Jun
01
2022
What Is Regulation T (Reg T) & What Does It Do?

Regulation T (Reg T): All You Need to Know

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Regulation T (Reg T): All You Need to Know

Regulation T, or Reg T for short, is a Federal Reserve Board regulation governing the extension of credit from brokerage firms to investors (also called margin accounts).

In margin trading, Regulation T is used to determine initial margin requirements. An investor who fails to meet the initial margin requirements may be subject to a Reg T call, which is one type of margin call.

Understanding Regulation T and Regulation T calls is important when trading securities on margin. Keep reading to learn more.

What Is Regulation T?

Regulation T is issued by the Federal Reserve Board, pursuant to the 1934 Securities Exchange Act. The purpose of Reg T is to regulate how brokerage firms and broker dealers extend credit to investors in margin trading transactions. Specifically, Regulation T governs initial margin requirements, as well as payment rules that apply to certain types of securities transactions.

Margin trading means an investor borrows money from a brokerage to make investments. This allows the investor to potentially increase their investment without putting up any additional money out of pocket. For example, an investor may be able to put up $10,000 to purchase 100 shares of stock and borrow another $10,000 on margin from their brokerage to double their investment to $20,000.

Regulation T is central to understanding the inner workings of margin accounts. When someone is buying on margin, the assets in their brokerage account serve as collateral for a line of credit from the broker.

The borrowed amount is repaid with interest. Interest rates charged on margin accounts vary according to the brokerage and the amount borrowed.

Trading on margin offers an opportunity to amplify returns, but poses the risk of steeper losses as well.

How Reg T Works

Regulation T works by establishing certain requirements for trading on margin. Specifically, there are three thresholds investors are required to observe when margin buying, one of which is directly determined by Regulation T.

Here’s a closer look at the various requirements to trade on margin:

•   Minimum margin. Minimum margin represents the amount an investor must deposit with their brokerage before opening a margin account. Under FINRA rules, this amount must be $2,000 or 100% of the purchase price of the margin securities, whichever is less. Keep in mind that this is FINRA’s rule; some brokerages may require a higher minimum margin.

•   Initial margin. Initial margin represents the amount an investor is allowed to borrow. Regulation T sets the maximum at 50% of the purchase price of margin securities. Again, though, brokerage firms may require investors to make a larger initial margin deposit.

•   Maintenance margin. Maintenance margin represents the minimum amount of margin equity that must be held in the account at all times. If you don’t know what margin equity is, it’s the value of the securities held in your margin account less the amount you owe to the brokerage firm. FINRA sets the minimum maintenance margin at 25% of the total market value of margin securities though brokerages can establish higher limits.

Regulation T’s main function is to limit the amount of credit a brokerage can extend. It’s also used to regulate prohibited activity in cash accounts, which are separate from margin accounts. For example, an investor cannot use a cash account to buy a stock then sell it before the trade settles under Reg T rules. Here are more details about leveraged trading.

Why Regulation T Exists

Margin trading can be risky and Regulation T is intended to limit an investor’s potential for losses. If an investor were able to borrow an unlimited amount of credit from their brokerage account to trade, they could potentially realize much larger losses over time if their investments fail to pay off.

Regulation T also ensures that investors have some skin in the game, so to speak, by requiring them to use some of their own money to invest. This can be seen as an indirect means of risk management, since an investor who’s using at least some of their own money to trade on margin may be more likely to calculate risk/reward potential and avoid reckless decision-making.

Example of Reg T

Regulation T establishes a 50% baseline for the amount an investor is required to deposit with a brokerage before trading on margin. So, for example, say you want to open a margin account. You make the minimum margin deposit of $2,000, as required by FINRA. You want to purchase 100 shares of stock valued at $100 each, which result in a total purchase price of $10,000.

Under Regulation T, the most you’d be able to borrow from your brokerage to complete the trade is $5,000. You’d have to deposit another $5,000 of your own money into your brokerage account to meet the initial margin requirement. Or, if your brokerage sets the bar higher at 60% initial margin, you’d need to put up $6,000 in order to borrow the remaining $4,000.

Why You Might Receive a Regulation T Call

Understanding the initial margin requirements is important for avoiding a Regulation T margin call. In general, a margin call happens when you fail to meet your brokerage’s requirements for trading in a margin account. Reg T calls occur when you fall short of the initial margin requirements. This can happen, for instance, if you’re trading options on margin or if you have an ACH deposit transaction that’s later reversed.

Regulation T margin calls are problematic because you can’t make any additional trades in your account until you deposit money to meet the 50% initial margin requirement. If you don’t have cash on hand to deposit, then the brokerage can sell off securities in your account until the initial margin requirement is met.

Brokerages don’t always have to ask your permission to do this. They may not have to notify you first that they intend to sell your securities either. So that’s why it’s important to fully understand the Reg T requirements to ensure that your account is always in good standing with regard to initial margin limits.

The Takeaway

Margin trading may be profitable for investors, though it’s important to understand the risks involved. Specifically, investors need to know what could trigger a Regulation T margin call, and what that might mean for their portfolios. Regulation T is used to determine initial margin requirements — i.e. the amount of cash an investor must keep available relative to the amount they’ve borrowed.

An investor who fails to meet the initial margin requirements may be subject to a Reg T call, which is problematic because they are restricted from making additional trades until they deposit the 50% initial margin requirement. If the investor doesn’t have cash on hand to deposit, then the brokerage can sell off securities in the account until the initial margin requirement is met.

Margin trading may increase the potential for gains, but it can also increase the risk of steeper losses. If you’re up for the risk, SoFi offers margin loans. When you open a SoFi Invest brokerage account, using margin can help you increase your buying power, take advantage of more investment opportunities, and potentially increase your returns while borrowing at one of the most competitive rates in the industry.* Once your account is set up, you can trade stocks and ETFs.

Start Trading on Margin

*Borrow at 10%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.


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Jun
01
2022
What Is Market Overhang?

What Is Market Overhang?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is Market Overhang?

Market overhang is a market phenomenon whereby investors hold off trading a stock that’s seen a drop in price, because the expectation is the price will drop even further.

A market or stock overhang can be precipitated by the awareness that a large block of shares — say, from an institutional investor — is about to hit the market, potentially driving a stock’s price down. But it can result from other factors as well. Although the event has not happened, investors may hesitate to sell or buy shares in anticipation of price drop — and this can further depress the stock price.

While there is also a business use of the term “overhang,” we’ll primarily focus on how market overhang works in finance and what it means for investors.

Market Overhang Definition

In its broadest use, an overhang describes a somewhat artificial market condition brought on by an anticipated shift in supply and demand (a.k.a. the price of a stock). Market overhang has a couple of uses in the business and finance worlds, and in an IPO market as well.

What Is an Overhang in Business?

An overhang in a business context can refer to the practice whereby a company, typically an industry leader, delays the release of a new product in order to stoke greater consumer demand for that product.

A familiar example might be the release of a new technology product or video game. The anticipation of the new release may cause consumers to avoid buying other products as they wait for the arrival of the new one. The overhang may result in lower purchases for existing products — and higher purchases of the newly released product. While this practice can be considered manipulative, it’s not uncommon.

What Is an Overhang in Finance?

More commonly: An overhang in finance is used to describe a dynamic that’s specific to how investors’ expectation about supply and demand can impact a company’s share price.

A market overhang is when a stock’s price declines because investors expect a further price drop on the horizon. Thus, some shareholders may hesitate to sell their shares, because that could further drive down the share price. Other investors may also hesitate to buy shares because of the anticipated price drop.

The business use of the term and the finance use describe different situations, but the common element is how investors’ anticipation of a future event can impact a company’s revenues or share price.

Needless to say, a market overhang can cast a shadow over a company’s performance, influencing share price, liquidity, and more, especially if the situation is prolonged. In many cases, though, market overhang is relatively short-lived and temporary. The difficulty for investors is knowing when the overhang, like bad weather, is finally going to pass. To that end, it helps to know some conditions that can cause a market overhang.

How Market Overhang Is Created

There are a few conditions that can lead to a market overhang. Often these conditions can overlap.

A Stock Decline

The first is where a stock is already declining, perhaps owing to a change in key economic indicators or market conditions, and there is a buildup of selling pressure as investors hesitate to let go of their shares in a down market. This type of market overhang may be resolved once there are signs of price stability (even if it’s at a lower level).

The Role of Institutional Investors

Another type of stock overhang can be created by institutional investors — or companies that manage investments on behalf of clients or members of a firm. Institutional investors tend to have a larger stake in a particular stock compared with individual investors. This means that when the institutional investor plans to sell a large portion of their shares, a market overhang could kick in when investors become aware of this possible sale.

The anticipation of a large block of shares entering the market could drive prices down, and thus investors might hold off trading this particular stock — impacting its price, even before the institutional investor has made a move.

The stock overhang might be worse if it occurs during a price decline. In that case, investors may see the decline in share price, become aware that a large investor may sell a block of shares (which could further depress the price), become even more wary of buying or selling the company’s shares.

IPOs and Market Overhang

A third way that market overhang may occur is after an initial public offering (IPO). An IPO market can be a hot market, after all, and a company may get significant press coverage as its IPO approaches, which can drive up the stock price.

But if the IPO isn’t a big hit, and the share price isn’t what investors hoped (in IPO terms), there might be a bit of an overhang as investors wait for the lock-up period to end. The lock-up period is when company insiders can sell their shares, potentially flooding the market and further lowering the price.

Understanding the Effects of Market Overhang

Market overhang can last for a few weeks or even months — sometimes longer. The chief impact of a market overhang is that it can artificially depress the price of a stock, and if the market overhang is prolonged, that can have a negative impact on company performance.

As noted above, a market overhang typically ends when a stock price stabilizes. Unfortunately that often occurs at a lower price point than before the shares began to decline.

Example of Market Overhang

While some consider the market overhang phenomenon more anecdotal than technical, it’s something to watch out for. It could present an opportunity. And it doesn’t require a complicated, technical stock analysis to understand.

For example, let’s say a large tech company is trading at $300 a share. But there are reports that the company has been facing some headwinds, and it may undergo a rebranding and repositioning. In the face of this change and uncertainty, it’s natural that it might impact company performance and the share price might wobble a bit. But then, if enough investors are concerned about the company’s “new direction,” there could be a bigger shift in trading behavior that might further depress the share price in advance of the company pivot — creating an overhang.

While this isn’t ideal for current shareholders, a market overhang like this could be a “buy” opportunity for other investors. It depends on a number of factors, and it’s always important to understand market trends as well as company fundamentals. But it’s possible that some investors may view the company as a good prospect, despite a currently undervalued share price, and buy shares with the hope they might rise to their previous levels.

Why Market Overhang Matters

Market overhang is a valuable phenomenon for investors to be aware of, largely because it reflects many of the basic tenets of behavioral finance, which is the study of how emotions can impact financial choices. A market overhang could be viewed as the result of loss aversion and herd mentality — two well-documented behavioral patterns among investors.

Loss aversion is, as it sounds, the wish to avoid incurring losses. Herd mentality is, not surprisingly, the tendency for investors to behave as a group: buying or selling in waves. You can see how these two very human impulses — to protect oneself from losses, and to follow the herd — might create a market overhang.

The good news, though, is that investors are capricious and markets can be volatile, which means the market overhang will usually pass, and the stock will regain its normal momentum, whatever that may be. As an investor witnessing the changing weather, so to say, it’s up to you whether a stock overhang might present a buy opportunity or a sell opportunity — if you need to harvest some losses, for tax purposes.

What Market Overhang Means for Shareholders

Market overhang affects different shareholders differently. Since institutional investors tend to be the ones who create market overhang, they also tend to have the upper hand on what it means for their investments.

Regular investors might worry that some of their shares are losing value. But with the ebbs and flows of the stock market, a price can rise and fall at various times throughout the year — even throughout a given day. Fluctuation is normal and this is part of the risk in investing in the stock market. Consider waiting out the storm to make an informed decision. There’s a chance the stock could rise to new highs and your investment will be worth even more.

The Takeaway

What is a market overhang? While this type of trend is considered more behavioral in nature, it’s worthwhile for investors to keep it in mind when a stock isn’t performing as expected. In some cases, when investors anticipate an event that could drive down a stock’s price, they may hold off on trading that stock, further depressing the price and creating a market overhang.

In that sense, a market overhang can become a self-fulfilling prophecy. Institutional investors can create a market overhang, for example, when they contemplate selling a large portion of their holdings. This might spook other investors, who likewise decide not to trade their shares, creating a sort of temporary downward spiral in the share price. But because two common investor dynamics are at play here — the fear of losses, and the desire to comply with what other investors are doing — the emotions are usually temporary, and the market overhang passes. And just because a price decline might upset some investors, it could present a buying opportunity for others.

If you’re ready to start your own portfolio, consider opening an Active Invest self-directed brokerage account with SoFi Invest. You can set it up easily on your phone or laptop, and start trading stocks, ETFs, crypo, IPO shares, and more. SoFi members even have access to complimentary financial advice from professionals. Get started investing for your future today!

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.


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Jun
01
2022
What Are NFTs (Non-fungible Tokens)_780x440

What Are Non-Fungible Tokens (NFTs)?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Are Non-Fungible Tokens (NFTs)?

Non-fungible tokens (NFTs) are cryptographic digital assets that each have uniquely identifiable metadata and codes. Their data is stored on the blockchain, ensuring that they can’t be replicated or forged.

The tokens act as a representation, like an IOU, for either digital or tangible items. For instance, one could create NFTs that stand for digital artwork, virtual real estate in a game, collectible Pokemon cards, or even someone’s personal identification information. Currently, most of the NFT market is focused on collectibles like sports cards and digital art. But there are other highly priced NFTs on the market tool, such as a tokenized version of the first-ever tweet, created by Twitter CEO Jack Dorsey.

Let’s dive into the details about how NFTs work, why they’re important, and what makes them valuable.

How Do NFTs Work?

As an asset, an NFT works in the same way as trading any other asset: stocks, bonds, real estate, gold, and exchange traded funds (ETFs). You buy and sell NFTs for a profit or a loss, similar to other types of assets: NFTs are not cryptocurrencies, but you may use crypto to buy and sell non-fungible tokens. The purpose of NFTs is to monetize and tokenize ownership of all types of items, be they virtual or tangible.

If you’re interested in trading NFTs, you’ll need to find an NFT marketplace or platform on which to trade, a crypto wallet, and cryptocurrencies. There are many NFT marketplaces — like Rarible and others, cited below — so you’ll also need to do your due diligence when choosing one.

One way to make money from NFTs might be to purchase collectibles that you believe are undervalued, wait for them to appreciate, and then sell them in the marketplace.

What Are NFTs Used For?

The concept of digital representations of material items is not new. But the addition of blockchain technology makes NFTs important. As part of a blockchain, NFTs are easily verifiable and unique, each one able to be traced back to the original issuer.

NFTs are revolutionizing gaming, art, and the collectibles market. They also have the potential to transform real estate, travel, and identity management. Millions of dollars have been spent on NFTs over the past few years, and their popularity is increasing amongst both collectors and crypto traders.

NFTs and Gaming

For the first time, immutable ownership and efficient sale of collectible and in-game items is possible. This opens up many opportunities for online gaming and world creation. For instance, within virtual worlds like The Sandbox, players can create pretty much any business one might create offline — design and sell hats, create avatars, or sell theme park tickets. Players can even create in-game currencies to sell to other users.

NFTs and Art

NFTs are revolutionizing the art world. Using an NFT exchange, artists can sell digital art directly to buyers, removing the need for a gallery or auction house. Typically, middle men can take a large percentage of sale profits, which means artists may be able to increase their profits using NFTs. It’s even possible for artists to earn royalties each time their artwork or music is sold. The most expensive digital art sold so far was a group of NFTs created by Beeple which sold for over $69 million.

NFTs and Identity Management

There are also use cases for NFTs in identity management. Currently people around the world travel with physical passports, which can easily be lost or stolen, and even replicated or forged. Storing identity information on the blockchain has the potential to eliminate these risks and may one day make travel processing more efficient.

NFTs and Real Estate

Another use case for NFTs is in real estate. Dividing up a property is difficult, but dividing digital real estate is easy. Multiple people can invest in and exchange property if it has been digitized. This principle can also be applied to other material assets.

NFTs and Supply Chain

NFTs can also help improve and validate supply chains. For instance, a coffee company could prove that their beans are fair trade. A wine company could create an NFT for each bottle of wine to keep track of every step of its production.

NFT Standards

Most NFT tokens are currently created using one of two Ethereum token protocols, ERC-721 or ERC-1155. These are essentially blueprints for tokens that were created by the Ethereum team. The blueprint creates a template for certain information — such as security and ownership information — that must be included when creating any new NFT. By standardizing this information, NFTs are easily distributed and exchanged.

Starting with a blueprint, software developers can create NFTs that are compatible with large public exchanges and NFT wallets such as MyEtherWallet and MetaMask. This ensures that people can buy and sell the NFT and hold it in their own personal wallet.

Other blockchain networks such as Tron, Neo, and Eos are also building out NFT token standards. Each of these platforms has different token functionality, so software developers can choose which platform is best for the token they are creating.

What Makes NFTs Valuable?

As with any type of asset, supply and demand drives the price of NFTs. Because there is a limited amount of NFT collections or individual non-fungible tokens, demand for them can be very high.

One might wonder what the value would be in owning a representation of a limited edition item as opposed to the real thing. NFTs are both easily verifiable and completely unique. This makes them easily tradable online. Their code is also useful because each NFT can be traced, including past transactions of that token. This provides security, transparency, and prevents fraudulent items from being sold.

Gamers, investors, and collectors have been flocking to the NFT market because they see the potential for market growth and significant profits.

Within certain online games, for example, real estate is a prized possession. Say you buy a plot of land on a main road in a virtual world, where it’s possible to build a casino. Because a casino has the potential to make a lot of money, so also is your plot of land on its own very valuable.

Resale Value and the Market For NFTs

The resale value for works of art and other collectibles in the secondary market is typically much higher than their original cost in the primary market. And this is true for the traditional art world as well as the digital art world.

Although NFTs have been around since 2014, the year they really took off was 2021, in what some think was a kind of NFT bubble. The resale market for NFTs did well in that year. But it was and continues to be dominated primarily by the flashy, big-ticket creators — like Beeple, CryptoPunks, FEWOCiOUS, WhIsBe, and Xcopy — whom the media has helped make popular. Their work sells for millions of dollars. Most NFTs, however, do not sell for those figures.

As with stocks, the value of NFTs goes up and down; the NFT marketplace is just as volatile as the market for crypto. For an asset to be profitable for the long term, it needs to have a robust secondary market, and it remains to be seen whether that can happen with NFTs. Because it is volatile, new, and unproven, you might not want to park your nest egg in the NFT market today. Though profit in the secondary market might be high for a few names at the top, most collectors and content creators do not reap large profits from reselling NFTs. Moreover, the current market is highly saturated. As with cryptocurrencies, it’s important to remember that there is never a guarantee of making money from NFTs.

Royalties

The value of art and collectibles is often hard to discern because it’s based so much on a consumer’s personal taste. For many, an NFT might appeal to factors other than money only. In this way, NFTs are unique in more ways than just being one of a kind.

Perhaps an NFT reminds the buyer of something soothing and familiar from their childhood; or it could act as a visual escape, a mini-vacation that takes the holder to far-off places. An NFT collectible also could serve as a status symbol in some circles. And, if the buyer of an NFT is wealthy, purchasing the item could invoke their philanthropic nature; they’d be helping the artists and creators directly.

Royalties are a huge help to content creators of NFTs. Each time an NFT is resold in the secondary market, the artist gets a percentage of the sales price. This is usually between 5% and 10%, and is paid out automatically to the artist upon resale. These royalties are perpetual; they continue indefinitely for the creator’s lifetime. Artists and creators set the percentage of royalties at the time they mint the NFT.

Cryptocurrencies vs NFTs?

You can buy NFTs with cryptocurrencies. But crypto and NFTs are not the same thing.

Because NFTs and crypto are both created with the same technology, blockchain, some might think that they’re the same, or at least more connected. But a better way to think of them is as a subset of the cryptocurrency culture; they can attract the same players.

Cryptocurrencies, like fiat currency, are fungible assets, which can be exchanged and used for financial transactions because they are identical to one another. For example, one U.S. dollar (USD) is always equal in value to another USD. Think of an NFT like a passport or a ticket to an event. Each one is unique.

An NFT that represents a baseball card can’t be directly exchanged for one that represents a piece of digital art. And even an NFT that represents one baseball card can’t be exchanged for one that represents a different baseball card. The reason for this is that each NFT is unique and contains specific identification information.

However, NFTs are similar to cryptocurrencies in that they have attributes and metadata that makes them easily transferable and identifiable.

💡 Recommended: A Beginner’s Guide to Cryptocurrency

Differences Between Crypto and NFTs

Cryptocurrencies

 Non-Fungible Tokens (NFTs)
Identical to one another other Unique; no two alike
Digital assets that can be exchanged for goods and services Digital representations of a specific item; conferring ownership
Like currency; its only value is economic; exchangeable; one USD = one USD Value goes beyond economics; varies based on demand, interest, popular culture, and often personal taste
Can be bought and sold in fractional shares Can be bought and sold in their entirety only; can’t be divided into smaller portions

NFTs and Energy Consumption

Essentially, NFTs and cryptocurrencies are made of code, on very high speed computers, with blockchain technology as their base. Not only is developing code for these end products labor-intensive, it’s also energy-intensive, and leaves a large carbon footprint on the earth.

The major NFT marketplaces use Ethereum (ETH) to keep a secure record of all transactions on the blockchain. This is done via a mining process that verifies whether crypto transactions are valid. Mining Bitcoin, or any crypto, involves a complex network of computers that use advanced cryptography — and in doing so uses energy on the scale of a small country.

Joanie Lemercier is a French artist who’s known for his intense digital sculptures that gyrate into complicated patterns of light, color, and form.

When he learned that this process of making art was so energy-intensive. Lemercier began to look closely at his own energy use. In Lemercier’s calculations were a huge heating bill for his studio in Brussels, electric bills for the high-end computers to compose his creations, and dozens of plane flights per year to attend his exhibits around the world. After this exercise, this artist vowed to reduce his annual energy expenditures by 10%. He met his goal successfully and went on to become a climate activist.

As artists, content creators, and investors become more aware of just how large a carbon footprint these activities leave, they’ve begun to turn their attention to exploring other forms of sustainable energy; and even have joined groups to protest mining coal and projecting, projecting lasers onto excavation sites and government buildings.

💡 Recommended: Exploring NFTs and Their Environmental Impact in 2022

Key Characteristics of NFTs

NFTs have traits that make them different from other types of assets:

•   Indivisible: Unlike Bitcoin or other forms of cryptocurrency, NFTs can only be bought and sold in their entirety. They can’t be divided into smaller portions.

•   Non-interoperable: Just as NFTs can’t be exchanged for one another, one type of NFT can’t be used in another NFT system or collection. NFTs used in online games, for instance, are like a playing card or game piece. Just as a Monopoly piece can’t be used in the game of Life, the owner of a CryptoKitties NFT can’t use that NFT in the Gods Unchained game.

•   Direct Ownership: One important characteristic of NFTs is that the person who buys one actually does own it. They can sell it or hold it. It’s not held by a company the way iTunes holds music and licenses it out for users to listen to.

•   Extensible: Two NFTs can be combined to create a new, unique NFT.

•   Can Store Metadata: NFT creators and owners can add metadata to NFTs. An artist can sign their artwork digitally, for instance.

Where to Buy and Sell NFTs

When NFTs first emerged, the way to buy and sell them was via creators of NFTs, themselves. Creators of NFTs can include artists, musicians, public companies, trade groups, and universities. NFTs’ popularity, however, has spawned dozens of independent online platforms known as NFT marketplaces, where you may buy and sell these assets.

Many of these NFT marketplaces have a specific focus or niche. We may classify the marketplaces according to style, format, and subject to appeal to a wide assortment of audiences, such as artists, musicians, sports fans, gaming enthusiasts, and collectors.

Types of NFT Marketplaces

•   Open marketplaces: A broad array of NFTs created by various sources

•   Curated marketplaces: NFTs come from more specific or specialized sources

•   Collectibles marketplace: Focus on items like sports or movie collectibles

•   Games marketplaces: NFTs that are specific to online gaming

Some popular NFT marketplaces

•   Foundation: Foundation.app is a simple, no-frills way to bid on digital art, using Ethereum. Since the marketplace’s launch in early 2021, Foundation has sold more than $100 million of NFTs.

•   Nifty Gateway: Nifty Gateway has spearheaded the sale of some of the most popular digital artists, such as Beeple and singer/musician Grimes. It’s an art curation platform powered by the crypto exchange Gemini.

•   OpenSea: Currently the leader in NFT sales, OpenSea offers all kinds of digital assets, which are free to browse. It also offers artists and creators an easy-to-use process to mint their own NFTs.

•   Rarible: Similar to OpenSea, all kinds of art, videos, collectibles, and music may be bought, sold, or created on the Rarible platform. However, unlike OpenSea, Rarible has its own token (RARI), which you’ll need to use to buy and sell on the Rarible marketplace.

•   SuperRare: The SuperRare marketplace, like Rarible, is building a marketplace for digital creators. The site includes art, videos, and 3D images, but collectors can purchase artwork using Ethereum.

Investing in Cryptocurrencies Today

The NFT market is still new and full of potential for creators and investors. However, before investing in cryptocurrencies, NFTs, or any other digital assets, it’s important to research and understand the market.

FAQ

What makes NFTs so expensive?

One thing that makes NFTs so expensive is that right now, non-fungible tokens are still new. So the NFTs that are coming to market are literally the first of their kind. A “first” of anything collectible is more valuable than an item that has been produced for many years. Moreover, we are in the midst of a blockchain craze in which makes NFTs’ value whatever will pay for them. These inflated prices will become lower the longer NFTs have been around and the easier they are to come by.

What type of investment are NFTs?

NFTs are digital assets that are created using blockchain technology. Usually, when you purchase an NFT, you are investing in the ownership of something.

What are NFTs used for typically?

Typically, NFTs are used by artists to create one-of-a-kind works of art, though literally anything that’s created on the blockchain and stores metadata may become an NFT, including passports and real estate transactions.

Are NFTs cryptocurrencies?

No, NFTs are not cryptocurrencies. You may purchase NFTs with crypto, but NFTs themselves are not used as an exchange of value. However, because they are created using blockchain technology, NFTs have become a sort of subset of crypto.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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Jun
01
2022

Fiat Currencies: Defined, Explained, Compared to Cryptocurrencies

By | Growing Wealth, invest, Investing | Comments Off on Fiat Currencies: Defined, Explained, Compared to Cryptocurrencies

A fiat currency is money that is issued and backed by a government, whereas cryptocurrencies are digital and are not issued by a government, bank, or other central authority. Examples of fiat currencies include the U.S. dollar, the euro, the yen, and most internationally traded currencies.

Fiat currency is considered centralized, because these traditional types of currency are typically governed by a single authority. Cryptocurrencies are generally decentralized, meaning they rely on blockchain technology and are overseen and managed by a distributed network of computers.

These days, it’s important for investors to understand how fiat money works, why it matters, and how it relates to different types of cryptocurrencies.

What Is Fiat Currency?

Fiat money evolved from asset-backed currencies, when governments would mint or print money that was either made from a physical commodity, i.e. precious metals like gold or silver — or could be redeemed for the equivalent amount of that commodity. Over time, though, it became impossible for governments to hold enough of a precious metal to back every coin or piece of paper currency, and so-called fiat currencies became common.

For example, the current fiat money system came about in the U.S. during the 20th century when many countries moved away from the gold standard, where currencies were directly tied to gold. Fiat money cannot be redeemed for an underlying asset, so its value is based on government policy and foreign currency markets.

There are currently some 180 fiat currencies in the world today. The value of fiat currencies is driven by the forces of supply and demand. Central banks like the Federal Reserve set monetary policy to control the supply, gauging how much money is needed in the economy and printing accordingly. The biggest risk is that they could print too much, triggering a bout of hyperinflation — rapid, out-of-control price increases that can lead to economic devastation.

Faith in a fiat currency hinges on the stability of the government that issues it, as well as trust in the central bank that manages its supply. Here’s a deeper dive into the fiat-currency systems that are fixtures of modern economies.

How Do Fiat Currencies Work?

Fiat comes from the Latin and generally means “a formal authorization; a decree.” So fiat money refers to an order by the government that gives these currencies value and makes them legal tender.

There is no underlying store of gold or silver to give fiat currencies material value.

Instead, fiat money is backed by the authority of each government. For example, the U.S. dollar is backed by the “full faith and credit of the U.S. government.” According to the Federal Reserve:

“(Dollars) are not redeemable in gold, silver or any other commodity, and receive no backing by anything. The notes have no value for themselves, but for what they will buy. In another sense, because they are legal tender, Federal Reserve notes are ‘backed’ by all the goods and services in the economy.”

Fiat money may be more susceptible to inflation and deflation because a government can print as much money as it wants. Also the value of these currencies rides on the confidence of consumers and the currency markets.

The Background of Fiat Money

Needless to say, the history of money is long and complicated. But the history of fiat currency is less so.

Essentially, for thousands of years goods were paid for by trading other goods (e.g. trading livestock for grain). During certain periods in the Roman Empire, salt was considered so valuable that people used that to purchase goods and pay people (that’s where the word “salary” comes from). Over time precious metals like gold and silver became a form of payment as well.

Asset-backed coins and paper money may have first emerged centuries ago in China. This representative money caught on because people could use it to pay for goods and services — and also redeem it for an underlying commodity. For example, currency in the United States was historically based on — and redeemable for — gold or silver. That ended in the Great Depression, when the Emergency Banking Act of 1933 stopped allowing citizens to redeem dollars.

The U.S. moved off the gold standard completely in 1971 for international transactions. And the dollar became a fiat currency. However, the Federal Reserve holds collateral that’s equal to the value of U.S. dollars in circulation in the form of government-issued debt.

Today, the Federal Reserve is required to hold collateral equal to the value of the dollars in circulation, and it does so using government-issued debt.

Alternatives to Fiat Currency

There are many alternatives to traditional fiat currencies, including something called “hyper-local currencies”, cryptocurrencies, and other tender created as a means of payment or exchange. Anyone, whether a company or individual, can create a form of tender (or payment) that can be used as an alternative to traditional currencies.

Alternative currencies don’t have to be regulated in order to function — all that’s required is for a group of people to agree to accept the alternate form of money as a store of value. For example, many businesses (e.g. airlines, credit cards) use systems of rewards and points that enable people to “earn” a kind of currency with that company that can be spent on other products.

What Are Hyper-Local Currencies?

Some areas of the world have independent forms of currency. In the Berkshires region, for example, there is a form of money called BerkShares, which is a way to stimulate the local economy. Similar examples exist in communities around the world, including in parts of England and Europe, where an alt currency was introduced to help support the local area.

Is Crypto an Alternative Currency?

Because most forms of crypto are highly volatile and can’t be used as actual payment for goods, services and other transactions, it’s an open question whether crypto can be considered a currency at all. Some forms of crypto are gaining traction as a form of payment, but the use cases are still somewhat rare.

Fiat vs Crypto: What’s the Difference?

Currencies basically serve two main purposes: as a medium of exchange and as a store of value. The rapid rise of investing in cryptocurrency has raised questions about whether fiat currencies will continue as the dominant medium of exchange.

Cryptocurrencies emerged almost a decade into the 2000s, with the launch of Bitcoin in 2009, the first and still the largest form of crypto. Cryptocurrencies are in essence virtual currencies that are part of the new DeFi, or decentralized finance, movement. They’re managed by a decentralized network rather than by a single authority, like government-issued fiat currencies.

Transactions made with cryptocurrencies are permanently logged on a ledger known as a blockchain. This ledger is viewable to anyone, therefore functioning as a public database. Because crypto transactions can be expensive, time-consuming, and complicated (to do business using crypto, you need a crypto wallet, for example) crypto may not be suited to real-world behaviors.

Fiat vs Crypto for Payment

Some proponents of cryptocurrencies argue that one day digital currencies will take over fiat money as the main mode of payment, because of their ability to deliver near-instantaneous transactions in some cases. They argue that if trust vested in a fiat currency is in the government backing it, trust vested in crypto is in the power of blockchain technology.

So far, though, cryptocurrencies haven’t really taken off as a medium of exchange. While some vendors and businesses accept crypto as payment, most transactions around the world are made with fiat currencies.

Critics argue that the volatility of cryptocurrencies like Bitcoin make them less ideal as a mode of payment. Imagine getting a paycheck in Bitcoin — such market fluctuations could dramatically magnify or shrink a person’s income in a matter of days.

Fiat vs Crypto as Store of Value

Cryptocurrencies like Bitcoin have arguably functioned more as a store of value, similar to how people have historically invested in precious metals.

Like precious metals, cryptocurrencies like Bitcoin need to be “mined,” which limits its supply. In fact, Bitcoin was designed with a cap on the number of coins that could be mined: 21 million.

Meanwhile, with fiat currencies like the U.S. dollar, the supply is potentially limitless. As of December 2020, there’s about $2 trillion or so of U.S. paper currency outstanding in the world. The Federal Reserve’s balance sheet— a proxy for the amount of money in the system — has grown by a staggering amount since 2007, as the central bank fought off recessions during the financial crisis of 2008 and the Covid-19 pandemic of 2020.

Meanwhile, speculators and investors have put money into the crypto market with the hope that their coins will maintain their worth or, ideally, increase significantly in value.

However, many others cite volatility as a reason why digital coins are not a reliable store of value.

What Are Central Bank Digital Currencies (CBDC)?

One potentially interesting development could be the advent of central bank digital currencies (CBDC) — virtual currencies that are created and backed by a nation’s central bank.

CBDCs sounds to some people like an oxymoron because cryptocurrencies by definition are decentralized and don’t have an authority backing them, but a January 2020 survey by the Bank of International Settlements found that 80% of central banks were researching and experimenting with CBDCs.

Fiat Currency

 Cryptocurrency
Physical currency that’s issued and overseen by a central bank Digital currency that’s created by a decentralized system
Can be used as a store of value Too volatile to be a reliable store of value
Primarily used for real-world payments Rarely used for real-world payments

Could Crypto Take Over Fiat Money?

Could cryptocurrencies become so ubiquitous that crypto would replace fiat currency? It’s hard to imagine, given the current state of crypto. Cryptocurrencies are still highly volatile and risky investments. In order for the vast majority of people to use crypto to pay for goods and services, there would have to be more stability in the crypto market.

Pros and Cons of Fiat Money

Pros of Fiat Money

A major convenience of paper currencies is that they are easy to produce, carry around, and consequently, good at facilitating exchange.

Another plus is not being reliant on a physical commodity market like gold. This means the money system isn’t as susceptible to the risk of outside players manipulating a metal’s supply and demand in order to distort currency prices.

Arguably, the most important advantage of fiat currencies is that they allow central banks to control money supply. Deciding how much currency to print is a valuable tool when trying to manage economic cycles.

For instance, the Federal Reserve has a dual mandate of keeping both unemployment and inflation low. In order to keep unemployment low, the central bank can boost currency supply, and when that starts to spark inflation, the Fed can raise interest rates to tame price increases.

Cons of Fiat Money

The biggest risk to a fiat-currency system is that the central bank miscalculates or mismanages and prints too much money — a situation that could result in hyperinflation, when the rate of inflation grows at more than 50% a month.

Fiat Currencies and Hyper Inflation

A 2012 study by the Cato Institute found that some of the worst cases of hyperinflation include Germany after World War I, from which there are photographs of German children playing with bundles of money as building blocks, and Zimbabwe from 2007 to 2008, when prices of bread skyrocketed and people carried cash in wheelbarrows.

Most recently, in 2019, hyperinflation in Venezuela reached 1,300,000%, pushing the government to issue 50,000 bolivar notes, which equaled $8.13 in U.S. dollars at the time.

Investing in Cryptocurrencies

A fiat currency is issued by a government, while cryptocurrencies are digital and rely on blockchain technology. Examples of fiat currencies include the U.S. dollar, the euro, the yen, and most internationally traded currencies. While there are fewer than 200 fiat currencies in the world, there are thousands of types of crypto: e.g. Bitcoin, Ethereum, Polkadot, Dogecoin, Litecoin, and more.

Fiat currencies by themselves have no intrinsic value. Instead, it is up to a government and its central bank to preserve their value, while also ensuring that there’s a healthy supply for an economy to grow. In a way, cryptocurrencies are similar in that they don’t possess inherent value, but investor demand means that some forms of crypto do have value and some are even used as payments.

While people argue that cryptocurrencies could challenge fiat as a store of value and medium of exchange, that possibility is a long way off. Cryptocurrencies like Bitcoin have seen their prices and popularity jump. However, they haven’t yet become a common way for people to pay for goods. Volatility in the market has also made some investors believe that digital coins aren’t a good store of value, although many investors have faith that crypto will grow.

FAQ

What are some examples of fiat currencies?

Most internationally traded currencies are fiat currencies: e.g. the U.S. dollar, the Japanese yen, the British pound, the EU’s euro, and so on.

Is Bitcoin considered a fiat currency?

No. Bitcoin is the oldest and still the largest form of cryptocurrency.

Why do they call it fiat money?

Because it’s backed by the authority of a governmental system (fiat means by an order or decree). It’s not tied to an underlying commodity such as gold or silver.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

SOIN0522019

2Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.
First Trade Amount Bonus Payout
Low High
$50 $99.99 $10
$100 $499.99 $15
$500 $4,999.99 $50
$5,000+ $100
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