Have you been following the price action in Bitcoin lately?
It’s been hard to ignore.
Bitcoin is hardly the only cryptocurrency, but it is the most popular and has become something of a bellwether.
The price of a single Bitcoin rose from just under $1,000 at the beginning of 2017 to nearly $20,000 by the end of the year.
More recently the price has been staying well below $10,000.
And, while Bitcoin has been stealing all the headlines, it’s major competitor, Ethereum, has actually experienced even more dramatic price swings, though at much lower levels.
After trading for just pennies in 2015, the price boosted an all-time high over $1,400 early this year.
That’s a wild ride, but it’s the kind of price action that gets your attention. It’s certainly gotten mine.
Up until a couple of months ago I mostly ignored Bitcoin.
But it’s recent popularity, as evidenced by the incredible price run-up, is making me wonder if it’s time to become a believer in cryptocurrency, as a whole.
But, before we get too caught up in price swings, let’s talk about some basics.
What is Bitcoin?
Bitcoin (BTC) is the largest and best known of the many cryptocurrencies.
In theory, it’s a currency – or at least it’s supposed to be.
I say in theory, because it isn’t an acceptable method of payment in most places. It may have been intended as a currency, but right now it’s functioning more as a very speculative investment.
Bitcoin is a digital currency released as open source software in 2009.
It was created by software developer Satoshi Nakamoto. Curiously, Nakamoto isn’t even a real guy. The name is a pseudonym for someone who prefers to remain anonymous.
The basic characteristics of Bitcoin are that it only exists on the Internet, is not issued by any government or central bank, and is limited to just 21 million units. However, each of those units can be divided into 100 million Satoshi.
The total amount of Satoshi that can be potentially created is – get this – 2.1 zillion – if you can imagine a number that large.
Here is the Bitcoin price history from early 2013 through the spring of 2018:
In this article, I’m going to discuss cryptocurrencies in general, but Bitcoin in particular.
It’s by far the most important cryptocurrency, and the one is getting all the attention – at least for now.
But there are other cryptocurrencies as well (over 1,600 now!), and we might want to keep an eye on them (well… a handful, perhaps).
What is Ethereum?
Ethereum is the second biggest cryptocurrency currently.
Its development is a bit more complicated.
It got started in Switzerland in 2015, but has since split into two separate blockchains (we’ll discuss blockchains and a little bit – trust me, this stuff is complicated!).
We now have Ethereum (ETH) and Ethereum Classic (ETC), which continues as the original.
Ethereum hasn’t gained nearly the level of acceptance or investor interest that Bitcoin has. That doesn’t make it any less important. The entire cryptocurrency phenomenon is in its infancy and is playing out in real time.
That’s why as much as we want to focus on Bitcoin, the other crypto’s can’t be ignored. The entire conglomeration has only been in existence for a few short years.
What’s more, prices for both Bitcoin and Ethereum only began to take off late in 2016.
In fact, most of the price action took place in 2017.
Here is the Ethereum price history from August 2015 to the spring of 2018:
You can see how it compares to Bitcoin, lined in orange.
We’re not going to spend any time on other singular cryptocurrencies, but I do want you to know that they’re out there.
And at any point in time, any one of them could rise up and become the dominant cryptocurrency.
The whole cryptocurrency movement is happening very quickly, and even unpredictably.
Much as it was in the early days of the Internet, it’s hard to predict who the long-term winners will be based on the current alignment.
Some of the other major cryptocurrencies include Ripple, Litecoin, Cardano, Stellar, IOTA, and more. It’s a safe bet that more will be rolled out going forward.
Meanwhile, governments are looking to roll out their own cryptocurrencies. It may be that they’re waiting to see how Bitcoin, Ethereum and the other assorted cryptocurrencies work out before formally launching their own versions.
How Cryptocurrencies Work
This stuff is incredibly complicated and I certainly don’t claim to be an expert.
But I want to do a high-altitude discussion of the mechanics of cryptocurrencies.
I’m going to try and make it simple, though I’m not sure that’s even possible. If you’re not interested in how cryptocurrencies work – and you just want to accept that they exist and go from there – feel free to skip over this section (I would if I were you!).
This is the “nuts and bolts” that cryptocurrencies are built on, including Bitcoin.
It’s a chain of information registration and distribution that’s operated by cryptocurrency participants. Once again, there’s no government, central bank, private bank or corporation operating behind the scenes, and making it all work.
Blockchain is quite literally a series of transactions between individuals and their computers.
In fact, one of the primary attractions of cryptocurrencies is the fact that they don’t pass through banks and other financial institutions. They literally operate between individual users.
Private Key. This is a unique code that contains encrypted details about each individual Bitcoin, including its ownership. The private key enables the owner to engage in business transactions without ever revealing his or her identity to other parties.
There are advantages and disadvantages to these anonymous transactions, but we’ll get into those separately.
Transactions are authorized by the blockchain networks application and maintenance of its protocol.
On a practical level, transactions work very similar to the way they do with other online payment methods, like credit cards, debit cards and PayPal.
The major difference being that the transactions are directly between buyer and seller, and never pass through an intermediary.
Are your eyes glazing over yet?
“Mining” is the process by which Bitcoin comes into existence.
As I said earlier, no more than 21 million Bitcoin can ever be produced. “Miners” are the people who enable that production to happen. They get a reward of Bitcoins (or a percentage of) when they successfully create a “hash”.
Let me explain…
Within the Bitcoin network are individuals and businesses who keep records of the transactions. All transactions are collected for a given period of time, onto a list, which is known as a “block”. This is where the blockchain comes into play.
In order to verify the activity, an updated copy of the block is given to everyone who participated in it. The miners then take each block and apply a mathematical formula to it.
This creates a short, random sequence of letters and numbers – the hash.
The hash is stored at the end of the blockchain, and then each block is sealed off.
That’s when the miner receives his or her reward of Bitcoin, inching the total closer to the ultimate maximum of 21 million.
The miners use software written specifically to mine blocks. The reward provides an incentive for minors to continue to perform their function, and increase the number of Bitcoin.
That at least is my interpretation of how the process works. I’m pretty sure it’s actually more complicated than that. But I think you have to be a cryptocurrency insider to really understand how it works.
This explanation will work for our purposes. I don’t want to beat this discussion to death because I really don’t understand the process myself.
If there any cryptocurrency experts reading this article, feel free to jump in – please?
The Advantages of Bitcoin (And Cryptocurrencies, in General)
Apart from the recent profit potential of cryptocurrencies, they actually do have certain core qualities that all but guarantee they have a future.
There are even opinions that cryptocurrencies, or at least blockchain technology, will be as revolutionary as the Internet.
But closer to the ground, here’s what gets people excited about cryptocurrencies…
Privacy. This is one of those cherished qualities that’s just about disappeared in 21st Century. Since most transactions happen online now, somebody somewhere knows everything you do with your money.
It’s making at least some people uncomfortable and is one of the forces driving cryptocurrencies.
Privacy comes about as a result of the ability to conduct financial transactions without providing any information that identifies you personally. It’s an invisible medium of exchange, much like cash – except that you can use it to make online transactions.
Cryptocurrencies can be as easy to use as credit cards. Because they exist online, you can use them to make financial transactions the same way you do with credit cards and debit cards.su
No chargeback capacity. This is another feature of Bitcoin that appeals to merchants. Anytime you make a purchase with a credit or debit card, you can charge it back if for any reason you’re not satisfied with the transaction.
In most cases, the card issuer will take your side against the merchant.
But with Bitcoin, every purchase is final.
You can always dispute the transaction with the merchant, but it’s never an automatic process.
The Disadvantages of cryptocurrencies
The privacy factor will certainly appeal to anybody who considers it important. And it’s definitely easy to see why merchants will like cryptocurrencies. But they do have disadvantages.
No chargeback capability. While this is a welcome feature for merchants, it could be a nightmare for consumers.
How confident will we be making online purchases if that ability doesn’t exist?
This will be an even bigger problem with international transactions since legal recourse will be nonexistent.
Privacy breeds unsavory activity. That includes the potential for criminal activity. cryptocurrencies, being virtually invisible, can become a preferred payment method by criminal elements.
It might also make it easier for unscrupulous merchants and businesspeople to scam consumers. It remains to be seen how that will be worked out.
Bitcoin can be lost. That sounds strange, considering that it’s a cyber currency, and nothing like change in your pocket. But, yes, cryptocurrency can be lost.
Since they are stored on your computer’s hard drive, they can be lost if the drive becomes corrupted. There are online services where cryptocurrencies can be stored, but the security protocols vary from one site to another.
If a service gets hacked, any crypto’s stored there can be lost or stolen.
Lack of general acceptance. At the moment, Bitcoin seems to be more of an investment phenomenon than a medium of exchange.
While the number of merchants and businesses that are accepting the currency is growing, it’s still just a tiny fraction of all the businesses in existence.
Right now, you can’t go down to a gas station and pay for a fill using Bitcoin. That may work itself out in time, but we’re not even close to that point.
But there’s an even bigger threat to all cryptocurrencies, including Bitcoin.
Government Restrictions – the Big X Factor Hanging Over cryptocurrencies
Governments are already aware of the potential use of cryptocurrencies by criminals.
They can also be used in income tax evasion.
The IRS is well aware of that and is using summonses and software to identify cryptocurrency users. They’re forcing cryptocurrency exchanges to provide lists of both users and transactions.
Will that happen? No one knows.
But it’s important to be aware of the potential so that you don’t go out and load up on cryptocurrencies, thinking nothing can stop them.
How Widespread is Bitcoin?
We could ask this question about all cryptocurrencies, but let’s keep it focused on Bitcoin since it’s the largest.
I said earlier that one of the negatives with cryptocurrencies is that they lack general acceptance.
That’s true, but it’s also changing fast.
The big news early in 2017 was that the government of Japan approved Bitcoin as legal tender in that country.
That was a major advance for Bitcoin since Japan is the third largest economy in the world.
And as a result of that decision, 20,000 stores across the country are now accepting it. If other countries do the same, that will move the entire cryptocurrency shift into high gear.
Here in the US, there are already hundreds of businesses large and small that accept Bitcoin.
Some of the more recognizable names include:
- Whole Foods
- Etsy vendors
- Dish Network
That may not seem like a long list of merchants, but we have to remember that cryptocurrencies only came into existence in 2009.
I’m thinking that the level of acceptance of Bitcoin in the US and around the world is what will really determine its future.
If Bitcoin becomes widely accepted for practical use, it will have truly “arrived”, even if the price speculation dies off.
Scams and Risks of Buying cryptocurrencies
This is probably an inherent risk of any new or speculative boom.
At the core, there’s legitimate money to be made.
But that core is always surrounded by scams.
Unfortunately, people who expect to make big money quickly are targets for scams. And with something as new as cryptocurrencies, it can be hard for anybody to separate scams from legitimate activity.
The cryptocurrency universe has already developed more than its share of scams.
Bitcoin itself recently reported cryptocurrency scams are running $9 million per day. They reported a long list of specific scams that took place just in the first two months of 2018:
Common Cryptocurrency Scams
Ethereum World News issued a list of 7 common cryptocurrency scams:
Twitter frauds. Bogus post tweets proclaiming a giveaway. Send one cryptocurrency unit, you’ll get back 10. But you won’t get anything back.
Market manipulation. A person or business with deep pockets runs up the price of the cryptocurrency. As others buy-in, the manipulators sell off, making a large profit before the price falls to its natural level.
Fake buy/sell walls. Fake charts are created indicating a fake wall (which is a charting term). As the chart circulates, investors get panicky and sell. Scammers then buy the cryptocurrency at lower prices.
Pump and dumps. A group purchases a single cryptocurrency, running up the price. When it reaches a certain price level, the group sells out. It creates a manufactured price rise, where only the insiders can win.
Paid promotion. This is where a famous or influential person is paid a fee to promote a cryptocurrency. That can raise the price on little more than the star power of the influencer. Sometimes it can even be done through group forums on Reddit and Facebook.
Shady/shoddy exchanges. With cryptocurrency being so new, not all the exchanges are legitimate. Some are vulnerable to hacks, or have security flaws. It’s risky to keep your cryptocurrencies on these exchanges. The better option is using a wallet to hold your coins. Two wallets to consider are Trezor and Ledger Wallet.
Phishing attacks. A phisher purchases domains and Google ads that match popular exchanges. They can be indistinguishable from the real ones. But they direct you to the real exchange, where you enter your credentials. The phisher then has access to your legitimate account, and cleans it out.
How to Buy cryptocurrency and Bitcoin and Ethereum
I’m saying “buy” because I’m not certain cryptocurrencies qualify as a true investment, at least not yet.
It can be purchased on cryptocurrency exchanges, and there are several now available.
You can purchase cryptocurrencies on the exchanges using a credit or debit card, or with a linked bank account.
Each time you buy or sell cryptocurrency on an exchange, there’s a small fee going in each direction.
For example, below are the rates charged by Coinbase in the US (there’s a different fee structure for each country):
You may also be able to purchase cryptocurrencies directly from private owners.
Storing Your cryptocurrencies
Technically speaking, cryptocurrencies aren’t actually stored.
Remember the public and private keys we talked about earlier? Those are what you actually store.
They’re digital keys that are used to access your public Bitcoin address, and to sign transactions.
It’s that information that needs to be stored, not the cryptocurrency itself.
Storage takes place in one of three places, generally referred to as “wallets”:
- Online web-based services
- Software wallets held on the hard drive of your computer
- Vault services that hold the currencies off-line
Software wallets might be the most convenient since they’re held on your own computer. But they’re also inherently insecure.
They’re subject to all of the same threats your computer is.
Examples of software wallets include Electrum, Exodus, Bitcoin Core, Copay and Armory.
As far as offline vault services, they’re often available with cryptocurrency exchanges.
For example, Coinbase has vault services for storing Bitcoin, Ethereum and Litecoin.
Security is higher than with software wallets, due to specialized storage capability. Coinbase claims that “98% of digital currency is stored totally offline, in geographically distributed safe deposit boxes and physical vaults.”
Online web-based services are also common with cryptocurrency exchanges, including those listed in this article. Your private keys are stored on a computer controlled by someone else, and connected to the Internet.
One of the big advantages with online wallets is that they can be accessed from anywhere, including smart phones. But one major negative is that control of your private key will be held by the service.
In a way, it’s a form of shared ownership that not everyone is comfortable with.
Cryptocurrency storage is a topic all its own, and I may cover it in a future post.
Other Ways to Invest in Cryptocurrencies
Up to this point at least, investing in cryptocurrencies requires owning it directly.
But that’s starting to change.
As cryptocurrencies, especially Bitcoin, rise in popularity and price, the traditional financial markets are starting to want in.
In December 2017, it was announced that CBOE Global Markets applied with the Securities and Exchange Commission (SEC) to list six Bitcoin related exchange traded funds (ETFs).
If you’d like to invest in Bitcoin through ETF’s, keep an eye out for the following funds:
- First Trust Bitcoin Strategy ETF
- First Trust Inverse Bitcoin Strategy ETF
- REX Bitcoin Strategy ETF
- REX Short Bitcoin Strategy ETF
- GraniteShares Bitcoin ETF
- GraniteShares Short Bitcoin ETF
However, more recently, the whole idea of Bitcoin ETFs has come into question, including the funds listed above (which are still not available!).
At just about the same time, the New York Stock Exchange (NYSE) also made application to the SEC for approval of two ETF’s. Keep an eye open for the arrival of ProShares Bitcoin ETF and the ProShares Short Bitcoin ETF.
The funds will track either the Chicago Board Options Exchange (CBOE) or Chicago Mercantile Exchange (CME) Bitcoin futures, and invest their assets in benchmark futures contracts with the option of investing in contracts outside the benchmark.
It also looks as if banking giant Goldman is setting up a trading desk for cryptocurrency’s, including Bitcoin.
cryptocurrency fever is spreading, and gaining acceptance in the mainstream financial universe. Other financial concerns, like Fidelity and Van Eck, are also working on rolling out cryptocurrency ETF’s.
In time, it may be possible to invest in cryptocurrencies in the very same way that you do stocks and bonds. But in the meantime, holding crypto’s directly is the preferred method.
Is it Time to Get on the Bitcoin Bandwagon?
Even after writing more than 3,000 words on this topic, it’s hard to come to a solid conclusion.
Are we talking about the Bitcoin that ran from under $1,000 on January 1, 2017, all the way up to nearly $20,000 by mid-December 2017? Or the Bitcoin that plunged from $20,000 to below $14,000 in the same month.
Let’s also keep in mind that the $6,000 decline happened in a matter of just a few days.
Or are we talking about the Bitcoin that’s currently trading at under $10,000?
It should be obvious that “investing” in Bitcoin, or any other cryptocurrency, requires a very strong stomach.
That’s hard to resist.
We have to ask ourselves if this kind of price growth is likely to continue…
My answer: I have no idea. And I don’t think anybody does.
Two Investment Scenarios
I can envision two scenarios where you might want to hold cryptocurrencies, Bitcoin in particular:
- You want to begin using cryptocurrencies as a payment method, and/or
- You think that the huge price gains will continue.
If you want to get in for the second reason, it’s probably a good idea to go in with only a very small slice of your portfolio. 5% might get the job done.
If it has gains that are anything like what happened during most of 2017, a 5% position can grow to match the rest of your portfolio in size.
Still, I wouldn’t bet on that outcome.
This thing has all the traits of a speculative boom. It might be worth it to buy in only after price crashes, like what’s happened after December 2017.
And for the record, a similar situation happened in the summer of 2017 when China moved to shut down cryptocurrency exchanges in that country.
I’m not an expert on Bitcoin, Ethereum or any the other cryptocurrencies, so move at your own discretion. The whole cryptocurrency thing seems too new and too sudden to be considered an investment, least of all a predictable one.
From everything I’m reading, the blockchain technology that supports cryptocurrencies may be the real story.
If it does turn out to be as big as the Internet, getting into one or more of those pending ETF’s might turn out to be the best long-term strategy of all.
What do you think?
Do you own Bitcoin, Ethereum or any of the other cryptocurrencies?
Where do you think it’s heading, and how do you think we should play it?