2021-03-11 19:29:00

Thinking of Loading Up on Ethereum? Here’s What to Know Before You Do

The cryptocurrency trade is alive and well today. As such, many eyes are on Ethereum (CCC:ETH-USD). After all, Ethereum is currently second only to Bitcoin (CCC:BTC-USD) in terms of market capitalization. This is a digital currency with a massive network effect and a large following. The fact that Ethereum has more than doubled since the beginning of the year is something that has raised the eyebrows of even the most unsophisticated investors.

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In this article, I’m going to speak to such unsophisticated investors looking to assess Ethereum. There’s many that have seen the returns of this cryptocurrency and are eager to put a little “funny money” to work in such digital assets.

Here are the pros and cons of doing so with Ethereum today.

What Is Ethereum, Relative to Bitcoin?

Like Bitcoin, Ethereum is a decentralized, open software platform based on blockchain technology. The main advantage Ethereum offers relative to Bitcoin is the decentralized applications (or “dapps”) it allows for. Developers are able to build and deploy such applications using smart contracts. These contracts are directly written into lines of code and define the terms of agreement between the buyer and seller.

These dapps allow for a range of possibilities. Among the most commonly referenced are stablecoins and “decentralized finance,” or “DeFi,” applications.

In the case of stablecoins, developers can use Ethereum’s blockchain protocol to create collateralized tokens that are backed by some fiat currency or hard asset. Such applications have garnered a lot of attention, and for good reason. Particularly, large financial institutions, tech companies and the government are beginning to evaluate the potential of stablecoins as a streamlined, decentralized way to create asset-backed digital assets.

In the case of DeFi applications, this is where the platform’s smart contracts really carry value. The ability to generate direct buyer-seller agreements written into code (unchangeably) is attractive. Indeed, there’s an incredible range of possibilities in the areas of finance, insurance and law. A number of dapps have popped up that some see as having the potential to render traditional banking obsolete. Traditional banking features, such as borrowing, exchanging currency or earning yield, are now possible using DeFi apps.

Additionally, Ethereum’s nodes (computers in the network validating transactions) have been used to eliminate the need for the servers and cloud-computing systems used by major internet providers. The ultimate goal of Ethereum is to become a global computer. Theoretically, this could provide banking infrastructure across the globe to underserved areas. The possibilities are seemingly limitless, if one believes in the potential of the Ethereum blockchain.

How Can Investors Buy Ethereum?

Investors can buy Ethereum on centralized exchanges, decentralized exchanges or with a wallet. Below, I’m going to discuss some concerns investors might have with centralized exchanges. Decentralized exchanges are becoming more popular, but holding Ethereum in a wallet is perhaps the best way for most investors to go right now.

A wallet can take a range of web, digital or physical forms. It’s essentially the product that holds your cryptocurrency. Many digital or web-based wallets allow investors to manage their account, view their balances, send transactions and many other functions traditionally found on banking sites.

However, cryptocurrency investors looking to store their digital tokens in the most secure fashion typically choose the physical hardware route.

There’s been a significant amount of interest in the potential for an Ethereum-based ETF (exchange-traded fund) to come to market soon. With the world’s first Bitcoin ETF launching in mid-February, this seems like a logical next step. In Canada, a preliminary prospectus has been filed for two such ETFs that would track the daily price movements of the U.S. dollar price of Ethereum.

Such an ETF would provide another option for retail investors to get direct exposure to the rising price of Ethereum.

What Are the Risks Involved With Cryptocurrencies?

Once marketed as “unhackable,” various blockchain technologies such as Ethereum have been hacked.

Additionally, various exchanges holding cryptocurrencies have been hacked on numerous occasions. I’d encourage investors to take a look at the scale of these hacks and consider the risks with buying and holding digital currencies outside of a wallet in cold storage (i.e., in an offline storage device).

Given how important exchanges are in creating a safe marketplace that investors can trust, these hacks are significant. There’s a lack of trust among many cryptocurrency investors in the traditional banking system. However, the lack of visibility in certain aspects of blockchain technology could be cause for concern for many unsophisticated investors.

Ethereum, like its cryptocurrency counterparts, is also a highly volatile investment. Right now, there’s a high degree of speculation built into the prices of these digital currencies. Indeed, any asset that is difficult to value is likely to be ripe for speculation. Investors should retain proper portfolio sizing discipline when assuming the heightened risk these assets provide.

On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article.

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