The cryptocurrency sector has gained a lot of momentum, which reveals that the world is increasingly digitalised.
However, the dominant view of this sector is still mostly related to the volatility of the price of Bitcoin, the most popular digital currency.
In a report published by the American website Moderndiplomacy, writer Syed Zain Abbas Razavi said that with the increasing number of people wishing to invest in this asset class, it is necessary to acquire basic knowledge about this decentralized and highly volatile field.
What is blockchain technology?
And what exactly is decentralized finance?
The majority of investors are still confused about the difference between Blockchain technology and decentralized finance.
Although the two terms are interrelated, the main point of difference between them lies in their scope of application in the real world.
Blockchain technology is a system that acts as a digital ledger that facilitates distributed transactions across a diverse network of computers.
It also constitutes a digital encryption system to record duplicate information over an extended network in which it is impossible to hack, change or destroy data during processing or storage.
This technology is widely used in logistics and crypto financial asset services.
Decentralized finance is used in a complex range of digital products, from digital currencies to non-fungible tokens.
Decentralized finance involves a blockchain-based structure to run a massive network of shared ledgers.
With no central authority to verify transactions and manage supply, a field of complex algorithms is used to perform verification and storage between users themselves.
Decentralized finance is one of the most promising financial and technological innovations in financial services.
What is bitcoin?
How is it different from blockchain technology?
One of the most common misconceptions among novice cryptocurrency investors is to think that blockchain and bitcoin are the same thing. Blockchain is a technology used by a lot of different industries such as the financial industry including bitcoin, while bitcoin is a digital currency that is exchanged as a digital token via a system of shared ledgers called blocks. This currency was created in the aftermath of the 2008 financial crisis by an anonymous entity under the pseudonym "Satoshi Nakamoto". The trading of this digital currency is located via a coherently regulated complex platform, the distributed ledger system, which makes it impossible to control this currency.
To verify transactions, “Bitcoin miners” use sophisticated computer programs to solve complex equations to add blocks of transactions to the Bitcoin blockchain. They earn about 6.25 bitcoins. Bitcoin is highly vulnerable to speculation which ultimately feeds into price volatility that worries investors.
Is it risky to invest in bitcoin?
When Bitcoin first began trading in 2009, price volatility was limited. Over the past year, the market capitalization of Bitcoin has crossed the $2 trillion mark, making it the first non-institutional entity to record such a high value. Governments are beginning to adopt this digital currency as an official means of exchanging goods, and even popular investment banks and hedge funds are accepting payments with digital currencies.
Despite a 40% drop in value from the record price of $69,000 it reached last November, Bitcoin is currently trading at $42,000, which is 500% more than it has been in value since the end of 2019.
When comparing risk-adjusted returns, Bitcoin shows an outperformance compared to other assets.
For example, Bitcoin's risk-adjusted return since September 2020 is more than double that of the S&P 500.
Whether at the beginning of 2015 or the beginning of 2020, Bitcoin has managed to outsmart traditional investment trends.
Investors were able to gain significant returns, despite the decline in the value of this currency in the market, whether in 2017, when its value fell by 80%, or during 2021, when China launched a campaign against digital currencies that prompted the market to stop using it in commercial exchanges.
What is the best strategy for investing in digital currencies?
And when should it be implemented?
2021 was the most turbulent year in the cryptocurrency world.
Non-fungible tokens have gained more popularity, while the value of a large group of cryptocurrencies has more than halved.
The dynamics of this market are likely to change during 2022.
The writer mentioned that as the US Federal Reserve prepares to open discussions about bonds and raise interest rates, the value of digital currencies - especially bitcoin - is expected to decline in the following months.
Cryptocurrencies will remain under pressure, while the Federal Reserve reduces the injection of liquidity.
Its popularity is set to wane as regulations tighten.
The writer advises to wait until the end of the year before investing in bitcoin because its price could drop to around $20,000 by then. If you are looking for wider options, then you should invest in Bitcoin and other digital currencies such as Ethereum and Solana equally. Since their adoption in trade is still limited compared to Bitcoin, these digital currencies are likely to experience relative growth without experiencing sharp price fluctuations. For example, Ethereum is currently trading at around $3,000 per unit.
The writer also recommends investing some money in the "Metaverse" especially the non-fungible tokens that are available on most crypto platforms and brought huge profits.
Whether you are new to investing in this asset class, or just looking to diversify your investment portfolio, you need to be prepared to take long-term risks and closely monitor market regulations to reap tangible gains.