Advisors Need to Refine Their Definition of Crypto

Before we engage in funds and strategies, we have to understand the language of digital assets.

Crypto and digital assets are full of new technological terms and jargon that might be daunting or confusing to advisors and clients. For that reason, having some basic, clear definitions of crypto terms might be helpful when answering client questions and serve as a foundation for an advisor’s further incursions into the realm of crypto education.

Alas, digital assets are a very busy space, and the idea was quickly abandoned in favor of keeping up with some of the fast-moving news within the crypto for advisors space. It’s no coincidence that over the past 12 months the financial services industry has made significant progress in developing technology and processes so that financial advisors can begin to help their clients with a digital assets allocation.

Perhaps it’s time to revisit the glossary concept. In our first and only entry into it, we talked to Tyrone Ross (then-CEO of Onramp Invest) and Ric Edelman (founder of the Digital Assets Council for Financial Professionals) about some of the more confusing crypto terms for financial advisors, and we found that the problem began at the beginning – what should we be calling these assets? You’ll notice in this article I have used crypto, cryptocurrency and digital assets almost interchangeably.

Let’s go back to the beginning to make sure we all understand what we’re talking about here – because while crypto-curious clients have already done this research, many clients will come to advisors with the fundamental questions.

What is cryptocurrency?

Simply put, a cryptocurrency is a form of digital currency or money built on a blockchain.

Take bitcoin (BTC), the world’s first cryptocurrency. Bitcoin (with a small b), the crypto token, is built on Bitcoin (with a large B), the protocol, a blockchain. The blockchain is, in very simplified terms, a record of every transaction that occurs on the Bitcoin network.

On a blockchain, transactions are grouped into blocks, which are verified by computers on the network. In Bitcoin’s case, these computers are miners in a process called “proof-of-work.” But in other “proof-of-stake” cryptocurrencies, these are other crypto holders who “stake” some of their holdings to help verify transactions. Over time, the Bitcoin protocol links successive blocks together in chronological order, creating a blockchain.

Why is a blockchain valuable?

The blockchains underlying bitcoin and most other cryptocurrencies provide several facets of value.

One of these facets of value is the consensus-based verification process for transactions, which eliminates the need for a trusted third party to facilitate the transfer of assets or wealth between people or other entities. Blockchains like Bitcoin’s protocol are not controlled by banks or governments – they operate independently.

Another facet of value is that information on the blockchain is permanent and immutable. We can always see who has done what and where, a very powerful tool for both investors and regulators.

Most importantly, however, is a third facet of value. Blockchains can, for the first time, digitally define scarcity. Previously, scarcity did not really exist in the digital realm. A file could be copied indefinitely. For example, if I was sending a copy of the draft of this story to another computer over my home network or the internet, I was effectively creating a copy of this file before sending it away – meaning this file would exist in two places. If I were sending it to four different editors, I would have made five copies of this article, all of which could be independently proofread and edited by a different person and leading to a potentially long, difficult process to reconcile the differences in editions and versions.

A blockchain creates a single source of truth for all of the participants on the network, which was a necessary precursor to the advent of digital money – it wouldn’t do to have users able to send or spend the same dollar multiple times. There had to be a way to eliminate or throttle the duplicative nature of files. Hence, the verification work of the blockchain ensures that once a bitcoin or a fraction of a bitcoin is spent, it is forever transferred from one party to another and cannot be re-spent.

Back to lowercase bitcoin

What does all this have to do with cryptocurrency? A blockchain needs computing power to verify transactions – people, with their computers, need to participate for the system to work.

So the inventors of Bitcoin, under the pseudonym Satoshi Nakamoto, created a way to incentivize users to participate on the new network as miners – by compensating them with tokens that could be used as a store of value or to transfer value. That way, every time a user verifies a block of transactions, they are compensated with some bitcoin tokens.

Of course, there’s a lot more to crypto, even bitcoin, the grandfather of crypto. We can get into satoshis (the smallest fraction of a bitcoin). We can get into the supply cap – there’s a finite amount of bitcoin that will ever be mined. And we can get into bitcoin’s supply issuance schedule. But for those clients coming to advisors and asking what a bitcoin is and what a cryptocurrency is, we have some basic answers.

Other terms

Cryptocurrency has become the popularly embraced term for these particular blockchain-based assets. “Crypto assets,” a term favored by Ross (the former Onramp CEO), expands the definition to include non-fungible tokens, or NFT, which are blockchain-based tokens offering a digital definition of uniqueness, not just scarcity.

Then there’s the even broader term “digital assets,” favored by Ric Edelman, that encompasses the entire universe of cryptographic tokens and derivatives, plus a number of innovative asset classes and decentralized finance projects.