Crypto includes assets described as coins, tokens or sometimes cryptocurrencies. They may or may not be backed by physical assets.
How crypto works
Crypto-assets (crypto) describe an asset class that includes cryptocurrency, crypto or digital tokens and 'coins'. It does not exist physically as coins or notes. Crypto is kept in a unique digital or software wallet (hot) or hardware (cold) wallet. Each wallet has a private key, a secret code that lets you access your tokens. If you lose your private key, you usually lose the crypto.
These digital tokens rely on cryptography and technology such as blockchain for security and other features. The Reserve Bank of Australia's website explains how crypto and blockchain technology (including mining) works.
Crypto can be used for payments, to execute automated contracts, and run programs. A crypto-asset can be created by anyone, and it's believed that millions are currently circulating. Crypto-assets (even Australian dollar stablecoins) are not legal tender in Australia and are not widely accepted as payment. Few people use it for everyday transactions. It's not the sort of investment to use to build your savings.
Most crypto are high-risk investments. The value of crypto is very volatile, often fluctuating by huge amounts within a short period.
Buying and storing crypto
You can buy or sell crypto on a trading platform using money. Or buy or sell it directly.
Each digital or software wallet (hot) or hardware (cold) wallet has private keys that authorise transactions on the blockchain network.
A hardware wallet stores these private keys on a secure device not connected to the internet. This can make it harder for hackers to access your wallet.
A software wallet can be held by you or by a crypto trading platform on your behalf. This can simplify buying, selling and storing crypto.
You must be prepared to lose what you invest with crypto-assets and be wary of scammers. Scammers target crypto-assets as they’re easy to create, gaining popularity, and not easily recovered. Currently there’s also no public register to check the legitimacy of crypto exchanges.
Types of crypto-assets
Each crypto-asset has different features and there are no universally defined categories of crypto-assets.
Some common types are listed below, but this does not cover them all. New cryptos are created all the time, but many aren’t well structured and don’t last.
Native tokens
What are they
These are the assets that make the specific blockchain work. They're designed to act as a medium of exchange within the crypto ecosystem, with transfers enabled on blockchains. These can have no intrinsic value and are only worth what people are willing to pay for them, but they derive their value from the demand for the use of the blockchain.
Examples include: BTC, ETH, Litecoin
Stablecoins
What are they
A ‘Stablecoin’ is a marketing term for crypto that aims to maintain a stable value relative to a specified asset, or basket of assets.
Sometimes the term is only used for those that aim to track the value of a national currency (for example, the AUD or USD). Some stablecoins track other assets such as gold, equities, bonds or other crypto.
Stablecoins try to stabilise their market value by:
- being physically backed 1-for-1 by an external asset, such as government-issued currency, gold or securities
- being physically backed by a variety of assets where the value of these assets is intended to be greater than the value of the Stablecoin on issue
- using algorithms to control the available demand and supply of the asset, such as minting additional assets or adjusting an interest rate for holding the asset
Examples include: AUDM, AUDF, AUDD
Non-Fungible Tokens (NFTs)
What are they
NFTs are tokens which record ownership of an object using blockchains. Each NFT is unique (hence they are not ‘fungible’). However, owning an NFT may not give you exclusive rights to the underlying asset.
Examples include: Bored Apes, game tokens
DeFi tokens
What are they
These are tokens created through participating in decentralised finance (DeFi) protocols. Each token will have unique features based on the DeFi protocol that it relates to.
Other token types
What are they
There are a broad range of terms for other types of tokens. Some types include:
- utility tokens — allow you to undertake certain activities, or perform an action, in a crypto project, such as being exchanged for a service
- governance tokens — these allow you to participate in the running of a crypto project
- community (or membership) tokens — ownership gives you access to the community
Crypto and risk - what you need to know
Prices can swing wildly
Investing in crypto-assets is highly speculative. The market value can fluctuate a lot over short periods of time. It is affected by things like media and social hype, and investor opinion.
The price of unbacked crypto may depend on:
- its popularity at a given time (influenced by factors like the number of people using it)
- how easy it is to trade or use
- the perceived value of the asset
- its underlying blockchain technology.
So, if you buy crypto-assets, be prepared to lose everything that you put in.
Many crypto providers are unlicensed
Many crypto-asset providers are not licensed at this point in time. This means you may not be protected if the platform fails or is hacked.
If a crypto-asset fails, you will most likely lose all the money you put in. In most countries, crypto is not legal tender. You're only protected to the extent that crypto fits within existing laws.
Your money could be stolen
Be aware that a hacker can potentially steal the contents of your digital wallet.
Crypto systems allow users to stay anonymous and there is no central data bank. So, if a hacker steals your crypto, you have little hope of getting it back.
Using a wallet held offline, a ‘hardware wallet’ or ‘cold storage’, may offer more protection.
Technical complexity
Crypto-assets can be hard to understand.
There’s usually no product disclosure statement or prospectus that explains clearly how the crypto works. Developers may issue a ‘whitepaper’ to describe it, but these can vary in format and information.
A crypto-asset’s code may not be available to review. Or it may hard to understand. The underlying code of the crypto may also change over time.
To access a crypto network, you may need special software and need to know how transaction fees operate. Unfamiliar users run the risk of:
- sending a transaction to an incorrect address
- over-paying on transaction fees called ‘gas’ (sometimes by thousands of dollars)
- not paying enough for a transaction fee (and so losing the fee and transaction)
Crypto scams are common
Scammers use crypto because transactions are not easy to recover and have limited oversight. Money can quickly be sent overseas and is very hard to trace.
Read more about crypto scams and what to watch out for.
Rhett saw an article on a news website about ‘The biggest deal in Shark Tank history, that can make YOU rich in just 7 days!’.
The news article was really an advertisement. It took Rhett to a website that included endorsements from Shark Tank judges for Bitcoin trading software. The endorsements were fake.
Rhett was interested in trading bitcoin, so he provided his contact details. Soon, an Account Manager named Max began calling Rhett. Max called often, pressuring Rhett to open a trading account and make a deposit. By depositing between $40,000 and $50,000 upfront, Max promised Rhett he could earn at least $15,000 per month.
Max promised Rhett that the money he deposited would be safe because he would have total control of the account. “It’s more or less moving your money in your left pocket from your right pocket,” Max said. Max promised Rhett that he could withdraw his money whenever he wanted to.
Max eventually convinced Rhett to open an account and deposit $40,000. Rhett started trading bitcoin, but things didn’t go to plan, and Rhett started losing money. Max encouraged Rhett to deposit more money and promised Rhett that he would be able to withdraw the money he needed in a week.
Rhett deposited more money in the hope he could recoup his losses. Rhett ended up depositing and losing a total of $97,000.
Finding the right investments can be challenging. If you need some help to build a diversified portfolio, talk to a financial adviser.