Cryptocurrencies have once again become an investment frenzy, which means – because I cover this area in the Wall Street Journal – that I answer questions from a lot of people I usually do not hear from. Recently, a high school friend I had not spoken to in years approached me. He started investing in cryptocurrencies but was looking for guidance.
“I was happy for tips on where to find good information, especially for new people in the field,” the friend wrote.
As a group of assets, crypto is so new that even some people in the field do not understand it. And the unstoppable rising and falling nature of the wild west of this market also attracts bad players.
How do you navigate all this? cautiously. We will recall this general guideline, and answer some common questions about cryptocurrencies.
What is crypto and why does bitcoin matter?
“Cryptocurrencies” is a term used for a broad group of digital assets that began to exist in 2009 with Bitcoin. There are thousands, but only about a dozen of them have significant size and potential future.
There is a lot of hype about Bitcoin. Some people claim it will become the world’s reserve currency. Some think he is the new gold. Some people simply believe that it will continue to climb in value and make everyone who owns it rich. Some people think this is a passing fad or a Ponzi scam.
If we ignore for a moment the basic value or the possibility of using Bitcoin, the main reason it matters is this: Bitcoin allows any two people, anywhere in the world where they have an Internet connection, to transfer value between them in a few minutes and without any mediation.
With Bitcoin, you can send a million dollars to someone, pay a small transfer fee, and the whole transaction ends in 10 minutes or less. No banks, no place for money exchange. With this technology, anything that can be digitized can be traded quickly and cheaply.
How do cryptocurrencies work?
The basic idea is that cryptocurrencies work on software networks, where many computers run separate copies of the same program. The computers are interconnected but there is no single computer that controls the network. In the language of Bitcoin, this is a “distributed” network.
These computer networks have two main uses: one is to process transactions, the other is to keep the database that records and stores these transactions. In general, transactions are processed in “blocks”, which are then linked in chronological order in a “chain”. That’s why the software got the name “Blockchain”.
Who controls the computers?
Anyone can download and run these programs; Are “open source” software. The database in which the transactions are recorded, usually called a notebook, is available for viewing by anyone who wants to.
This makes sure that no one on the network is counterfeiting the coin or taking out the same coins twice. The transaction history is collectively agreed upon by each of the computers so that it cannot be changed later. Transactions are fixed.
The people who run these programs have an incentive: competition with a cash prize. They compete against each other to put together a block of deals. The first block sold by the network entitles the computer that created it to some new coins. Today, the prize stands at 6.25 Bitcoin units, each embedded in about 10 minutes. These are the “miners” of Bitcoin, a nickname given to them because what they do is like mining gold.
Competition does two things: it gives people an incentive to maintain the network and it is also the mechanism through which new coins are created.
How did it all start?
On October 31, 2008, someone using the Satoshi pen name Nakamoto issued a nine-page document describing a new “electronic cash” system called Bitcoin.
What Bitcoin promised was an alternative to the existing financial system, and it has exposed nerve to many people after the global economic crisis. “Bitcoin” has become a social movement no less than a technological product. This is one reason he had so many followers: crypto supporters believed they were causing an economic revolution to happen.
Beyond that, because Bitcoin was released as open source software, anyone can take the code and create their own version. This way you can change it to work differently, or change it completely for other uses. So there are thousands of crypto platforms that do different things, all from distributed versions of operating systems (Atherium), digital banking services (DeFi), supply chain networks (IBM and others), and even new types of collectible products and artifacts (NFT, or non-tokens) Exchanges). It’s a huge, live experiment, applying a new technology.
The first thing a curious investor should do is read Nakamoto’s original white paper. It is technical but not inaccessible and it explains quite clearly how the Bitcoin network works.
Bitcoin is getting so expensive. How can I afford it?
Bitcoin rose to almost $ 70,000 in 2021, compared to about $ 30,000 at the end of 2020. However, each bitcoin can be divided up to eight places after the decimal point, meaning that each Bitcoin currency has 100 million small units (called Satoshi). Therefore, you can buy almost any amount of Bitcoin you want.
How to buy currency?
Originally, the idea of Bitcoin was to download the software and run a self-version of it, and “mine” new Bitcoin coins yourself. Each was his own banker, in the idea of ”self-sovereignty.”
In practice, however, it is too cumbersome – and expensive – for most people. The most common way to buy Bitcoin is through a crypto exchange like Coinbase or Gemini, or mobile exchange software like Robin Hood, PayPal or WeBull.
If you have financial advice, the advisor or consultant may purchase Bitcoin for you or put you in one of the Bitcoin mutual funds. At least in the US, these mutual funds are based on Bitcoin futures contracts, not Bitcoin itself. There are some Bitcoin mutual funds traded outside the US.
Stock exchanges and other brokers sometimes act as money keepers. This means that they are responsible for protecting your account – to some extent. If you allow someone to access your account who is trying to scam for example, this factor may drain your account, probably on a regular basis. In Bitcoin, there is no way to reverse a transaction made fraudulently.
What should be kept?
A lot of things. Because crypto is such a new field, and for the most part has not been subject to regulation or only very light regulation, there are plenty of cases of fraud. The Federal Chamber of Commerce warns investors to beware of opportunities that promise to make a lot of money in the short term, or that seek to recruit other investors, that offer guaranteed money or free money, or contain sky-high promises but include few details.
In general, it is best to stay away from any investment offer made through social networks, especially if they reach you. I keep getting emails from readers who have not heeded this warning and Romo. And do your research on any investment manager or offer. If you are not able to learn enough and feel comfortable, move on.
How to make money?
Buying Bitcoin is not like buying a stock or a bond. When you hold Bitcoin, you do not hold part of a company. Make money from Bitcoin in one way: by selling it to someone else for more money than you bought it.
There is one evolving part of the crypto market called defi, short for distributed finance. These are bank-like services that allow you to lend or borrow money against your crypto holdings. If you borrow money, you can earn interest rates ranging from 5% to 20%. If you are a borrower, you can take the crypto loan and invest it elsewhere in the market, again, hoping to sell for more than you bought it.
However, defi is a new field, with almost no business standard. Almost once a week, there is a loss of funds. Very often, a badwill encoder finds damage in the defi software and empties the accounts. Sometimes, bad software crashes and deletes transaction history. Sometimes, the platforms were founded just to steal money (a practice known as “pulling the rug”). Research firm Elliptic estimates that by 2021, about $ 10 billion will be lost on defi platforms. This is an environment where buyers need to be careful.
Eventually, it is possible to make profits in crypto, but know that you are putting money into an area that is mostly unregulated and has a lot of opaque and volatile corners. Billionaire hedge fund manager Paul Tudor Jones realized this when he entered the market, calling Bitcoin “big speculation.” That’s about the best description I’ve heard.
Cryptocurrencies: Digital coins used to transfer money between computers of users with minimal fees.
Blockchain: The simple and accessible notebook for the public that underlies the currency. When a Bitcoin owner transfers a currency to another person, he or she displays the transfer in a blockchain, and signs it in a unique sequence of numbers and letters. Even financial companies that doubt Bitcoin and other cryptocurrencies have adopted blockchain technology on their own.
Miners: Bitcoin “miners” validate transactions by entering numbers into formulas run by powerful computers.
Satoshi: One of the units that are one part of the hundred million that make up each bitcoin. Also, the first name of the man who allegedly invented bitcoin, the mysterious Satoshi Nakamoto.
Defi: Abbreviation of decentralized finance, or banking services that allow investors to lend or borrow money against their bitcoin holdings.
Want to learn more? Dozens of books have been written about the way cryptocurrencies began. Some are very technical, some were written especially for amateurs. Read as much as you can afford in terms of time and money. Among the best: “Digital Gold” by Nathaniel Popper; “The Kings of Crypto” by John Jeff Roberts; “The Infinite Machine” by Camilla Russo