Cryptocurrency and Bitcoin…., Huh?

How did this all start?

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On Oct. 31, 2008, somebody using the pseudonym Satoshi Nakamoto released a nine-page paper describing a new system of “electronic cash” called bitcoin.

What bitcoin promised was an alternative to the existing financial system, and it struck a nerve with a lot of people in the wake of the global financial crisis. “Bitcoin” became as much a social movement as a piece of technology. That’s one reason it has such a passionate following; crypto’s adherents believe they are willing a financial revolution into existence.

Moreover, because bitcoin was released as open-source software, anybody can take the code and create their own version of it. They could tweak it to operate differently, or alter it for an entirely different use case. This is why there are thousands of different crypto platforms doing different things, everything from decentralized versions of operating systems (Ethereum), digitized banking services (DeFi), supply-chain networks ( IBM and others), even new kinds of collectibles and art (NFTs, or nonfungible tokens). It’s a massive, live experiment in applying a new technology.

The first thing an inquisitive investor should do is read Nakamoto’s original “white paper.” It’s technical but not inaccessible and it explains quite clearly how the bitcoin network operates.

Here’s What You Should Know

Cryptocurrencies let you buy goods and services, or trade them for profit. Here’s more about what cryptocurrency is, how to buy it and how to protect yourself.

A cryptocurrency (or “crypto”) is a digital currency that can be used to buy goods and services, but uses an online ledger with strong cryptography to secure online transactions. Much of the interest in these unregulated currencies is to trade for profit, with speculators at times driving prices skyward.

The most popular cryptocurrency, bitcoin, has had volatile price moves this year, reaching nearly $65,000 in April before losing nearly half its value in May. By mid-October, the price had risen rapidly again: it hit an all-time high above $66,000 before falling back. (You can check the current price to buy bitcoin here.)

Here are seven things to ask about cryptocurrency, and what to watch out for.

1. What is cryptocurrency?

Definition: A cryptocurrency is an encrypted data string that denotes a unit of currency. It is monitored and organized by a peer-to-peer network called a blockchain, which also serves as a secure ledger of transactions, e.g., buying, selling, and transferring. Unlike physical money, cryptocurrencies are decentralized, which means they are not issued by governments or other financial institutions. Cryptocurrencies are created (and secured) through cryptographic algorithms that are maintained and confirmed in a process called mining, where a network of computers or specialized hardware such as application-specific integrated circuits (ASICs) process and validate the transactions. The process incentivizes the miners who run the network with the cryptocurrency.

Cryptocurrency is a form of payment that can be exchanged online for goods and services. Many companies have issued their own currencies, often called tokens, and these can be traded specifically for the good or service that the company provides. Think of them as you would arcade tokens or casino chips. You’ll need to exchange real currency for the cryptocurrency to access the good or service.

Cryptocurrencies work using a technology called blockchain. Blockchain is a decentralized technology spread across many computers that manages and records transactions. Part of the appeal of this technology is its security.

The basic idea is that cryptocurrencies operate on software networks, where myriad computers run separate copies of the same program. The computers are linked, but no one computer controls the network. In bitcoin parlance, it’s a “decentralized” network.

These computer networks have two main functions: One is to process transactions, the other is to maintain the database that records and stores those transactions. In general, transactions are batched into “blocks,” which are then connected in chronological order in a long, unbroken “chain.” This is why the software became called “blockchain.”

2. How many cryptocurrencies are there? What are they worth?

Nearly 15,000 different cryptocurrencies are traded publicly, according to CoinMarketCap.com, a market research website. And cryptocurrencies continue to proliferate. The total value of all cryptocurrencies on Nov. 29 2021, was more than $2.5 trillion, having fallen off an all-time high above $2.9 trillion weeks earlier. The total value of all bitcoins, the most popular digital currency, was pegged at about $1.1 trillion.

Best cryptocurrencies by market capitalization

These are the 10 largest trading cryptocurrencies by market capitalization as tracked by CoinMarketCap, a cryptocurrency data and analytics provider.

There is a lot of hype around bitcoin. Some people claim it will become the world’s reserve currency. Some fashion it as the new gold. Some people simply think it will keep rising in value and make anybody who holds it rich. Some people think it’s a fad or Ponzi scheme.

Setting aside for a moment bitcoin’s fundamental value or use case, the primary reason it matters is this: Bitcoin allows any two people, anywhere in the world with an internet connection, to make a transfer of value in a few minutes without any middleman.

With bitcoin, you could send $1 million to somebody, pay a small transaction fee, and have the exchange settled in 10 minutes or less. No banks, no foreign exchange. With this technology, anything that can be digitized can be exchanged cheaply and quickly.

Cryptocurrencies appeal to their supporters for a variety of reasons. Here are some of the most popular:

  • Supporters see cryptocurrencies such as bitcoin as the currency of the future and are racing to buy them now, presumably before they become more valuable
  • Some supporters like the fact that cryptocurrency removes central banks from managing the money supply, since over time these banks tend to reduce the value of money via inflation
  • Other supporters like the technology behind cryptocurrencies, the blockchain, because it’s a decentralized processing and recording system and can be more secure than traditional payment systems
  • Some speculators like cryptocurrencies because they’re going up in value and have no interest in the currencies’ long-term acceptance as a way to move money

4. Are cryptocurrencies a good investment?

Cryptocurrencies may go up in value, but many investors see them as mere speculations, not real investments. The reason? Just like real currencies, cryptocurrencies generate no cash flow, so for you to profit, someone has to pay more for the currency than you did.

That’s what’s called “the greater fool” theory of investment. Contrast that to a well-managed business, which increases its value over time by growing the profitability and cash flow of the operation.

“For those who see cryptocurrencies such as bitcoin as the currency of the future, it should be noted that a currency needs stability.”

Some notable voices in the investment community have advised would-be investors to steer clear of them. Of particular note, legendary investor Warren Buffett compared bitcoin to paper checks: “It’s a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money too. Are checks worth a whole lot of money? Just because they can transmit money?”

For those who see cryptocurrencies such as bitcoin as the currency of the future, it should be noted that a currency needs stability so that merchants and consumers can determine what a fair price is for goods. Bitcoin and other cryptocurrencies have been anything but stable through much of their history. For example, while bitcoin traded at close to $20,000 in December 2017, its value then dropped to as low as about $3,200 a year later. By December 2020, it was trading at record levels again.

This price volatility creates a conundrum. If bitcoins might be worth a lot more in the future, people are less likely to spend and circulate them today, making them less viable as a currency. Why spend a bitcoin when it could be worth three times the value next year?

5. How do I buy cryptocurrency?

While some cryptocurrencies, including bitcoin, are available for purchase with U.S. dollars, others require that you pay with bitcoins or another cryptocurrency.

To buy cryptocurrencies, you’ll need a “wallet,” an online app that can hold your currency. Generally, you create an account on an exchange, and then you can transfer real money to buy cryptocurrencies such as bitcoin or Ethereum. Here’s more on how to invest in bitcoin.

Coinbase is one popular cryptocurrency trading exchange where you can create both a wallet and buy and sell bitcoin and other cryptocurrencies. Also, a growing number of online brokers offer cryptocurrencies, such as eToro, Tradestation and Sofi Active Investing. Robinhood offers free cryptocurrency trades (Robinhood Crypto is available in most, but not all, U.S. states).

There’s no question that they’re legal in the United States, though China has essentially banned their use, and ultimately whether they’re legal depends on each individual country. Also be sure to consider how to protect yourself from fraudsters who see cryptocurrencies as an opportunity to bilk investors. As always, buyer beware.

7. How do I protect myself?

If you’re looking to buy a cryptocurrency in an ICO, read the fine print in the company’s prospectus for this information:

  • Who owns the company? An identifiable and well-known owner is a positive sign.
  • Are there other major investors who are investing in it? It’s a good sign if other well-known investors want a piece of the currency.
  • Will you own a stake in the company or just currency or tokens? This distinction is important. Owning a stake means you get to participate in its earnings (you’re an owner), while buying tokens simply means you’re entitled to use them, like chips in a casino.
  • Is the currency already developed, or is the company looking to raise money to develop it? The further along the product, the less risky it is.

It can take a lot of work to comb through a prospectus; the more detail it has, the better your chances it’s legitimate. But even legitimacy doesn’t mean the currency will succeed. That’s an entirely separate question, and that requires a lot of market savvy.

But beyond those concerns, just having cryptocurrency exposes you to the risk of theft, as hackers try to penetrate the computer networks that maintain your assets. One high-profile exchange declared bankruptcy in 2014 after hackers stole hundreds of millions of dollars in bitcoins. Those aren’t typical risks for investing in stocks and funds on major U.S. exchanges.

8. Who controls the computers?

Anybody can download and run these software programs; they are “open source” programs. The database where transactions are recorded, usually called the ledger, is therefore visible publicly to anybody.

This ensures that nobody on the network is counterfeiting the currency or double-spending the same bitcoins. The transaction history is collectively agreed upon by every computer, so it can’t be later changed. Transactions are permanent.

The people running these programs have an incentive: a competition with a monetary reward. They race against each other to batch together a block of transactions. The first block to be recognized by the network earns the winning computer a batch of newly minted bitcoins. Currently, the reward is 6.25 bitcoins, meted out roughly every 10 minutes. These are bitcoin’s “miners,” a nickname given because what they’re doing is like mining for gold.

This competition does two things: provides an incentive for people to maintain the network, and is the mechanism through which new bitcoins are created.

Should you buy cryptocurrency?

Cryptocurrency is an incredibly speculative and volatile buy. Stock trading of established companies is generally less risky than investing in cryptocurrencies such as bitcoin.

What online brokers offer cryptocurrencies?

Of the online brokerages and cryptocurrency exchanges that NerdWallet reviews, the following currently offer cryptocurrencies.

What is Cryptocurrency? Cryptocurrency Security: 4 Tips to Safely Invest in Cryptocurrency

Technology has changed the way people work, communicate, shop and even pay for goods. Companies and consumers don’t always prefer cash anymore, and this behavior is giving way to contactless payments like Apple Pay. With the quick wave of a smartphone, consumers can pay for items at digital registers. Now, a new payment system is emerging: cryptocurrency.

Probably everyone heard about Bitcoin by now. It was the first cryptocurrency to go mainstream, but others are growing in popularity. There are more than 2,000 different types of cryptocurrencies, and more are developed every day.

Research suggests most people have heard of cryptocurrency but don’t fully understand what it is. So, what is it, is it secure and how do you invest in it? To help, we’ll answer those questions. Think of this as Cryptocurrency Investing 101.

Cryptocurrency is a digital payment system that doesn’t rely on banks to verify transactions. It’s a peer-to-peer system that can enable anyone anywhere to send and receive payments. Instead of being physical money that is carried around and exchanged in the real world, cryptocurrency payments exist purely as digital entries to an online database that describe specific transactions. When you transfer cryptocurrency funds, the transactions are recorded in a public ledger. You store your cryptocurrency in a digital wallet.

Cryptocurrency got its name because it uses encryption to verify transactions. This means advanced coding is involved in storing and transmitting cryptocurrency data between wallets and to public ledgers. The aim of the encryption is to provide security and safety.

How Secure Is Cryptocurrency?

Cryptocurrencies are usually built using blockchain technology. Blockchain describes the way transactions are recorded into “blocks” and time stamped. It’s a fairly complex, technical process, but the result is a digital ledger of cryptocurrency transactions that’s hard for hackers to tamper with.

In addition, transactions require a two-factor authentication process. For instance, you might be asked to enter a username and password to start a transaction. Then, you might have to enter an authentication code that’s sent via text to your personal cell phone.

While securities are in place, that doesn’t mean cryptocurrencies are un-hackable. In fact, several high-dollar hacks have cost cryptocurrency startups heavily. Hackers hit Coincheck to the tune of $534 million and BitGrail for $195 million in 2018. That made them two of the biggest cryptocurrency hacks of 2018, according to Investopedia.

4 Tips to Invest in Cryptocurrency Safely

Investments are always risky, but some experts say cryptocurrency is one of the riskier investment choices out there, according to Consumer Reports. However, digital currencies are also some of the hottest commodities. Earlier this year, CNBC forecasted that the cryptocurrency market is expected to reach a value of $1 trillion by the end of 2018. If you’re planning to invest in cryptocurrencies, these tips can help you make educated choices.

Research Exchanges

Before you invest one dollar, learn about cryptocurrency exchanges. These platforms provide the means to buy and sell digital currencies, but there are 500 exchanges to choose from, according to Bitcoin.com. Do your research, read reviews and talk with more experienced investors before moving forward.

Know How to Store Your Digital Currency

If you buy cryptocurrency, you have to store it. You can store it on an exchange or in a digital “wallet,” for example one of the crypto wallets described in our Blog post Which cryptocurrency wallet to choose. While there are many different kinds of wallets, each has its own benefits, technical requirements and security. As with exchanges, you should investigate your storage choices before investing.

Diversify Your Investments

Diversification is a key to any good investment strategy, and it holds true when you’re investing in cryptocurrency too. Don’t put all of your money in Bitcoin, for example, just because that’s the name you know. There are thousands of options, and it’s best to spread your investment around to several currencies.

Prepare for Volatility

The cryptocurrency market is a volatile one, so be prepared for ups and downs. You’ll see dramatic swings in prices. If your investment portfolio or mental wellbeing can’t handle that, cryptocurrency might not be a wise choice for you.

Cryptocurrency is all the rage right now, but remember, it’s still in its infancy. Investing in something that’s new comes with challenges, so be prepared. If you plan to participate, do your research and invest conservatively to start.

Bitcoin has become so expensive. How can I afford it?

Bitcoin rose to almost $70,000 in 2021 from about $30,000 at the end of 2020. However, every bitcoin is divisible out to the eighth decimal place, meaning there are 100 million little units (nicknamed Satoshis) within one bitcoin. Therefore, you can buy pretty much any amount of bitcoin you want.

How do I buy one?

Originally, the idea behind bitcoin was that you downloaded the software itself and ran your own version of it, “mining” new bitcoins yourself. You were your own banker, a “self-sovereign.”

In practice, however, that’s too unwieldy—and expensive—for most people. The most common way to buy bitcoin now is through a crypto exchange like Coinbase or Gemini, or a mobile broker like Robinhood, PayPal or WeBull.

If you have a financial adviser, he or she might buy it directly for you, or put you into one of the new bitcoin exchange-traded funds. In the U.S. at least, these ETFs are based on bitcoin futures, not bitcoin itself. There are some bitcoin ETFs that trade outside the U.S.

Exchanges and other intermediaries often act as custodians for your funds. This means they are responsible for safeguarding your account—to a degree. If you allow access to your account to somebody in a phishing scam for instance, that person can drain your funds, probably permanently. In bitcoin, there is no way to reverse a fraudulent transaction.

What should I be on guard against?

A lot. Because crypto is such a new area, and has largely been unregulated or only lightly regulated, cons and frauds are rife. The Federal Trade Commission warns investors to steer clear of any opportunities that promise you can earn lots of money in a short time, or that ask you to recruit other investors, that offer guaranteed money or free money, or that make exorbitant claims short on details.

In general, it’s best to steer clear of any investment offer via social media, especially if it comes to you. I regularly get emails from readers who don’t heed this warning and got scammed. And do your research on any investment manager or offer. If you can’t learn enough to feel comfortable, move on.

How do I make money?

Buying bitcoin is not like buying a stock or bond. When you hold bitcoin, you don’t own a piece of a company. You make money with bitcoin in one way: by selling it to somebody else for more than you bought it for.

There is one burgeoning part of the crypto market called “defi,” short for decentralized finance. These are banklike services that allow you to lend out or borrow against your crypto holdings. If you lend, you can earn interest that typically ranges from 5% to 20%. If you borrow, you can take the borrowed crypto and invest it elsewhere in the market, again hoping to sell it for more than you bought it for.

MORE IN ‘NEED TO KNOW’

However, defi is a new field, with virtually no business standards. Almost once a week, there’s a loss of funds. Very often, some malicious coder finds a flaw in a defi program and drains accounts. Sometimes, bad software crashes and erases transaction histories. Sometimes, the platforms were set up just to steal money (a “rug pull”). The research firm Elliptic estimates that about $10 billion has been lost in 2021 on defi platforms. This is a buyer-beware environment.

Ultimately, you can make a profit in crypto, but know that you are putting money into a largely unregulated area with a lot of opaque corners and volatility. The billionaire hedge-fund manager Paul Tudor Jones understood this when he got into the market, calling bitcoin “a great speculation.” That’s about the best description of it I’ve heard.

GLOSSARY

Cryptocurrencies: Digital tokens used to transfer money between individuals’ computers with minimal fees.

The blockchain: The simple, open-access ledger that underpins the currency. When a bitcoin owner transfers a token to another person, he or she posts the transaction to the blockchain, signing it with a unique string of numbers and letters. Even financial firms that are skeptical about bitcoin and other cryptocurrencies have embraced the blockchain technology itself.

Miners: Bitcoin “miners” verify transactions by running the numbers through formulas on high-powered computers.

Satoshi: One of the one hundred million units that make up each bitcoin. Also the first name of bitcoin’s alleged inventor, the mysterious Satoshi Nakamoto.

Defi: An abbreviation for “decentralized finance,” or banking services that allow investors to lend out or borrow against their cryptocurrency holdings.

The evolution of cryptocurrency

In recent years, cryptocurrency—and in particular, Bitcoin—has demonstrated its value, now boasting 14 million Bitcoins in circulation. Investors speculating in the future possibilities of this new technology have driven most of the current market capitalization, and this is likely to remain the case until a certain measure of price stability and market acceptance is achieved. Apart from the declared price of cryptocurrency, those invested in it appear to be relying on a perceived “inherent value” of cryptocurrency. This includes the technology and network itself, the integrity of the cryptographic code and the decentralized network.

The blockchain public ledger technology (which underlies cryptocurrency) has the potential to disrupt a wide variety of transactions, in addition to the traditional payments system. These include stocks, bonds and other financial assets for which records are stored digitally and for which currently there is a need for a trusted third party to provide verification of the transaction.

In our view, the cryptocurrency market will develop at a pace set by the key participants, characterized by likely growth spurts of legitimacy from one or more of these participants in what we call “credentialising moments.” For the market to reach the next phase in its evolution toward mainstream acceptance and stable expansion, each of the five key market participants—merchants and consumers, tech developers, investors, financial institutions and regulators—will play a role.

Keys to market development

Consumers and merchants

For consumers, cryptocurrencies offer cheaper and faster peer-to-peer payment options than those offered by traditional money services businesses, without the need to provide personal details. While cryptocurrencies continue to gain some acceptance as a payment option, price volatility and the opportunity for speculative investments encourage consumers not to use cryptocurrency to purchase goods and services but rather to trade it.

Only 6% of respondents to PwC’s 2015 Consumer Cryptocurrency Survey say they are either “very” or “extremely” familiar with cryptocurrencies. We anticipate that familiarity will increase as consumers begin to have access to innovative offerings and services not otherwise available through traditional payment systems.

From the perspective of businesses and merchants, cryptocurrencies offer low transaction fees and lower volatility risk resulting from nearly instantaneous settlement, and they eliminate the possibility of chargebacks (the demand by a credit card provider that a retailer make good on the loss of a fraudulent or disputed transaction).

Tech developers

Many talented tech developers have devoted their efforts to cryptocurrency mining, while others have focused on more entrepreneurial pursuits such as developing exchanges, wallet services and alternative cryptocurrencies. In our view, the cryptocurrency market has only started to attract talent with the depth, breadth and market focus needed to take the industry to the next level. For the market to gain mainstream acceptance, however, consumers and corporations will need to see cryptocurrency as a user-friendly solution to their common transactions. Also, the industry will need to develop cybersecurity technology and protocols.

Investors

Investors generally appear to be confident about the opportunities associated with cryptocurrencies and cryptography. The “inherent value” of the underlying technology, discussed above, gives these investors good reason to be optimistic. As a result, only recently have some of the more established cryptocurrency companies attracted institutional investors and Wall Street attention.

Financial institutions

Traditionally, banks have connected those with money to those who need it. But in recent years, this middleman position has been diluted, and disintermediation in the banking sector has evolved rapidly. This has resulted from the rise of Internet banking; increased consumer usage of alternative payment methods like Amazon gift cards, Apple Pay and Google Wallet; and advances in mobile payments.

Regulators

Government attitudes around the world are inconsistent when it comes to the classification, treatment and legality of cryptocurrency. Regulations are also evolving at different paces in different regions.

Looking ahead

In our view, cryptocurrency represents the beginning of a new phase of technology-driven markets that have the potential to disrupt conventional market strategies, longstanding business practices and established regulatory perspectives—all to the benefit of consumers and broader macroeconomic efficiency. Cryptocurrencies carry groundbreaking potential to allow consumers access to a global payment system—anywhere, anytime—in which participation is restricted only by access to technology, rather than by factors such as having a credit history or a bank account.

The discussion is no longer one of whether cryptocurrency will survive, but rather how it will evolve—and when it will reach maturity.

Resources

nerdwallet, “What Is Cryptocurrency? Here’s What You Should Know: Cryptocurrencies let you buy goods and services, or trade them for profit. Here’s more about what cryptocurrency is, how to buy it and how to protect yourself.” By James Royal, Ph.D.Kevin Voigt; kaspersky, “What is Cryptocurrency? Cryptocurrency Security: 4 Tips to Safely Invest in Cryptocurrency;” wsj.com, “What Is Cryptocurrency, and How Does It Work? We answer some commonly asked questions about this hot, but little understood, asset.” By Paul Vigna; pwc.com, “Money is no object: Understanding the evolving cryptocurrency market.”

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