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Bitcoin and other forms of cryptocurrency have taken over financial news media the past several months. First for soaring up from $1,000 at the start of 2017 to over $19,000 at the close, and now for crashing back down over 50% so far in 2018. A volatile investment with the potential of making one rich always turns heads. But what is Bitcoin? Can it really replace traditional currency? And does it deserve a place in your investment portfolio? To answer these questions and everything you need to know about cryptocurrency, I went to an expert.
Meet my good friend, Cyber Fish! (Is anyone surprised that an expert in Bitcoin and cryptocurrency wants to remain anonymous? It goes with the territory, I guess!) Cyber Fish and I have been friends for years, and he has worked with Washington think tanks, major universities, and now a large tech company on cybersecurity. His work focuses on how malware and other viruses develop in the “dark web”, so he runs into Bitcoin and other cryptocurrencies on a regular basis. Here is what he had to say to we beginners!
The Basics of Bitcoin (and Other Cryptocurrencies)
What is blockchain and how does it play a role in the development of cryptocurrency?
Cyber Fish: The blockchain is a shared list of everyone’s actions, broken up into little byte size chunks. If I exchange currency with someone, that transaction is recorded in this shared list. After enough transactions, one byte-size chunk is full and it’s time to start filling the next one. Like links in a chain, each of these chunks is tied together.
What ties these chunks together are essentially a math problem. Solving these hard problems is one of the ways new currency is generated. Each time the right answer is found for a new problem, a small amount of currency is generated. Solving these problems is known as “mining.”
Solving these problems also has another use. It is a way to verify that two parties have actually exchanged currency or completed some action. As such, blockchain is not unique to Bitcoin or other cryptocurrencies. It can be used to accurately track large amounts of data in numerous domains.
Cyber Fish: Cryptocurrencies offer the potential for anonymity in transactions (though this varies with different currencies) and the opportunity for communities to make their own rules around monetary policy. It’s not necessarily an alternative to traditional fiat currencies but a compliment for people who prioritize privacy or want more of a voice in how the currency they’re using is governed.
Alright, so you could get more privacy. But isn’t that why cryptocurrency is so often used for very nefarious purposes like sex trafficking and cyber-crime? Is there any way for the system to crack down on this in the future?
Cyber Fish: There isn’t really a “system” to crack down on anything. As a distributed currency [no central governing body], the only real governance comes from choices the developers make around the protocol. Cracking down takes place through a lot of old-fashioned (and some new-fangled) law enforcement work to target exactly those activities, whether the criminals are using cryptocurrency or not.
Currencies or jurisdictions that provide anonymity or privacy are a boon for things good (free speech activists and those who want to transact without involving a small set of nosy payment processors) and bad (human trafficking, drug trade, etc.). That isn’t really a feature that can be fixed.
Some sources say cryptocurrency is a better alternative to traditional currency because there is a permanently limited supply. Why can’t the creators of Bitcoin, or other currencies, just create more Bitcoin?
Cyber Fish: Bitcoin is a cryptographic protocol, essentially a set of rules that computers interact with. The way this protocol is designed, there is a finite amount of currency (21 million Bitcoin) that will ever be generated. Because Bitcoin is just software, its users could rewrite it and allow more currency to be created but that would create a new version of Bitcoin, incompatible with the original. People could then choose to use one or both Bitcoin versions.
While the Bitcoin protocol has a finite supply but there’s nothing to stop people from creating new currencies. Part of what drives Bitcoin’s valuation is the relative scarcity of new Bitcoin but there are tons of other currencies including Monero, Cardano, Ethereum, Tether, Siacoin, Lisk, Qtum, Bytecoin, and many others.
Bitcoin, Ether, Dash, and All the Types of Cryptocurrency
We’ve all heard of Bitcoin, but it seems like there are actually over 1,300 types of cryptocurrency in existence today. How many are actually used and have value? How many currencies could actually be in functional, daily use at one time?
Cyber Fish: As of today (27JAN18), there are 35 currencies with more than $1 billion total USD in circulation. There’s no theoretical limit to how many currencies can exist at once, it’s limited only by the market’s tolerance for diversity and people’s ingenuity in coming up with new ways to implement a currency. Coinmarketcap.com lists 1,494 different cryptocurrencies.
How can Bitcoin remain the leading cryptocurrency in an ultra-competitive market? Is there anything that stops it from becoming like MySpace or AOL – an early mover and market changer, but ultimately something that gets overshadowed?
Cyber Fish: There are a variety of markets to exchange between cryptocurrencies, so there’s not much lock-in for people who hold Bitcoin. The difference comes for those who mine Bitcoin. Different cryptocurrencies are optimized for different types of proof of work problems and so buying incredibly specialized (and expensive) hardware to mine Bitcoin might not help you mine Ethereum or other currencies.
Because these currencies are essentially software, they can also be changed to create new versions (also known as forks). Bitcoin has been forked several times, each time creating a parallel but slightly different currency based on a new branch of the blockchain. While most of these forks have faded from use, one (Bitcoin Cash) remains in wide use.
What if any cryptocurrency looks like the next big mover? Are there any differences in technology that make one different from the other?
Cyber Fish: Litecoin and Monero are picking up a lot of bitcoin refugees. You can start to tell what’s popular, in part, by what cybercriminals try to steal. Some groups have even switched strategies, moving from extortion plays to packaging cryptocurrency mining software with malware and trying to infect unwitting victims. Some currencies have yet to rival the size of Bitcoin but are technically much better designed. One example is ZCash, whose founding group includes a prominent cryptography professor at Johns Hopkins University.
The Risks of Cryptocurrency
If you own cryptocurrency, is it safe? What are the chances of a currency with no government backing being stolen?
Cyber Fish: Well, the issue isn’t government involvement – people steal currencies with government backing all the time from the old Jesse James and outlaw gangs pillaging banks in the wild West to someone (North Korea?) stealing money from the banking network, called SWIFT, used by most major financial institutions.
Bitcoin, like some other cryptocurrencies, is held as a digital file called a wallet. These wallets, like banking information or credit card data, are stolen all the time. People have also broken into the digital exchanges people use to swap bitcoin and other cryptocurrencies for fiat money like US dollars.
Owning cryptocurrency requires you to be just as careful with that digital information as your personal data. Storing wallets on phones or other easy to access devices can seem attractive but presents a juicy target for criminals. The safest thing to do is store your cryptocurrencies on a USB stick or other storage device that isn’t connected to a computer until you need it.
How could a rise in cryptocurrency impact traditional foreign currencies? Could global standard currencies like the U.S. Dollar or the Euro be devalued?
Cyber Fish: It is unlikely that Bitcoin or another form of cryptocurrency becomes a serious reserve currency. [A reserve currency is a stable currency that countries and large banks use to store assets.] Given the way even the largest cryptocurrency’s value fluctuates, it would be hard to treat as any kind of benchmark. Much of any cryptocurrency’s value is still in how it can be exchanged for traditional currency.
But are governments preparing in any way for the rise of cryptocurrency? What developments would banks have to undertake to be able to handle this new kind of money?
Cyber Fish: Some governments are. The last year or two has seen a major spike in regulations, though these often run the gamut. Japan and the United States have been trying to regulate exchanges and facilitate cryptocurrencies as a medium of exchange for regular transactions. Other countries, like China, have moved to ban mining and exchanges outright, though the moves may be more about controlling major price fluctuations and bubbles.
With no governing body, it seems like cryptocurrency only works if everyone plays by the same rules. What effect could there be if large corporations or countries start hoarding computing power? Could they dictate cryptocurrency valuations as they see fit?
Cyber Fish: Cryptocurrencies split and evolve constantly. Some have their changes dictated by a small group of designers, while others are subject to various forms of majority rule. A concentration of computer power, and what kinds of power matter most, depends on the currency.
So, let’s say mining capacity can influence the behavior of cryptocurrencies, even if not through changes to the currency’s design. In Bitcoin, for instance, the majority of mining is done in China; one Bejing based company, Bitmain, controls 30% of all mining in the blockchain. In fact, it was the influence of these Chinese based miners that drove one of the most successful forks in Bitcoin, creating Bitcoin Cash. [Forks are when a type of cryptocurrency splits and creates a new type, related but incompatible with the original.] Centralized power can create splits and valuation changes, but not always in ways that are easy to predict.
Should You Invest in Cryptocurrency?
Cyber Fish did his best to simplify some of the more difficult questions one faces when they look at cryptocurrency. But, unless I’m the only one, it was still confusing. This is a new field that is developing rapidly. It also faces what professional investors call “stroke of the pen” risk, in which any cryptocurrency’s value could be slashed by a major government changing the rules for its expected use on their soil.
These factors mean that the price of any cryptocurrency, even Bitcoin as the largest, is massively volatile. It isn’t uncommon for its value to jump or fall 20% or more in a day. And while some people may look at this uncertainty as a way to make the big bucks, it comes with incredible risk. For most people, it doesn’t belong in their portfolio.
Cryptocurrency is confusing. And it should be. It is still in its infancy and its long-term usefulness is still unclear. That makes it almost impossible to value. Choosing to buy now is more speculating than investing.Click To Tweet
If you are interested in investing in cryptocurrency, I recommend you follow one simple rule. Don’t invest in things you don’t understand. Cryptocurrency is confusing. And it should be. It is still in its infancy and its long-term usefulness is still unclear. That makes it almost impossible to value. Choosing to buy now is more speculating than investing.
Personally, I don’t own any cryptocurrency. Cyber Fish doesn’t either. I choose to invest with a simple strategy of low-cost mutual funds where I know that if I invest for the long-term, I won’t end up broke. I don’t have that confidence when it comes to Bitcoin.
What You Need to Know About Cryptocurrency
Even if cryptocurrency isn’t a smart investment for the average investor, it doesn’t mean you should completely ignore it. The technology at play, particularly blockchain, is fascinating and important. It could change how businesses function by making data more reliable and easier to track. And the realities of cryptocurrency could impact how we handle our personal data and finances online. (Hint: We all need to be careful!) So, keep an eye on the headlines as an interested citizen. And stick to your reliable, risk-appropriate, simple investment strategy!
What other questions do you have about cryptocurrency and Bitcoin? Do you own any cryptocurrency today? If so, how did you get comfortable with the risk? Drop a note in the comments with your thoughts!
This post was proofread by Grammarly.
Hi, I’m Chelsea! I’m the founder of Mama Fish Saves and I’m almost embarrassingly passionate about reducing money stress for moms. As an ex-hedge fund investor, I’m an investment pro. I’m also a certified National Financial Education Instructor, mom to two hilarious young boys, and wife to my amazing husband (who’s a stay-at-home dad!). Let’s do great things together!