Cryptocurrency has become an increasingly popular investment in recent years, with more than one in five Americans reporting having traded or used it at some point. There’s also been a growing acceptance among mainstream financial institutions and media, making it seemingly impossible to avoid conversations about it.
As cryptocurrency becomes a more prevalent part of our financial system, it’s natural for parents to wonder how they’ll teach their children about it. Learn about the basics of cryptocurrency—including its risks—and how it can fit into your and your child’s broader financial picture.
Key Takeaways
- Cryptocurrency is a type of digital asset that more closely resembles securities such as stocks and bonds than it does an actual legal currency.
- Cryptocurrency has become increasingly popular in recent years, but also has some major risks.
- Cryptocurrency operates using a blockchain, which is a decentralized, digital ledger of transactions.
- Cryptocurrency can have a place in your (or your child’s) portfolio, but it’s important to understand how it fits in with the rest of your financial picture.
Basics of Cryptocurrency
If you’re planning to teach your child about cryptocurrency, it’s important to start with the basics. Just as your child probably learned to crawl before they could walk, the foundations of cryptocurrency are important before you move on to teaching them about more advanced investing concepts.
How Cryptocurrency Works
Cryptocurrency is a type of digital asset that relies on cryptography. Despite “currency” being in the name, it’s not a type of currency in the same way the U.S. dollar or any other legal currency is. Instead, it’s an asset that is treated similarly to stocks, bonds, and other securities.
Note
Cryptocurrency isn’t considered a legal currency, but many proponents believe it eventually could be. In fact, El Salvador and the Central African Republic have already approved bitcoin as a legal currency.
“Staunch believers think that, eventually, cryptocurrencies will pose an alternative to the centralized financial system, which has been in place for decades, and hence, certain cryptocurrencies will become extremely valuable,” Max Coupland, director of the cryptocurrency education website CoinJournal, told The Balance in an email.
Growing Popularity of Cryptocurrency
Cryptocurrency has become increasingly popular in recent years. As of this writing, more than one-fifth of Americans have reported trading or using cryptocurrency, and the rate is even higher for certain demographics, including Black Americans and young people. The most likely cryptocurrency investors are young men—roughly half of men who are 18 to 49 years old have invested in cryptocurrency.
One of the reasons cryptocurrency has become so popular is its explosive growth.
“During the rally last year, it was not uncommon to see a cryptocurrency double or triple in value in a day, while many smaller cryptocurrencies went up 100 [times] or even 1,000 [times] during the same time period,” Coupland said. “These returns, while amounting to gambling, in reality, are not possible with other asset classes such as stocks or commodities.”
According to Coupland, the lack of centralization and regulation are also part of what makes cryptocurrency so popular.
“There are also fewer barriers in terms of KYC (Know Your Customer standards), jurisdictional restrictions, and other regulatory-related perks, given the assets are mostly decentralized and not controlled by a centralized financial institution or regulatory body,” Coupland said.
Risks of Cryptocurrency
Some of what makes cryptocurrency so popular are also what makes it so risky. These risks may lead many parents to use the classic lesson of “just because other people are doing something, doesn’t mean it’s a good idea for you” when teaching their children about cryptocurrency.
“The industry is largely regulation-free, meaning it comprises somewhat of a Wild-West environment,” Coupland said.
This lack of regulation leads to several problems. There are fewer protections in place for consumers. It also means there’s an increased risk for scams and fraud, as well as less recourse for investors who fall victim to them.
When teaching your child about this lack of regulation, think of it like a sporting event with no rules and no referee. The game may closely resemble football, so you assume the rules are the same. But because there’s no official rulebook and no one enforcing any rules, there’s little to stop other players from acting in a way that harms others.
Another major problem with cryptocurrency is its volatility. We’ve already talked about some of the exponential returns some coins have had. The losses are just as extreme.
“Even the biggest two—Bitcoin and Ethereum—are down 70% and 77% from their highest point last year,” Coupland said. “Investing, especially over a short-term time horizon, is therefore extremely risky.”
One of the most frustrating parts of cryptocurrency returns is that gains and losses often seem completely arbitrary. When you’re investing in stocks, the successes and failures of the company often have a direct impact on the stock price. But in the case of cryptocurrency, asset performance isn’t tied to the performance of a specific company. Prices can fluctuate for no apparent reason.
“It is important for parents to teach children that a lot of this amounts to gambling and is not representative of investing in general,” Coupland said.
Basics of Blockchain
To fully understand how cryptocurrency works, it’s important to understand the blockchain technology on which it operates.
A blockchain is a digital ledger that records transactions and tracks assets. This technology relies on cryptography to link together various pieces of information. The blockchains that cryptocurrencies use are both public and decentralized. It is also both permanent and immutable, meaning no one can tamper with or change records in the ledger.
Note
The decentralization of blockchain technology and cryptocurrency is a part of what makes them so popular. Bitcoin—the first major cryptocurrency—was born during a time when people had a severe distrust of the traditional financial system. But unlike the stock market or real estate market, the blockchain can’t be controlled by a single entity, including the government or financial institutions.
Blockchain and Cryptocurrency Transactions
Blockchain technology is what allows for the transfer of cryptocurrency. In most cases, investors buy cryptocurrency on trading platforms known as cryptocurrency exchanges. Once a transaction is completed, it’s recorded in the public ledger.
An investor then can store their cryptocurrency in a cryptocurrency wallet. It has a private key, which is proof of ownership of the wallet and allows someone to access the cryptocurrency stored on the wallet.
Other Applications of Blockchain Technology
Blockchain plays an important role in cryptocurrency, but it has possible applications beyond that. Blockchain technology uses smart contracts, which could have applications in nearly every industry. Therefore, even if you aren’t interested in teaching your child how to invest in cryptocurrency, teaching them about the technology it uses could be invaluable.
“The blockchain technology underlying the cryptocurrency is worth teaching children about,” Coupland said. “This is a nascent invention that has real potential to impact the world. There is more to cryptocurrency than price-watching, and the advantages of the blockchain are fascinating—particularly if your children are interested in computers or technology.”
Fitting Cryptocurrency Into Broader Finances
As cryptocurrency becomes more prevalent, many investors may find themselves wondering how it fits into the rest of their financial picture. Should you add cryptocurrency to your investment portfolio? Should it replace other assets, or should you simply invest in cryptocurrency alongside other securities?
The first thing experts generally agree on is that there are some financial ducks you should have in a row before you start investing in cryptocurrency.
First, it’s important to make sure you have your financial safety net in place. Depending on your situation, this likely includes knowing how to budget and manage your money, having an emergency fund to protect you in the case of a job loss or unexpected financial emergency, and tackling any high-interest debt you have (often including credit cards).
In this case, building your financial foundation may also include contributing enough to a retirement amount each month to reach your retirement goals. Generally speaking, when you’re teaching your child about investing for the future, that’s a better place to start than teaching them about investing in speculative assets such as cryptocurrency.
If you—or your child—are ready to start investing in cryptocurrency, it’s important to be intentional about just how you’ll tie it into a portfolio. Diversification is a key principle of investing. Just as you wouldn’t put your entire investment portfolio in a single stock, it’s important to limit how much of it you’ll put in cryptocurrency.
Note
Depending on whom you ask, you may get different answers as to just how much you should invest in cryptocurrency. That said, many experts recommend devoting between 1% and 5% of your portfolio to these digital currencies.
According to Coupland, whether you’re investing in cryptocurrency, stocks, bonds, or anything else, there’s one important rule of thumb to follow: “One should never invest in something they don’t understand,” Coupland said. “It follows that it is important to get a full grasp of cryptocurrency before diving in. A better way to introduce oneself to the financial markets would be to learn about index funds or ETFs and graduate to other asset classes such as crypto thereafter.”
The Bottom Line
It’s been more than a decade since the first major cryptocurrency was introduced, and it has since become a major part of the financial industry. Whatever your feelings about cryptocurrency, it doesn’t seem to be going anywhere anytime soon. And teaching your child about cryptocurrency—and the technology it's built on—can give them the tools they need to navigate this financial asset and make smart decisions about their finances in the future.
Frequently Asked Questions (FAQs)
How old do you have to be to buy cryptocurrency?
There’s no minimum legal age to invest in cryptocurrency, but many mainstream crypto exchanges require you to be at least 18 years of age to open an account. Additionally, someone under age 18 could own cryptocurrency in a custodial account managed by their parent or another adult.
How do you cash out your cryptocurrency?
The process of cashing out your cryptocurrency is much like the process of cashing out any other investment. First, you’ll need to sell your holdings. Once you’ve done that, you can transfer the money from the sale from your cryptocurrency account to your bank account. Just know that you may face certain tax consequences when you sell, like you would when you sell a stock or any other security.
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