currency changes after each record is added.

Flowchart of how cryptocurrency works
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Flowchart of how cryptocurrency works
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This smart piece of technology or program that records, verifies and allows millions of transactions spread across the globe to settle them seamlessly, is called a blockchain, Each cryptocurrency has its own blockchain code that determines its use and development.

The value of cryptocurrencies fluctuates depending on the demand and supply of that currency, just like it does for the US dollar or the euro. The major difference is that while the US dollar and the euro are used in the real world today and are still considered reliable investments, cryptocurrencies experience significantly higher volatility and still struggle to gain real world acceptance as a currency. are doing.

How is cryptocurrency created?

In the case of physical currencies, central banks (such as the RBI) print currency notes or mint coins. Talking about cryptocurrency, it is created by computer code. The code of currency defines how new coins will come into existence. In theory, anyone can create their own cryptocurrency using blockchain and there are over 6500 cryptocurrencies present around the world.

The creation of new coins is associated with a process called ‘dig’, and this happens only when the transaction is confirmed. It is the small algorithmic jobs (such as verification and matching of transactions) that are needed to reward network computers with a fair amount of currency. This, of course, is not as easy and profitable for the average person as it seems. For example, it is estimated that 0.21% of all the electricity in the world goes to power bitcoin farms alone.

Although mining is the most popular form of new coin generation, other processes of generating new coins include rewarding its developers with more coins for various jobs or even more coins, depending on the code of the cryptocurrency. in the form of interest on its current holdings.

What are the Different Types of Cryptocurrencies?

There are over 6,500 cryptocurrencies in existence as of September 2021. However, not all are as popular or widely available as bitcoin, litecoin, ethereum, etc. Private organizations and individuals are free to create their own currencies, and there is no limit to the maximum number of currencies. It is also important to note here that there is still no clarity or acceptance about the legal tender status of these currencies in many countries.

Some of the most popular are listed here –

  1. Bitcoin
  2. Ethereum (ETH)
  3. Litecoin (LTC)
  4. Cardano (ADA)
  5. Polkadot (dot)
  6. Bitcoin Cash (BCH)
  7. Stellar (XLM)
  8. chain link (link)
  9. Binance Coin (BNB)
  10. Tether (USDT)

Can you use cryptocurrency in India?

Some global organizations have begun to accept cryptocurrencies in exchange for their goods and services, with payment platforms such as PayPal also accepting them as a means of payment with credit cards and bank accounts.

Although, In India, Few Organizations Currently Accept Cryptocurrencies, So in all practicality, you cannot yet freely buy goods and services in India using bitcoin or any other crypto. However, some small e-commerce companies, a restaurant, a rug seller and a tattoo studio have started accepting bitcoin to show solidarity with digital currencies or to make marketing statements. Remember, Cryptocurrency is still not a legal tender in India, Even if you are considering using them for some offshore purchases, you should be aware that these currencies are highly volatile and therefore, you need to make sure that when you use them to consume do for. You don’t want to pay for your purchases like Laszlo Hanyecz did!

taxation of cryptocurrencies

Since these cryptocurrencies are not yet considered legal tender,The gains from currencies are speculative gains. They will be subject to 30% flat taxation with applicable surcharge and 4% cess, In addition, every citizen is obliged to report whether any transactions in these cryptocurrencies result in profit.

cryptocurrency performance

While we have explained some important concepts about cryptocurrencies, Rahul and Atul are still curious about crypto-investing as there are so many advertisements for it and people are talking about bitcoin investing.

Cryptocurrencies, for example, bitcoin (BTC), are very new investment instruments with a history of hardly 12-13 years. Over the past decade, BTC has given more than 230% p.a., more than ten times that of the next best-performing investment – the Nasdaq 100 index in the US, which gave 20% p.a. over the same period. The Indian market (Nifty 50 Index) has given only 4.54% per annum (in USD terms) in this period. Simply put, For every rupee return made in Nifty, bitcoin gives a massive return of Rs 50.81., However, these capricious returns hide the bigger picture of risks, which is extremely important for any investor.

Sensex Vs Bitcoin Volatility Comparison
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Sensex Vs Bitcoin Volatility Comparison
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In this graph, we can again based on the prices of Bitcoin and BSE Sensex to examine the volatility of Sensex and Bitcoin. We can see that bitcoin prices have been very volatile over the past three years as compared to the Sensex.

Risks associated with cryptocurrency investing

Rahul and Atul, who are still young executives and are keen to gradually build up their savings pool, need to understand that this is a very new phenomenon. There is very little research and fundamentals available for cryptocurrencies. A fair amount of research must be done to fully understand how each currency works and the risks associated with such investments. must not forget Bitcoin was down more than 30% in a single trading session Only because of the simple tweets of Elon Musk. Bitcoin is down ~28% in less than a month, since achieving its lifetime high in November 2021. Also almost every other cryptocurrency has crashed in the same way. This asset class is one of the most volatile financial products and can lose value overnight.,

Some of the other major risks and problems associated with crypto investing are –

  1. cashless – Not all of these currencies are traded very often. Apart from the top 3-4 currencies, there is very little trading with wide fluctuations in prices.
  2. high cost of trading – Even if some currencies are well traded, due to limited institutional involvement and lack of market-making, the cost of trading can range from 2% – 10% depending on volume and will eat up your profits.
  3. lack of rules – While investing, an efficient exchange is required to trade. Unlike mainstream investments such as mutual funds, there are no laws in India to recognize or regulate transfers and trading in these currencies. Therefore, you are at the mercy of these exchanges and their policies regarding the various costs of trading and realization of profit.

ground level

While Rahul and Atul are like an adrenaline rush in IPL matches, they also want to be careful with their savings. As we discussed above, cryptocurrencies are an innovative development in the financial world. It may be worthwhile to study them closely before getting lured into investments where the risks are more pronounced than the current rewards.

We strongly advise you to stay away from them, as they are highly risky and at least until there is some clarity regarding rules and acceptance in day to day trade and commerce. If you still want to venture out and test the waters, you should only make do with the amount you want to lose over the next few years.

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