Often, I get this query, and I always wonder whether to start explaining the whole process or first give a warning that this is quite a risky venture not meant for the faint-hearted.
Bitcoin is on the lip of literally any person who occasionally goes online. It is a technology that has stirred emotions and debate online given that recently the Bitcoin price ballooned to Usd20k and then shivered to less than Usd8k in less than two months. I take calculated moves when introducing the matter to anyone interested, most of them close allies or relatives who can burn my house if things go belly up. (laugh).
You are only as smart as the knowledge you have. It is always good to take a few minutes to read well about any investment including cryptocurrencies before committing your capital. You can get all you need to know on www.financialmatters.co.ke
In the paragraphs below, I try to explain in simple terms what this new investment is all about.
The popular bitcoin is just one of the crypto/digital/virtual currencies. Others include Ethereum, Ripple, Neo, Salt among many others, counting over 1500 at the time of writing this blog.
Why create a digital currency?
To understand the need for a cryptocurrency, we have to look at the motivation of their introduction. Bitcoin and other cryptos were born due to the shortcomings in the mainstream financial mechanisms e.g. the 1930 recession and the 2008 housing bubble crash.
Traditionally whenever there have been financial crisis, people have always moved money from volatile investments like paper currencies, stock markets, index funds, money markets etc. to gold. Gold has been and still is a standard preserver of wealth, albeit on a conservative level today.
For a common guy like you and me, how close are we to possessing this rare commodity? The 2008 crash prompted the need for another form of ‘gold’, a wealth preserver that can equally store wealth, unaffected by volatility, and whose value cannot be controlled by any government or central body.
The new ‘gold’ had to go beyond national boundaries. Well, thanks to the noble invention called “internet”, we already have a communication tool that enables us to communicate and also a platform where we can store all kinds of digital data and assets.
Riding on internet technologies, a group of cryptographers operating under the pseudonym “Satoshi Nakamoto” created an open source algorithm upon which anyone can create a digital coin and use it for transactions.
One may ask who exactly is Satoshi Nakamoto? I don’t know who it is or who they are. The same reason we enjoy Coca Cola but will never know who has the magic formula. I guess it’s for his/her/their own security reasons that we do not know them.
What is this Bitcoin or Cryptocurrency?
Bitcoin is a peer to peer system that enables digital money to be sent between two users without the oversight of a central authority, such as a bank, a government or payment gateway.
It is created through a process called mining and held electronically in digital wallets. Bitcoins are held in electronic devises such computers and mobile phones and aren’t printed, like shillings or euros.
Cryptocurrency serve two purposes; one, as a currency for use in day today transactions and two as a store of value.
As a day to day currency
If you are a tourist travelling to California from the rest of the world, you need to convert your local currency into dollars so that you may use them in your new destination. If you owned Bitcoins, you would not really need to convert them into USD as you can use them as is in places where they are accepted.
Some online merchants such as amazon have partnered to enable customers purchase items using Bitcoins.
As a store of Value.
At current valuations, Bitcoins market capitalization is USD70B, Ethereum stands at USD30B and other cryptocurrencies at about USD10B. This value is the accepted value that investors are tapping into.
Since inception, someone who bought Bitcoins worth usd1 would be walking around with USD5000, at the recent highest capitalization.
Since bitcoins are tradable peer to peer, one can sell them at any time and unlock the value without excessive regulation and red tape.
What are the main characteristics of Bitcoin and cryptocurrencies?
1 – Decentralization
Governments are snoopy. They poke their noses in everyone’s business in the guise of preventing money laundering. Bitcoin’s is decentralized. No one controls the bitcoin network. It is maintened by a group of volunteer coders who run an open network of open source software on computers spread around the world. This therefore attracts individuals and unfortunately unlawful groups too that are uncomfortable with control that banks or government institutions can exert over their money.
2 – Limited supply
Fiat money refers to currency that a government has declared to be legal tender, and it is not backed by a physical commodity such as gold. Fiat currencies (dollars, euros, yen, etc.) have an unlimited supply – central banks can issue as much as they want, and always manipulates its value relative to others by holding or releasing their FX reserves as needed. Hapless holders of the currency have little control over what happens to the money as was seen in Zimbabwe and Venezuela in recent memory.
With Bitcoin and some other cryptos, supply is tightly controlled by the underlying software. There is a finite number of bitcoins that will ever be in circulation and that number has been set at 21million. After the last coin is mined, computing power will be rewarded through miners’ fees. A small number of new bitcoins blocks trickle out of digital mines every hour, and will continue to do so at a diminishing rate until the maximum has been reached. This in effect makes bitcoin more attractive as an asset – if demand grows and the supply remains relatively subdued, the value will multiply.
3 – Semi- anonymity
Users of bitcoin in theory operate in semi-anonymity, while senders of traditional currency must be identified to comply with anti-money laundering and other government legislation. Since there is no central “validator,” and users are operating at peer to peer level, they do not need to identify themselves when sending bitcoin to one another.
The Bitcoin protocol checks all previous transactions to confirm that the sender has the necessary bitcoin as well as the authority to send them electronically when a request is submitted and it does not need to know the person’s identity.
However, each user can be identified by the address of their wallets. Law enforcers can track transactions and users with some effort by using these wallet addresses if necessary.
4 – Immutability
Bitcoin transactions cannot be reversed normally, unlike electronic fiat transactions because there is no central “authority” that can say “ok, reverse the transaction.” If a transaction is recorded on the network, it is not possible to modify except through a hard fork process (change in code) by the network administrators. This means that transactions on the bitcoin network are tamper proof.
5 – Cost and time.
Users of cryptocurrency have touted transactions to be cheaper and much more cost effective than traditional money transfers. While it takes some banks and money services more than five days to transfer money internationally, it takes a second using crypto.
6 – Divisibility
The smallest unit of a bitcoin called a Satoshi is one hundred millionth of a bitcoin (0.00000001) – at today’s prices, about one hundredth of a US dollar cent. This could conceivably enable microtransactions that was not possible with traditional electronic money.
The world over, different countries are at different evolution levels as pertains Bitcoin and its related alt-coins. Although no country has banned its use, regulators are struggling to understand the implication of their use both legally and illegally. This is driving regulation and different actions in different countries.
Since cryptocurrencies are open source and not owned by any one individual or any one country, it will be impossible to shut this technology down by any one government. More or less, we will see regulations spring from all over the world to regulate the safe use of these digital currencies.