The Basics of Bitcoin
Is cryptocurrency worth the investment?
As cryptocurrency becomes more mainstream, people around the world have become interested in purchasing digital currency that can be held for investment purposes, exchanged globally or used to purchase goods without going through a bank.
The first cryptocurrency, Bitcoin, launched in 2009, in that time, the technology has created jobs and industry, with digital currency attached to unique functions and purposes. Even if you are not ready to plunk down some real cash in the trend, it is worthwhile to understand the technology, as it is growing at a fast pace and is not likely to go away any time soon.
A Quick Technology Primer
Cryptocurrency is based on a blockchain—a network of computers that polices itself through an algorithm originally developed as the accounting method for the virtual currency Bitcoin. Blockchains use a distributed ledger—a shared public record of transactions. Distribution of the ledger among a network of computers is intended to prevent data tampering, as opposed to keeping data in a private centralized location such as a bank.
Computers gather transactions into groups, called blocks, assigning a digital fingerprint to each block (called a “hash”). Each block is digitally linked to the previous and next block in the chain. A hacker cannot tamper with or remove a block in the chain because any disruption to a hash is easily detected and rejected. Blocks are public, meaning transactions gathered can be inspected and verified to ensure they are legitimate.
Bitcoin mining, or the purchase and linking of networked computers, creates the actual digital currency.
At this point, blockchain is considered extremely secure. But experts in academia say the supercomputing power of emerging quantum computing technology could break blockchains within 10 years.
What Can You Do With Cryptocurrency?
Cryptocurrency is already replacing, or being offered as an alternative to traditional payment methods globally. Examples of some things you can buy with Bitcoin include Dallas Mavericks tickets, a Whopper at Burger King in Arnhem, Netherlands, anything on the shopping website Overstock.com or a casket from Crescent Tide Funeral & Cremation in St. Paul, Minn. In the future, you are likely will be able to pay for all of your daily needs directly from your crypto wallet, without the need for a credit card, merchant system or cash.
Cryptocurrency is attractive to shady characters for illegal transactions and money laundering since purchases and sales are anonymous.
Millennials, who grew up with digital technology, are fueling the trend, but that does not mean we in the “older generations” are not embracing investing in and making purchases by cryptocurrency. But along with new technology are some risks.
With the current value of one Bitcoin at about $11,000, many are looking at digital currency as an investment. But though blockchain is designed as a secure system, there are still vulnerabilities. Cybercriminals have staged fake initial coin offerings (ICOs) of new currency, or hacked into investor’s digital wallets.
There is also investment risk for a technology that is still in its infancy. A flood of approximately 1,400 new digital currencies since the launch of Bitcoin has caused a dilution of the value and confusion among investors.
Top financial experts, albeit usually from traditional banks, claim cryptocurrency is not a wise investment. JPMorgan Chase CEO Jamie Dimon called cryptocurrency “a fraud” that will eventually be closed. With a lack of government regulation or guarantee, digital currencies generally have no fundamentals behind them, other than a concept to make capitalism more efficient. Cryptocurrency has no intrinsic value. It is not backed by gold reserves, real estate or anything tangible.
Investing in digital currency is highly speculative, with a history of wide value swings. While some have made huge gains, one should approach it with a willingness to lose everything invested.
If you are interested in investing in cryptocurrency, it is wise to do your own research and invest only what you can afford to lose. Start out with a reputable exchange to purchase coins, such as Coinbase.
Bitcoin and Ethereum are considered the “safest” cryptocurrency to purchase, understanding that the investment is still quite volatile. Look at the history of each currency. Generally, it is best to plan on buying and holding the currency over the long haul, and not react to dips in price.
The first time you make a purchase through Coinbase, it will take several days to verify your account and transfer funds from your bank account or debit card. Once the transfer is successful, however, the value of the coin is locked in at the date and time the system registered the purchase. Fees for using your bank account are much lower than using your debit card. Purchases by credit card are no longer allowed. After the initial transaction, future purchases of Bitcoin take about 10 minutes. Other options such as Litecoin cut the purchase time down to about two minutes.
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While one of the cornerstones of cryptocurrency is monetary decentralization without government control, governments and large financial institutions across the globe continue to attempt rule making on the trade of digital currency.
Earlier this year, Coinbase, one of the largest digital currency exchanges, was ordered by the IRS to turn over identities of investors with accounts holding $20,000 or more in cryptocurrency.
According to the IRS, cryptocurrency is considered property, and taxpayers are required to report capital gains or losses on transactions, whether they receive a form 1099 or not.
The Take Away
Investing in cryptocurrency is an irresistible wild ride if you have some discretionary income you are willing to put on the line.
Some of the risks and volatility of cryptocurrency may be overcome in time through technological developments in the future, or taken down entirely by quantum computing breaking blockchains. As cryptocurrencies become more mainstream they also attract more scrutiny from governments, with calls for regulation, which goes against the very nature of creating an anonymous, decentralized digital currency in the first place.
Regardless, it seems we have at least another decade to explore investing and trading in cryptocurrency in its current form, which is a lifetime in the technology realm.
Who knows what form digital currency will take after that?