42% of millennials were familiar with Bitcoin, as compared to, for example, 15% of persons aged 65 or older.
Cryptocurrency. For the uninitiated, the word itself conjures up images of James Bond villains and futures described in science fiction novels.
Just a decade ago, it would have been perfectly reasonable to think of cryptocurrency as science fiction. But that was then. Today, cryptocurrencies are real – although not tangible – assets used to purchase and sell real things, as well as traded on currency markets around the globe. And those markets have exploded.
One recent estimate put the total value of digital currencies at over $500 billion, and added a prediction that total market capitalization of such currencies could reach $1 trillion in 2018.
With those figures you’d think that cryptocurrencies would have the attention of every financial professional in the world. Not so, as cryptocurrencies remain a mystery to even seasoned financial experts, not to mention most average citizens. That’s where this guide comes in. Its purpose is to offer a comprehensive introduction to the world of cryptocurrencies: what they are, how they work, and what they can mean to you – as a means of buying and selling, as an investment, and more.
What is Cryptocurrency?
Cryptocurrency is a digital or virtual asset that functions as a medium of exchange in much the same was as more traditional forms of legal tender (like metal or paper currencies).
It is a form of digital money that employs cryptography to ensure security in the transfer of funds and creation of additional currency units. The foundation of any cryptocurrency lies in its security, anonymity, and accessibility to anyone with an internet connection.
Cryptocurrencies can be used to buy and sell goods and services, but today are primarily an investment asset traded on currency exchanges around the world.
There are currently over 1500 cryptocurrencies in existence, most of which very few people have ever heard of. There are, however, a number of well-known, highly-capitalized coins that garner the lion’s share of action and attention
Keep in mind, though, that the market for these coins is extremely volatile and often quite fickle. Put another way: Today’s hot coin may not be so hot tomorrow.
Millennials and Bitcoin: Facts and Figures
Bitcoin is very popular among young Americans, at least according to one recent survey conducted online by The Harris Poll for Blockchain Capital. Surveying over 2,100 U.S. millennials (adults 18 years of age and older), Harris found:
48% of millennials agree that Bitcoin is a positive innovation in financial technology. 27% believe that Bitcoin is more trustworthy than big banks.
30% of millennials prefer to own $1,000 of Bitcoin over $1,000 of government bonds. 27% prefer to own $1,000 of Bitcoin over $1,000 of stocks. 22% prefer to own $1,000 of Bitcoin over $1,000 of real estate. And 19% prefer to own $1,000 of Bitcoin over $1,000 of gold.
42% of millennials believe that most people will be using Bitcoin in the next 10 years.
A (Very Brief) History of Cryptocurrencies
As histories go, the history of cryptocurrency is a fairly brief one. Although there were a few earlier futile attempts at establishing online currencies with encrypted ledgers, cryptocurrencies really began in earnest with the publishing in 2008 of “Bitcoin – A Peer-to-Peer Electronic Cash System”, a paper written by Satoshi Nakamoto that outlined the concept and basic technical issues of a digital payment system that allowed for sending and receiving payment without the involvement of banks or other financial intermediaries.
Nakamoto quickly followed up the paper in early 2009 with the introduction of Bitcoin, the world’s first real cryptocurrency.
Bitcoin gained quick popularity among a small group of enthusiasts who began mining and exchanging the digital currency. The first known use of Bitcoin came in 2010, when someone purchased two pizzas for 10,000 Bitcoins. By 2011, a broader interest in Bitcoin had gained footing, and other cryptocurrencies began to appear with the intention of improving on the speed, security and anonymity characteristics of Bitcoin. Today there are literally hundreds of cryptocurrencies in circulation around the world.
Cryptocurrencies, primarily Bitcoin, also started to become accepted as payment by a number of companies for their goods and services. The world of cryptocurrencies has not been without its problems and setbacks, though. A number of hacks and thefts of currencies have occurred, most notably the Mt. Gox attack in 2014 in which approximately 850,000 Bitcoins simply vanished when the Mt. Gox exchange went offline. The result was a $450 million loss to the currency’s owners.
Cryptocurrencies, and the technologies that underlie them, are still in the early stages of their development. Therefore, continued volatility and upheaval in their markets is to be expected, and no one can be sure of how things will eventually settle out. The domination of a very few –or possibly a single – coin, coinciding with the obsolescence of others, is a strong possibility. Markets traditionally tend to consolidate over time. One thing is certain: interest in cryptocurrencies is unlikely to subside anytime soon.
Who is Satoshi Nakamoto?
As mentioned above, the story of cryptocurrency begins in earnest in 2009 with the publication of a white paper by Satoshi Nakamoto putting forth the concept of cryptocurrency, and the creation and introduction of Bitcoin. Satoshi Nakamoto is legendary in the world of crypto currency and has been described as “the world’s most elusive billionaire,” with a net worth estimated at $7 billion.
Here’s the thing: No one seems to know who Satoshi Nakamoto actually is. Nakamoto has, to say the least, kept a low profile, employing state-of-the-art encryption technologies and other methods to keep his – or her – identity a secret.
There is, of course, tremendous speculation about Nakamoto’s true identity, with more than a few names having been suggested. It’s believed that the U.S. Department of Homeland Security knows, but if they do, they’re not talking. It’s even possible that Nakamoto is actually more than one person. Regardless, as of this writing, the true identity of Satoshi Nakamoto, possibly one of the richest individuals on the planet, remains a mystery.
How Do Cryptocurrencies Work?
There’s almost nothing in the world more difficult than getting a grip on how cryptocurrencies work, at least for those of us who are mere mortals. Experts advise that the best approach is to just dive in and try to figure out as much as possible, with the hope that a working understanding will come with time and practice. This section is designed as a good place to start.
What is a Blockchain?
You can’t get too far into the world of cryptocurrencies without encountering the word “blockchain” or the term “blockchain technology.” An explanation of blockchains can get very complicated and technical, and would take up much more room than is available in this article.
Here’s a simple, but workable explanation: A blockchain is a digitized, shared public ledger that contains all transactions of a cryptocurrency. Put another way, a blockchain consists of a series (or chain) of files (blocks) containing the records of the most recent transactions of a cryptocurrency. As transactions take place, the blocks recording the transactions are added to the chain, allowing for a constantly up-to-date ledger. Blocks are kept in chronological order and each one contains a hash of the previous block. The blockchain database is shared by all nodes (computers connected to the cryptocurrency’s blockchain system), therefore assuring that the database cannot be altered or deleted.
Blockchains are at the heart of Bitcoin, likely the currency’s biggest single innovation, and variations of blockchain technology are the foundation of every other cryptocurrency.
What is Cryptocurrency Mining?
Another term anyone looking into cryptocurrencies is bound to run into is “mining”. Cryptocurrency mining doesn’t require owning a pickaxe or shovel, or spending your days in an underground tunnel. But it does bear some resemblance to traditional gold mining, for example.
Here’s why. Cryptocurrency mining (aka cryptomining, altcoin mining, and Bitcoin mining) is the process by which cryptocurrency transactions are verified, authorized and added to the currency’s blockchain. The process involves the efforts of cryptocurrency “miners” whose responsibility is to ensure the validity of transactions by verifying the elements of those transactions, primarily by determining that the coin owner has enough of the currency to pay for the transaction. This is accomplished by examining the balance in the owner’s wallet. (More on cryptocurrency wallets below.)
Once the transaction information is verified, it is authenticated and added to the blockchain by solving a complex mathematical equation or puzzle that is part of the cryptocurrency’s program. In the case of Bitcoin, the puzzle involves discovering a “nonce”, which is an integer between 0 and 4,294,967,296. Cryptocurrency miners, in effect, compete to solve the puzzle, with the first one to solve it rewarded by being given the task of authorizing and adding the transaction to the blockchain, and by earning a given amount of the cryptocurrency itself.
Is Cryptocurrency Mining Worth It?
It’s possible to earn units of a cryptocurrency through mining, and there are plenty of people out there working at doing just that. But is it really worth it? The answer: maybe. It all depends on the time, effort and resources one is willing to invest. And that can be a lot.
As with most things having to do with cryptocurrency, the best example is Bitcoin. To understand the value of mining Bitcoin, start with the fact that the total number of Bitcoins that will ever come into existence is 21 million. Currently, the number of Bitcoins that a miner will earn for solving one puzzle is about 12. Since there is only a finite number of Bitcoins that will ever be created, their value is expected to increase over time. And that’s the incentive for Bitcoin mining: the chance to earn lots of valuable Bitcoins.
The problem is that winning Bitcoins through mining is extremely difficult. Emphasis on extremely. That’s because the puzzles themselves are hugely complex, and to have any real chance of solving one requires an enormous amount of computing power. Emphasis on enormous. In fact, most competitive Bitcoin miners presently employ gigantic computer rigs requiring staggering amounts of energy running nonstop just to solve puzzles. Simply put, mining for Bitcoins today is beyond the capabilities of the average person.
Of course, Bitcoin isn’t the only cryptocurrency out there to be mined, and the mining process is significantly easier for those other coins. But miners will likely not make nearly as much, in terms of total monetary value, for winning a lesser cryptocurrency’s puzzle. Nevertheless, some may find mining these lesser coins worth the trouble.
How to Purchase Cryptocurrencies
Fortunately, mining is far from the only method of obtaining cryptocurrencies. The easiest way is simply to buy them. There are a number of options for purchasing cryptocurrencies, but the place most people buy them is on a cryptocurrency exchange. Cryptocurrency exchanges (also known as digital currency exchanges or DCE’s) are online platforms where people buy, sell, and trade cryptocurrencies.
There are literally dozens of them in operation, each with its own fees, processes, ancillary services, and particular currency listings. Most operate outside of the U.S. in order to avoid strict regulation of their activities.
There are two basic types of exchanges: fiat exchanges and cryptocurrency to cryptocurrency exchanges. Fiat exchanges allow customers to purchase cryptocurrencies with traditional money sources, like U.S. dollars or euros. Cryptocurrency to cryptocurrency exchanges, as the name implies, allow those who own one kind of cryptocurrency to trade it for another kind. Most major exchanges offer both fiat purchases and cryptocurrency to cryptocurrency trades.
The cryptocurrency exchange world is as new as cryptocurrencies themselves and, given their early growing pains and sparse regulation, it can be tricky choosing one to trust with your business. Obviously, customers will need to find an exchange that deals in the specific currency they are interested in. Beyond that, it may be best to seek out platforms with a solid reputation, and that are free from security breach and regulatory issues. To find information on a platform’s security and regulatory history requires a bit of online homework: checking news outlets and sites like Twitter and Reddit. Other factors to consider when picking an exchange include trading volume (sites with a lot of business likely have that much business for a reason), costs (fees), and access to quality customer support.
One last thing: No matter which platform you end up using, it’s a good idea to assume that platform security is always an issue. So, store your currencies in a wallet separate from the sites used for your cryptocurrency purchases, sales and trades.
There are lots of great security advantages that make cryptocurrencies attractive. But there is one big – and scary – security task that individual currency owners must take upon themselves: storage. That’s because the short history of cryptocurrencies is rife with stories of hacks that have resulted in owners losing their coins forever. So, taking personal responsibility for the proper storage of one’s coins is an absolute must.
Storing cryptocurrency means using a wallet. A cryptocurrency wallet is nothing like that old leather thing you’ve got in your back pocket, however. A cryptocurrency wallet refers to any one of several methods for securing the digital information a currency owner needs to store, receive and send his or her coins. More precisely, a cryptocurrency wallet stores the owner’s public and – most importantly – private keys that allow the owner access to his/her cryptocurrency stash.
There are a wide variety of types of cryptocurrency wallets, including desktop wallets (installed directly on an owner’s computer), online wallets (storage on the cloud), and mobile wallets (storage on a smartphone).
The problem with these wallet types is that they all leave their owners vulnerable on some level to hacking. That’s why it is highly recommended that owners employ a hardware wallet for their cryptocurrency storage. With a hardware wallet, the owner’s keys are stored on an external digital device, like an USB stick or smartcard. Hardware wallets are very secure since the information on them is contained offline and thus not assessable to hackers. The main disadvantage – and this can be a big one – is that if you lose your wallet, or if your wallet is damaged beyond repair, the keys stored on it are gone, along with the owner’s coins. And that loss may be forever. Unless, that is, the owner keeps a backup.
Buying and Selling Things with Cryptocurrencies
Now that you own Bitcoins or some other cryptocurrency, what can you do with them? The answer is pretty much the same as with any traditional currency. There are two basic uses. The first is to treat your coins as an investment: buying, holding, trading, and selling them to (hopefully) make a profit. The second is to use them to buy stuff – actual products and services.
In most cases, online retailers use the services of a third-party processor, like Bitpay, to facilitate payment with a cryptocurrency. Customers simply follow the prompts on the retailer’s website in much the same was as when making payment with a credit or debit card. Retailers that accept cryptocurrencies at their brick-and-mortar locations also use third-party processors, but payment by the customer is most often made via a “spending wallet” app on the customer’s smartphone or similar device.
Who Accepts Cryptocurrencies as Payment?
The list of merchants and companies that accept cryptocurrencies to pay for their products and services is relatively small, but that list is growing, and it includes a lot of very recognizable names. Not surprisingly, the most widely accepted cryptocurrency is Bitcoin, but many retailers will accept other major coins as well. Most merchants accepting cryptocurrencies do so online through their websites, but a growing number are starting to accept them at their brick-and-mortar locations.
The benefits to merchants include immediate processing, lower transaction costs, avoidance of fraud and chargebacks, and the attraction of new – and younger – customers.
Here’s just a small sampling of major merchants currently accepting one or more cryptocurrencies as payment for their products and services:
Investing in Cryptocurrencies for Fun and Profit
When it comes to cryptocurrencies, the big action is in investment. It’s easy to see why. Consider this: When Bitcoin was launched in 2009, its price hovered just above $15. It remained that way for years before jumping into the hundreds of dollars in 2013. It first broke the $1,000 mark in early 2017.
And then the rocket was lit, with Bitcoin’s price peaking at over $19,000 in January 2018. Not long after, however, Bitcoin’s price dropped substantially, and those buying the currency at its peak found themselves witnessing their investments drop precipitously. As of the time of this writing, the price of Bitcoin was just under $7,000.
The bottom line: With huge potential rewards, many investors simply can’t resist the lure of cryptocurrency investment. Along with big rewards, though, come big risks – and the real possibility of seriously big losses.
Today, of course, Bitcoin is only one of hundreds of cryptocurrencies open to investment, which is both exciting and concerning to the average investor. All of this begs the very important question: Should you invest in cryptocurrencies?
Deciding whether or not to invest in cryptocurrencies, determining how much of your hard earned traditional cash to invest, and picking the specific coins to purchase – all require at least as much time and effort in research as one would put into any other investment. Possibly the best advice concerning whether or not to invest in cryptocurrencies is offered by Mark Williams, a master lecturer in finance and executive in-residence at Boston University’s Questrom School of Business, in this recent BU Today article:
My advice to those contemplating buying cryptocurrencies: do your homework first, understand your personal risk tolerance, and if interested, commit only an amount of money that you are willing to lose and that won’t impact you financially if it is a total bust. For risk-adverse investors, stick with traditional stock and bond investing, companies that have real assets, real boards, real management, real cash flow, and real regulation. Few investors regret buying Apple.
Ask an Expert: Interview with Bobby Ong
Bobby Ong is the co-founder of CoinGecko, a cryptocurrency data website offering comprehensive rankings and evaluations on hundreds of cryptocurrencies. Mr. Ong holds a BS in Economics from the University College of London, University of London, and is a Fellow at the Singapore University of Social Sciences.
CoinGecko is a cryptocurrency data website. We provide the price, trading volume, market capitalization, and data surrounding how active the community and developers are for cryptocurrencies. The information is freely available to everyone.
There are over 1,500 cryptocurrencies out there in the market, and it can get pretty daunting trying to learn every single one of them. So what I always say is that the best way to learn is to just learn about the first cryptocurrency that was created, which is Bitcoin, and understand the underlying technology. Everything else is pretty much a variation of Bitcoin.
Bitcoin is the first decentralized digital currency. It is not controlled by any single entity or backed by any government or corporation. You can think of it as a decentralized version of PayPal, except you can send money from one person to any other person without any party controlling it. So, for example, if PayPal doesn’t like you, they can freeze your money or freeze your assets, where with Bitcoin no one can really do that.
The way Bitcoin works is that it uses this thing called a blockchain. A block basically contains a series of transactions, shows you A sending money to B, and you can see this being recorded on the blockchain. So, a blockchain is pretty much a decentralized ledger, and every single computer that runs the Bitcoin network maintains this ledger. The ledger tells you the history of the entire Bitcoin economy from day one, which was in January 2009. So, you can tell at any point in time who owns how many Bitcoins and who sent to who how many Bitcoin credits.
Bitcoin is not anonymous in the sense that – you know how many Bitcoins you own at any point in time, but what you really know is how many Bitcoins belongs to your Bitcoin address. Bitcoin addresses are basically a series of random numbers. It’s kind of like your bank account number. A Bitcoin address would be like a 1 or 3 followed by another 18 different random alphanumeric characters.
The difference between a centralized and decentralized bank, I like to say, is that with Bitcoin you are your own bank. With Bitcoin, no one can take your money, or freeze your money because you are your own bank and you control your own password and security. What this means is that you own the keys for the rights or the password to spend the Bitcoin. And if you lose those keys, you lose the rights to spend. There is no party, there’s no call center to say like, “I lost my password. Can you help me reset my password?” There is no such entity. So the key to protecting your Bitcoin is to really store them safely.
There’s a lot of ways you can store your Bitcoins. The best way to store them safely is to buy a hardware wallet. A hardware wallet has the private keys embedded into things like a USB stick. Examples are Trezor and LedgerWallet. If you use a desktop wallet, you’re storing your keys – which basically provide you with the right to spend Bitcoin – on your computer. If your computer gets hacked – for example, if there’s a Trojan horse on your computer – you may lose your entire fund. You can [also] use a third-party online wallet. For example, you can store your coins on Coinbase. Or some people store their coins on exchanges. But if you use Coinbase or an exchange, you are letting somebody be the bank for you. And if that bank goes down, there goes your fund. So, the rule of thumb is never trust your fund to someone else, you always try to store them securely using a hardware wallet.
Yeah, there are many companies that accept Bitcoin for their products and services. Bitcoin is another payment channel, sort of like accepting credit cards or PayPal. Bitcoin is just another way of paying.
It’s definitely getting more popular as Bitcoin becomes more mainstream. And it’s getting mainstream for young people. It’s really big in Japan. A lot of people use Bitcoin to spend in actual retail shops in shopping malls, for example.
No, it’s not a problem. What the merchants do is use a third-party payment processing company, like Bitpay or Coinbase, to receive the Bitcoin and convert it to an equivalent amount of [traditional currency]. So, the merchant doesn’t really take on any volatility risk by accepting Bitcoin.
It’s not dozens, it’s hundreds.
You can go to CoinGecko and take a look. They’re sorted by market capitalization. Coins that have larger market caps are usually the larger coins. Bitcoin, followed by Ethereum, those are the biggest ones. Then Litecoin, Ripple. Those are the top coins. It changes every day. And the prices of all of these coins change very, very significantly. That’s why you should never put in money you are [not] willing to lose. It’s pretty much like speculating on penny stocks, if you want to put it that way.
Some of the ways that you can evaluate how good these coins are is to look at the market cap. The larger market cap means that there are more people interested in the coin. Then you look at the trading volume, how much people are willing to trade in these coins. If there’s no trading volume, there’s no liquidity in these coins. And you want to see how big the community and developers are to see if people are actually following and innovating on the coins. If no one is doing anything about that, then it’s probably not worth looking into. It’s a very risky space. You should not buy the coin if you don’t understand what it does.
It is the Wild West.