It’s hard to ignore the hype around cryptocurrency. Once considered an overinflated phenomenon by the world’s biggest investors (Warren Buffet famously dubbed it, “rat poison squared”), many billionaires and traditional investors alike are joining the ranks of crypto enthusiasts to further develop this half-currency, half-investment. Whether backed by Elon Musk or not (he can’t seem to make up his mind) one thing is clear: cryptocurrency could change the future of finance not just in Canada, but the world.
But it’s notoriously difficult to understand. From Bitcoin to buying and selling crypto on an exchange crypto forces us to learn a lot of technical stuff fast. So, whether you’re new to the concept or you’ve picked up bits of information here and there, let’s start fresh: what is cryptocurrency, how does it work, and how can Canadians invest in it? Let’s take a closer look.
What is cryptocurrency?
Cryptocurrency is basically digital money that’s stored on a network called blockchain (we’ll get to blockchain in a moment). Like any fiat currency, such as the Canadian dollar, you can invest directly in cryptocurrency, or you can use it to buy goods and services.
Now, it’s important to note: if cryptocurrency was just digital money, it wouldn’t be unique. We’ve had digital money for over a few decades now (money on your debit card is technically digital money). What makes cryptocurrency unique is the technology behind it — most notably blockchain — which allows participants to conduct trades and confirm transactions without the need of a central authority.
That’s huge. Historically, governments and central banks have always printed money, controlled its distribution, and ensured monetary transactions were legitimate and valid. But cryptocurrency has no central bank or government controlling its supply, nor does it have an authority determining its value or distribution. It’s decentralized, meaning no single player makes all the decisions: every person in the network shares power equally.
This decentralization is what makes cryptocurrency so radical, and it’s challenging the way we’ve conducted financial transactions. With cryptocurrency, we don’t need third-parties, which can cut expense middlemen, give more power to a greater number, and possibly reduce inflation.
What is blockchain?
Blockchain is the technology that allows cryptocurrency to work. At its core, blockchain is a database that can record every crypto transaction without the need for someone (like a bank) to verify those transactions are indeed correct. Blockchain helps establish trust between crypto users, keeps everyone accountable, and creates a transparent record for everyone to see.
To help you better understand how blockchain can do this, let’s break it down into three easy to understand parts.
Blockchain is a digital ledger
A ledger is basically a record of financial transactions. A computer file of bank transactions is a ledger, as is a book of people’s debts and credits.
Blockchain is simply a digital ledger that records every crypto transaction in a database that all participants can see. That means, with blockchain, you can see the entire history of transactions for a specific crypto coin or currency, including where it was spent and how many people traded it.
Blockchain has blocks
All crypto transactions are records on block. Each block has a certain storage capacity, and when the block is filled, it’s closed and “chained” to the previous block (hence “blockchain”).
Each block is like a page in a ledger, except for one important difference: each block has a unique digital fingerprint called a hash. Two things you should know about hashes: (1) whenever you change the data on a block, you automatically change its hash, and (2) when a block is closed, its final hash is recorded on the next block (that’s how they’re “chained” together).
Both of these points ensure that a block’s information is always accurate without the need of a central authority, such as a lawyer, accountant, or bank, to protect it. Think about it: if you go back five years and try to change Block Z’s data, you’d automatically change Block Z’s hash. Every block after Block Z would now have an invalid hash (Block Z’s original hash), making it super simple for anyone to find the block with the modified data.
For this reason, blocks in a blockchain are immutable, meaning the information stored there cannot be changed, modified, or tampered with. This ensures that every crypto transaction is accounted for and set in stone.
Blockchain is decentralized
Finally, it’s important to note that blockchain has no central authority controlling its data. You’ll never find a single, central computer that has exclusive power to modify blockchain’s transactions. Rather, blockchain is managed by individuals and groups called “nodes.” In order to change the data on a blockchain, you must convince at least 51% of these nodes to implement your changes. It could happen, but it’s very unlikely.
How to invest in cryptocurrency in Canada
Once you know how cryptocurrency works, and you’re familiar with the risks, you can start investing in cryptocurrency. Fortunately, with the rapid development of crypto exchanges, buying and selling crypto has never been simpler.
Here’s what investors need to do to get started.
1. Pick an exchange
As we explained above, a crypto exchange is like a brokerage. It’s where investors buy and sell crypto. Investors can choose to buy crypto at an exchange that’s run by a third-party (centralized), one that’s not (decentralized), or a hybrid of the two. As they’re shopping for the right crypto exchange, keep an eye out for these things.
First, make sure the exchange uses top-notch technology and cryptography to secure its users’ crypto. Check to see how many of its assets are kept offline in cold storage, how many times it’s been hacked (if at all), and whether or not it has private insurance.
Next, check the fees paid to use the exchange. Investors may have to pay an administrative or annual fee, or they may have to pay fees to deposit, withdraw, and trade crypto. These fees are typically low (usually below 1%), but the higher the fees, the more they’ll eat into investments.
For a first-time crypto buyer, they may want a crypto exchange with 24/7 customer service and an excellent reputation for answering questions. No one wants to be locked out of their account or stuck wondering where their crypto went.
Range of cryptocurrencies
Finally, take a look at what crypto the exchange allows investors to trade. Though there are thousands of different cryptocurrencies out there, most exchanges will only allow investors to buy or sell a select few.
2. Buy your cryptocurrency
Once an investor has chosen their exchange, they’ll need to connect it to a payment method, such as your bank account or debit card. Keep in mind: some exchanges will charge lower fees for bank account transactions versus debit cards. In deciding to connect your bank account, check beforehand to be sure the bank allows crypto transactions, as some currently don’t.
After a payment method is set up, investors can start placing orders. Depending on the exchange you choose, they might be limited to only a few order types (such as market and limit orders), though some offer the full range of orders, including stop-loss, stop-limit, take-profit, and take-profit limit.
3. Keep your cryptocurrency safe
Finally, once an investor has bought crypto, make sure their private key is safe. While most exchanges offer the option of storing your private key and crypto with them, investors should consider getting a crypto wallet for extra security, especially if they amass large amounts of crypto.
How does cryptocurrency work?
Now that you understand the technology behind cryptocurrency, let’s take a closer look at how cryptocurrency works in the real world.
Again, to help you see the big picture, let’s break it down into some easy-to-understand parts.
Investors buy and sell cryptocurrency on a crypto exchange
A crypto exchange is simply a digital service where you can exchange your CAD for crypto or, more likely, exchange one crypto for another. Though other ways of buying crypto exist (such as using your credit card, Paypal, or even an ATM), these methods aren’t currently available in all countries. For that reason, when investors are looking to buy or sell crypto, they will probably do it on an exchange.
As investors are scanning the market of crypto exchanges, they’ll come across three different types: centralized, decentralized, and hybrid exchanges.
Some of the top crypto exchanges in Canada include:
Centralized exchanges (CEX)
Centralized exchanges (CEX) are nearly identical to traditional stock exchanges. Investors give money to your CEX, place an order for a certain crypto, and the exchange finds a seller (or buyer) to match that order. The investor will pay the CEX various trading fees, and then they can store your crypto directly on the exchange itself.
The biggest shortcoming with CEXs is, well, they’re centralized, meaning investors have to use a middleman. In the minds of crypto enthusiasts, that pretty much defeats the purpose of cryptocurrency.
Security can also be a problem. Because investors give a third-party private information (especially if investors are storing crypto on the exchange) investors can open themselves up to a potential cyber-attack. Most of the biggest crypto hacks, in fact, have happened on CEXs.
But CEXs are convenient. Instead of looking for a buyer or seller, the crypto platform does the hard work for investors, which can help investors take advantage of price movements. And, though CEX have some security shortcomings, most are extremely secure (some will even refund part or all of the crypto if an account is hacked).
As of now, most of the big crypto exchanges, such as Gemini, Robinhood, and Coinbase, are centralized exchanges.
Decentralized exchanges (DEX)
A decentralized crypto exchange (DEX) has no middleman. It’s simply a marketplace where buyers and sellers exchange crypto directly. On a DEX, investors don’t give private information to a third-party, nor do investors entrust them with your orders: they find a buyer and seller for their crypto, which means investors will pay far fewer fees and retain complete privacy.
But, of course, DEXs have their shortcomings, too. Finding a buyer or seller on their own may give them more control, but it can also take time. If an investor is trying to liquidize their crypto quickly, they might end up getting frustrated at a lack of options. Additionally, because there’s no middleman, if an investor forgets their log-in information, they could essentially lock themselves out of their DEX account.
Despite these challenges, DEXs are the closest to crypto’s original tenet: decentralization. Through advanced technology—blockchain, smart contracts, and atomic swaps—investors can exchange peer-to-peer with no central bank or intermediary.
Hybrid exchanges basically take the speed and efficiency of a CEX and combine them with the security and privacy of a DEX. On a hybrid exchange, investors have complete control of your assets (as they would on a DEX), and investors can trade them quickly, helping them take advantage of price movements.
Though hybrid exchanges are relatively new and fewer in number, many crypto enthusiasts see them as the future of crypto. Right now, the biggest hybrid exchange is Qurrez.
Investors store cryptocurrency in a crypto wallet
A crypto wallet is the central hub of cryptocurrency. It’s where investors manage your crypto, and it’s where investors send and receive cryptocurrency from other people.
But what is it exactly? Well, it’s basically a software program that gives exclusive access to the crypto an investor own’s place on the blockchain. Depending on whether the wallet is hot (connected directly to the internet) or cold (offline hardware), investors can carry their wallet on a mobile device or an external drive.
Keep in mind: crypto wallets don’t store cryptocurrency themselves. They store a public and private key, both of which allow investors to claim the cryptocurrency on the blockchain (where it lives).
To give you a deeper dive: the public key is like a bank account number. Investors give it to other users in order to receive cryptocurrency. A private key is like a PIN number. It is used to unlock transactions, prove ownership of crypto coins, and ultimately spend or trade them. Note: never under any circumstance give away this private key to another user. If someone has a private key, they can spend the crypto in the associated account.
When you own cryptocurrency, you’re basically saying you have the private key to prove the crypto is yours. Anyone on blockchain can look at the crypto’s public key to verify that you are indeed the owner. And—to bring it all home—your crypto wallet keeps your public and private keys (two highly complicated codes that you’ll probably never be able to memorize) extremely safe.
Crypto wallets come in a few different forms, including:
Perhaps the most popular option, mobile wallets are smartphone apps that help you access your crypto from any mobile device. These wallets are often instrumental in helping investors buy goods at retail stores where cryptocurrency is accepted.
These wallets store crypto in a cloud, which you can then access from your personal computer. Though online wallets are convenient to use, investors will have to store their private key online, which makes them a little riskier.
Unlike online wallets, desktop wallets store crypto directly on a personal computer. It won’t be accessible from anywhere (as it would be with a mobile or online wallet). But desktop wallets are typically more secure, especially if the desktop isn’t connected to the internet.
Hardware wallets store a private key on an external drive, which can help an investor access their crypto from multiple devices. Because hardware wallets are completely offline, they can help investors safeguard their wallet from cyberattacks. For large crypto amounts, investors may want to consider getting a hardware wallet.
Do you really need a crypto wallet?
In the early days of cryptocurrency, when crypto exchanges were more likely to get hacked, investors definitely needed a crypto wallet. But, nowadays, crypto exchanges have really stepped up their security measures, making them a much safer place to store a private key.
If an investor wants extra security, or plan to spend crypto at retail stores, they should consider getting a wallet. Likewise, if they’ve amassed a large amount of cryptocurrency, then a crypto wallet might be the safest place to store them.
Canadians can use it to buy goods and services
Finally, let’s not miss the point of cryptocurrency: it’s currency that can be used to buy things. Though, in the past, buying goods with crypto was a hassle, these days new apps and technology have made it much simpler. Here are a few ways crypto can be used to buy goods and services.
Perhaps the simplest way to spend crypto is to link it to a crypto card, which right now come in two main types: prepaid and debit cards.
A prepaid card is basically how it sounds: a card to a crypto wallet, then load it with funds. When everything on the card is spent, it can be loaded again. Of course, in order to load a prepaid card, an investor will first need to convert their crypto into CAD, which can become somewhat of a hassle, not to mention expensive if they have to pay exchange fees.
Debit crypto cards take the “loading step” out of the process. The card is linked directly to a crypto wallet, and, as long as the retail store accepts the debit crypto card, it can be used on point-of-sale devices. The exchange from crypto to CAD happens on the spot, allowing users to make purchases quickly. The only problem with debit crypto cards: in Canada, investors don’t have that many options. Though that may change in the future (especially with crypto credit cards on the horizon), for now interested investors will have to select a card from a very limited supply.
Retailers that accept crypto currency
A small (but growing) number of retailers will accept cryptocurrency (usually Bitcoin) as a form of payment. That means, investors can buy goods and services without exchanging crypto for CAD, which can save time and money in fees.
Payment processors that accept crypto
Many point-of-sale companies are likewise beginning to accept crypto as a valid form of payment. Shopify, Square, and even Stripe are starting to integrate crypto into payment processors, which could open the door for crypto holders to buy goods at numerous small businesses and local retailers.
How many cryptocurrencies are there?
As of writing this, Canada has about 5,500 different cryptocurrencies, with Bitcoin, Ethereum, Tether, Binance Coin, Cardano, and Dogecoin being the top six.
Fair warning: cryptocurrencies can appear and disappear in the blink of an eye. In the future, investors will probably find more (or less) than this number.
What are the risks involved in cryptocurrency investing?
As with any investment, crypto could potentially help investors build extraordinary wealth, though one big turn could mean losing an entire investment in a short period of time. But crypto has other risks, too: it’s still relatively new (circa 2009), and with governments still debating regulations, there’s no telling what will happen in the future.
So, before jumping on the crypto bandwagon, we generally recommend investors consider these risks (this is a short and incomplete list, please consider all associated risks in light of your own personal financial situation):
Market volatility is always a risk. Whether investing in stocks, bonds, or Bitcoin, no one can ever predict exactly where the market will move. With crypto, however, this risk is compounded. Because it’s so new, and because the technology’s potential hasn’t been fully realized, the crypto market is highly sensitive to changes in public perception.
Just look at what happened in 2021. Increased regulation, including a mandate by the Chinese government demanding banks stop accepting crypto as a valid form of payment, along with certain celebrities’ criticism over crypto’s negative environmental impact, wiped out a few trillion dollars in just a few weeks.
Crypto enthusiasts hope this volatility will stabilize over the next few years, but truthfully — when you invest in crypto, expect a wild ride. The market could fly high, or it could tank.
As if volatility wasn’t enough, investors also have to worry about hackers and bugs breaking into exchanges or wallets and depleting your crypto. Though many exchanges and wallets have become highly secure over the years, the threat of a security breach is still a possibility.
In the beginning, illiquidity (or the inability to sell an investment quickly for a reasonable price) was a major risk for crypto holders. These days, the rapid development of exchanges, payment cards, and regulations has made cashing out or trading crypto much easier.
But not for all crypto: while popular coins, such as Bitcoin, may have reduced their illiquidity, other lesser-known currencies have not. Before investors jump on a new currency, always consider the risk of not being able to sell the coins for a price you want.
Again, because cryptocurrency is so new, no one can predict which companies will become long-standing “blue chips” and which will eventually vanish. Many, in fact, believe crypto will go through its own “dotcom” bubble burst, which will reduce the number of cryptocurrencies.
Finally, many countries have no idea what to do about cryptocurrency. The Canadian government, for its part, has declared cryptocurrency a commodity and not a government-issued currency. Though the government may create more regulation around trading and exchanges in the future, as of right now, they do not interfere with crypto transactions.
Any news of regulation, however, has a negative effect on the crypto market. Whenever a country, such as China, demands banks stop accepting it as a form of valid currency, crypto investors begin to panic. The market reflects this, which is why we see so many dips after regulation announcements have been made. For that reason, no matter how our country regulates (or doesn’t regulate) crypto, regulation in other countries can still affect the value of crypto investments.
How is cryptocurrency taxed?
The Canada Revenue Agency (CRA) taxes crypto transactions as either business income or capital gains.
The difference between the two is immense. If crypto mining or trading is done as a business, then 100% of the capital gains are taxable. If, on the other hand, if an investor is crypto trading or mining that as a hobby, only 50% of the capital gains are taxable.
If you’re not sure if your crypto transactions are a business or a hobby, reach out to a tax professional. It’s better to pay a professional to help you understand the tax liabilities of crypto than to pay penalties for filing incorrectly later.
Please note, this information is provided for educational use only, and is not tax advice. For tax information that is personalized to your situation, please consult a tax advisor.
Is cryptocurrency a good investment?
Here at The Motley Fool we think investing in cryptocurrency can potentially present a world of opportunity. But it’s not without its risks. If investors treat crypto as a “get-rich-quick” strategy, they are likely not only to be disappointed when it doesn’t pay out but can also lose a lot of money.
When investors consider the risks involved and accept them, crypto can be a vital asset in a well-diversified investment portfolio, that is, an investment portfolio made of stocks, bonds, real estate, commodities, and, yes, currencies. As long as investors allocate the right proportion to currency — based on their risk tolerance — they could potentially profit highly from investing in crypto. At the very least, by diversifying in other assets, investors make it less likely that they will lose all of their money if the crypto market tanks.
Finally, for new investors to crypto, we generally recommend starting small. Seek to understand how crypto works, then invest a little over time.
Likewise, for those new to investing, we always recommend investors educate themselves on investing strategies first before jumping into a highly complicated investment such as cryptocurrency.
Investments in more established categories such as the stocks of companies you understand or in ETFs or mutual funds may offer more transparency, historical investment performance and disclosures of risk, unlike investments in cryptocurrencies.
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