Should I invest in cryptocurrency? For dummies (like me).

*please note this is a rapidly changing field and this article was published on 06/05/2017

Thinking of jumping onto the Bitcoin bandwagon?

A Concise Summary of The Blockchain Concept

  • Decentralised, Peer-to peer cryptocurrency i.e. a digital currency that does not need to be verified somewhere central such as a bank or other third party (eg. Paypal). Instead the payment is verified by a global peer-to-peer network (everybody who uses the system). The technology underlying this is known as Blockchain, the implications of which are tantamount.
  • Bitcoins come from ‘mining’ – some users put their computers to work, verifying transactions in the peer-to-peer network. This keeps the system running and users are rewarded with new coins, proportional to the amount of computing power they donate to the network.
  • There is no central person or authority in charge of Bitcoin, instead various programmers devote their time to developing the open source software and can make changes subject to the approval of a lead developer (currently Gavin Andresen). Individual miners can essentially ‘vote’ on new changes with their processing power and it is in their best interests to only accept changes that benefit the system in the long run. This makes it harder for any one person to manipulate the system.

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PROS OF DIGITAL CURRENCY

  • Reduced government control and freedom to purchase what you want : governments cannot freeze someone’s account, thus users currently have more freedom to do as they please with their money.
  • Currently no taxation : Bitcoins are traded anonymously and cannot be intercepted by a third party.
  • Privacy : only you have access to all your wallet address, meaning no one else can see how many coins you have in total (third parties could have access to financial data in our current system).
  • Lower transaction costs : since the burden of transaction costs is shared by everyone in the global community, the cost becomes negligible. Transactions are also much faster and don’t need to wait for third party approval.
  • No payment fraud : only the new owner can change ownership of the coins, ensuring less risk is involved. They cannot easily be counterfeited.
  • Harder to physically steal : stealing bitcoin requires access to the user’s computer or backup files, then the thief must send the coins to their own address.
  • No government inflation : A finite number of coins can be mined
  • Reduced identity theft: credit cards work on a ‘pull’ basis where the store initiates the payment and then pulls money from your account. Bitcoins use a ‘push’ mechanism that allows the holder to send exactly what they want, with no further information. The digital wallets also do not require names.
  • Wider access than banks : there are around 2.2 billion people with internet and mobile phone access who don’t have access to conventional exchange systems. A good example of a country adopting this new currency is Kenya.

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CONS OF DIGITAL CURRENCY

  • Financing illegal or immoral activities : due to its anonymity bitcoin’s reputation suffers from those who use the currency for money laundering or purchasing illegal products.
  • Need for increased regulation : the currency is currently subject to little bureaucracy, however it is possible that stricter regulation will be introduced in future and that this could negatively impact its value.
  • High risk of loss : there is no safety net or perfect way to protect your coins from human error (forgetting your password for example) – there is no customer service you can call for help, the coins will be lost.
  • Lack of security : currently the software is subject to technical glitches, such as hard drive failure and viruses. So far around 18 out of 40 online exchange platforms have gone out of business, with only 6 agreeing to reimburse customers. The median lifespan of an exchange (where you trade fiat for bitcoin) is 381 days, with 30% chance that a new exchange will close within a year of opening. The best way to avoid this is to store your coins on your own computer using software such as Mist or Exodus. Then backup your files onto a memory stick.
  • Limited scaling : the design of the system currently limits the speed and number of transactions processed.
  • Lack of applications : to be truly disruptive to existing fiat currencies (paper money), Bitcoin still needs improved liquidity, applications for low cost international transfers, the creation of complex electronic contracts, or use in kick-starter style fundraising campaigns. It also needs to start being adopted and used by a wider range of people.
  • Volatility : bitcoins have been 7.5 times as volatile as gold. Therefore they are not currently an ideal exchange system for buyers or sellers, limiting bitcoins as a significant vehicle for business. Speculation drives this volatility, with evidence to suggest that around ¾ of mined coins are hoarded, waiting for prices to rise (HODL).

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BITCOIN VS ETHEREUM

  • Ethereum is like an updated version of bitcoin. Etherereum was crowd funded whilst Bitcoin was released early and early miners own most of the coins that will ever be mined.
  • Etherereum is more secure.
  • Etherereum has faster transaction times at the moment. Its block time is set to 14-15 seconds as opposed to bitcoin’s 10 minutes.
  • Ethereum has a different economic model – bitcoin block rewards (rewards received for confirming transactions) halve every 4 years whilst Ethereum releases the same amount every year, ad infinitum.
  • Etherereum has its own Turning complete internal code, which Bitcoin does not. This means that given enough computing power and time, anything can be calculated.

CONCLUSION

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An investment in Bitcoin seems to be make or break – SecondMarket CEO Barry Silbert said ‘there will either be a total loss of principle, or a very very high return’ i.e. it’s all or nothing. The governments of China and France have issued public advisories to warn against potential risks in Bitcoins, and the government of India is expected to make a similar warning.

There is certainly demand for a suitable virtual currency in the Digital Age, however whether or not this is cryptocurrency, remains to be seen. As with any type of investment – limit your risks, remain informed and never put all your eggs in one basket.

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