A Basic Intro to Cryptocurrencies for Dummies
We do loads of research here at Nanalyze and we’re always watching the news for new and exciting emerging technologies. Over the past few weeks, we keep noticing in the news that bitcoin is making new highs and now all the pundits are saying insightful things like “proceed with cautious optimism” or gems like “there’s an equal likelihood this thing could go either way”. We’re largely unfamiliar with this space having only briefly touched on what blockchain is. We also took a look at three blockchain companies targeting financial services, though today we see all kinds of blockchain startups popping up. It’s time we take a closer look at what bitcoin is, what cryptocurrencies are, and why we should care about any of this stuff as investors.
What is Bitcoin?
A bitcoin is a digital currency (also called a cryptocurrency) that doesn’t exist in physical form but rather exists in a ledger that is distributed in 1000s of places around the world (also called a blockchain). Bitcoin was released as open-source software around 2009 by some unknown programmers as a digital payment system. There is no central administrator of bitcoins, but instead they are transacted on a peer-to-peer basis between any two individuals. The record keeping for these transactions is kept in a digital ledger called a “blockchain” which is impossible to hack because there are thousands of instances that all talk to each other and keep the entire ledger synchronized. The number of bitcoins in circulation gradually increases over time and at a rate that decreases over time such that eventually the total number of bitcoins in circulation will only ever be 21 million (16.4 million bitcoins are in circulation now).
How to Use Bitcoins
The first thing you’ll need to do is establish some ownership over bitcoins. In order to do so, you’ll need a “bitcoin wallet” which provides a unique address that you can use to identify yourself (just like your email address is used in PayPal). There are quite a few providers of bitcoin wallets as seen below:
Once you have installed a Bitcoin wallet on your computer or mobile phone, you can now obtain bitcoins by accepting them as payment for something or by purchasing them from a friend or one of the many bitcoin exchanges located around the world (like this one). This is where we get into the topic of how much a bitcoin is worth. Right now, a bitcoin is worth $2,530.08 in U.S. dollars as seen below:
You can see in the above price chart why everyone is talking about bitcoin. It’s had a rapid spike in price recently just barely breaching the psychological barrier of $3,000 before dipping sharply. Of course you don’t need to purchase a single coin but rather you can just purchase a fraction of a coin (up to one millionth of a bitcoin). The price of a bitcoin is determined by taking the average of what buyers and sellers are matching their bids for at the moment across different bitcoin exchanges. In order to show ownership of bitcoins, you need to have a “private key” which is a unique set of characters like you see below:
The private key you see above is the most important part of your bitcoin wallet because you need it in order to conduct any transaction with your wallet. You need it to add bitcoins, and you need it to give bitcoins to other people. You can see how this key then becomes something that hackers or any type of bad person would want to get their hands on. If you happen to lose the above key, you lose your bitcoins. Why not just make a copy of the file and store it in multiple places? Well, as we just told you, bad people are looking to get their hands on it. You may actually have malware on your computer that constantly looks for keys like that and when it sees your key, your wallet is suddenly emptied. That’s why you can actually just print out your key just like the example seen below:
Now you can fold up that piece of paper and put it in your wallet. As you can imagine, there are all kinds of offline storage methods that could be used and everyone’s trying to get a piece of that. One other approach is to take your private key file and copy it onto a thumb drive. If you do that then you’d probably want to make sure that the file has been deleted from any other place. The danger of course is that if you lose that thumb drive, you lose your money! This actually happened to a man who chucked his thumb drive into the trash with a private key that controlled 7,500 bitcoins which would be valued today at about $19 million.
How Many Cryptocurrencies Are There?
While bitcoin was the first cryptocurrency that made this form of digital currency known, there can be any number of cryptocurrencies created for any number of reasons. An Investopedia article called “The 6 Most Important Cryptocurrencies Other Than Bitcoin” gives you a hint that there are quite a few already and probably loads more planned. There’s a larger list of cryptocurrencies on Wikipedia that includes currencies like:
- The now defunct Coinye which Kanye West sued into oblivion
- The aptly named Titcoin for the adult industry
- The PotCoin which can be used to buy legal marijuana
It just bears repeating here that you shouldn’t just pile into any cryptocurrency that pops up hoping to fund your retirement. These things will no doubt come and go as time goes on and you don’t have any assurance of who is actually behind these ventures. Backing by any large venture capital firm should give you some assurance but even then there are still lots of risks, not to mention the actual volatility of these currencies. Just imagine what would happen if suddenly something bad happened and nobody wanted to buy your cryptocurrency. It would largely become worthless. This is why you’re best off sticking with the more well known currencies like ethereum or bitcoin if you want to invest in the cryptocurrency market.
A Final Warning
There’s a rather remarkable story on Medium which just shows how easy it is to lose your bitcoins. There was an individual who had $8,000 in cryptocurrencies stored on Coinbase when he received a message on his smartphone from Verizon asking him to call if he “wasn’t on the phone on Verizon”. Of course he wasn’t, and someone was using basic information to take control of his phone. Soon after, he sees an email saying that his Coinbase password has been reset. Shortly afterwards, his bitcoin wallet was drained. Of course it turns out that he broadcasted information that he shouldn’t have which led to this. The first rule of bitcoin is don’t discuss bitcoin.