What are cryptocurrencies and NFTs and should I have invested in them by now?

Bitcoin use began in 2009, which means that this year, you may well be celebrating your 14th anniversary of trying to ignore it and all the other digital currencies.

After 14 years, it doesn’t appear that bitcoin is going away anytime soon, even if the value of the digital currency has taken a very severe trouncing in 2022 - dropping in value over 60 per cent.

Like it or not, Bitcoin and all the other cryptocurrencies are not going away. The question for you, as you consider where you might find value in investing your money, is whether a cryptocurrency is a sound investment.

Cryptocurrencies and NFTs aren’t the same thing (even if they have elements in common).

A cryptocurrency is a type of digital money. It doesn’t have a physical representation that exists in the real world, like a coin or a banknote. Instead, it is a unique digital record that is made up of lines of computer code protected by a shared database called a blockchain (if you want a real-world point of comparison to understand what a blockchain is, think of it as a digital version of a ledger).

The best known cryptocurrency is bitcoin, but there are known to be over 21,000 different cryptocurrencies available – the majority of these are inactive or considered worthless. The reason so many exist is because cryptocurrencies are not regulated.

A unit of cryptocurrency (often referred to as ‘coins’) is created through computers mining for new ones. This is not like the discovery of gold where you may have a prospector in a mine chiseling away hoping to strike it rich, rather mining crypto involves a computer solving complicated math problems to generate a new coin. These math problems become more and more difficult the more coins are mined, which in turn makes it more difficult to mine new coins. It is increasingly laborious to have computers mining coins as it takes time, computer power and electricity.

An NFT is different. It is also a digital product, but unlike cryptocurrencies, these aren’t mined. Instead, they are a digital item like a photograph, movie, song that is digitally protected in a manner that is similar to the computer code that protects cryptocurrency.

The NFT, which stands for ‘Non-Fungible Token’, is purchased by a user with the understanding that they are buying the unique, original digital product. If you record a song and sell it as an NFT, the person who buys it then owns the song. But, you as the song creator can still own the copyright to the song and the ability to produce digital copies. This is the same as how the Mona Lisa artwork is currently held in the real world by The Louvre, but you can also purchase postcards with the Mona Lisa on it.

As far as public relations for cryptocurrencies goes, 2022 was a disastrous year.

Plunging value

On 1 January 2021, each bitcoin was valued at $69,898 (AUD), but come 31 Dec 2022, it saw in the new year valued at just $35,998 (AUD). The price of Bitcoin is down 76 per cent from an all-time high on 10 November 2021.

Bitcoin was not the only cryptocurrency to lose value – it was widespread across the market with $1.3 trillion (USD) dollars being estimated to have been lost.

The collapse of FTX

Shattering consumer confidence in crypto was the collapse of the $32 billion cryptocurrency exchange FTX. Founder Sam Bankman-Fried, has since been charged with wire fraud, securities fraud, and money laundering.

While there are moves to introduce greater regulation into the crypto market, it will take some time before such regulation is in effect. Moves toward regulation in the UK, US, and in Europe are underway with the EU’s Markets in Crypto-Assets (MICA) being the most advanced. MICA, which is still 12 months away, will aim to reduce the risks for consumers, making exchanges liable if they lose investors’ assets.

Declining profits for miners

The declining value in bitcoin and the market upheaval of the FTX collapse has had flow-on effects to those who were mining new bitcoin.

Miners work out the value of their work with a measurement called a ‘hashprice’. The hashprice is impacted by any fluctuations in the difficulty of mining crypto coins along with changes in the value of the cryptocurrency. In the days that followed news breaking about FTX, Forbes reported a dramatic drop in the hashprice - a miner running an industry standard machine like the Antminer S19j Pro was now only making only $6 in revenue per day per machine, compared to $36 per day in revenue at the same time the previous year.

Yes. No. Maybe. It is ultimately a matter of perspective in terms of where you prescribe value and how comfortable you are with a digital product and a real-world tangible product sharing a similar value.

When a value is placed on artwork/memorabilia/collectables, it is based on the premise of scarcity. Whether it is a unique painting or a rare baseball card, the perceived value of that item is based on the value that the owner has the item in their possession and the potential buyer is restricted from buying it elsewhere.

Generally, a digital artwork has almost no scarcity. It is very easy to copy and reproduce that art in a near-identical form. But by turning a digital work of art into an NFT (by encrypting it with an algorithm), the owner of the NFT has designated that artwork as being a unique authentic copy.

New York University’s Professor of Marketing Scott Galloway wrote an article about the value of NFTs during the height of NFT mania in 2021, commenting on the value of a digital artwork assigned to an NFT vs a real world physical artifact: “This approach jettisons our world-of-atoms obsession with a specific physical object, and acknowledges that scarcity has always been a function of bits, not atoms. Value is in the eye of the beholder.”

Ultimately, whether you want to see an NFT as a scam or not comes down to just that: Value is in the eye of the beholder.

The answer to whether you should invest in crypto is really a matter of perspective until either theory is borne out. Crypto enthusiasts are known to be bullish on the future prospects of crypto, which may be to their detriment.

Billionaire venture capitalist, David Draper, is on the overly-enthusiastic end of the spectrum. He contends that the bitcoin drop is at the bottom and that there is a chance that midway through the year a unit of bitcoin could be worth as much as $250,000 (USD).

At the other end, you have multinational bank Standard Chartered, which has offered a prediction suggesting a further 70 per cent drop in the value of bitcoin, leaving it worth $5,000 (USD).

If you are going to start paying attention to bitcoin or the other crypto coins, the most important thing you should understand is that the market can be incredibly volatile. Depending what sort of investor you are, that may be exactly what you are looking for or the very sort of thing you are eager to keep clear of.