Following is 4M Performance’s Guide through the world of cryptocurrency and blockchain technology. The Guide was composed as an easily understood yet conclusive reference source.
What is a Cryptocurrency?
A digital (virtual) currency that is secured by cryptography – meaning it is impossible to counterfeit or double-spend. Many cryptocurrencies are based upon blockchain technology – a ledger built by a network of computers.
Cryptocurrencies are NOT issued by any central authority or government making them theoretically immune to government interference or manipulation.
Having said that, think of a cryptocurrency as an asset with a store of value (like a dollar) but unlike dollars, which are in public circulation, cryptos are distributed across a large number of computers. Cryptocurrencies are complicated. They use a ‘one-way hash function’ cryptography (a complex math formula) or, simply put, a one-way digital portal. When data is put through it the cryptography transforms the data into something incredibly unfamiliar from its original state. So unfamiliar that it is impossible to undo by working backwards.
Types of Cryptocurrency
Bitcoin, was the first blockchain-based cryptocurrency and remains the most popular and most valuable. There are literally thousands of alternates to the Bitcoin. Launched in 2009 by an unknown creator known as ‘Satoshi Nakamoto’ the current value of a Bitcoin was $40,033 (closing price as of 1/7/21) with a market value of $743 billion. Total value of all cryptocurrencies, over $1 trillion.
Bitcoins are accepted as currency by many companies (Dell, Microsoft, PayPal to name several). Referred to as a BTC transaction the user provides the seller a signature (a line of security code encrypted with 16 distinct symbols). The transaction is secure because it occurs via a peer-to-peer computer network.
Bitcoins are valued on a market price which is based on supply and demand. There are approx.18 million BTC in existence and their price can fluctuate widely. For example, in the last 12 months the price of a coin has risen 400%.
Any coin that is not a Bitcoin is referred to as an ‘altcoin’. There are currently over 1,000 altcoins. It is easy to create a new coin – just copy and paste the Bitcoin code (available online), create a logo, and put it on a WordPress page. You’re done!
How It Works: Day-to-Day
- Jim wants to send money to Mary
- Jim puts together the transaction on his computer describing how much he wants to send
- This transaction is called a ‘block’
- This ‘block’ is sent all over the cryptocurrency network, then
- thousands of computers validate the transaction by looking at all prior transactions that lead to Jim having enough currency to send.
- The currency is sent to Mary
- The Transaction is now in the ‘block’
- To obtain the currency Mary uses her ‘private key’
- Each new ‘block’ on this chain adds another layer of difficulty. Thus it becomes exceedingly more difficult to change or alter the validation of Jim’s transaction as more ‘blocks’ are added.
The main appeal of Bitcoins and other ‘altcoins’ is they function via blockchain technology, which is used to keep an online ledger of all of the Bitcoin transactions that have ever been conducted. This provides a data structure for the ledger that is quite secure and is shared and agreed upon by the entire network of computers maintaining a copy of the ledger. Every new ‘block’ in the chain must be verified by each computer before being confirmed making it almost impossible to forge transaction histories.
Blockchains can be used in various other applications to solve security issues. For example, online voting, crowdfunding, and payment processing. Funds can be directly transferred between two parties without the need for a third party, like a bank or credit card company. Each crypto ‘user’ has a ‘wallet’ or account address (a public key) while a private key known only to the owner is used to sign transactions.
Bitcoin mining is the process of creating new bitcoins by solving a computational puzzle. This process is performed by high-powered supercomputers that solve complex math problems. These problems are so complex that they cannot be solved by hand and tax the most powerful computers.
What is the result of mining:
- When computers solve the complex math problems on the Bitcoin network, they produce a new Bitcoin (like a mining operation extracts gold from the ground).
- By solving the problems, Bitcoin miners make the Bitcoin payment network trustworthy and secure by verifying its transaction information.
- When the miners add a new block of transactions to the blockchain, part of their job is to make sure that those transactions are accurate and that the Bitcoin is not being duplicated (‘double spend’).
Digital information can be reproduced relatively easily, so with Bitcoins, there is a risk that a spender can make a copy of their bitcoin and send it to another party while still holding onto the original. With hundreds of thousands of Bitcoin purchases and sales occurring on a daily basis, verifying each of those transactions can be a lot of work for miners. As compensation for their efforts, miners are awarded Bitcoin whenever they add a new block of transactions to the blockchain. These are called, ‘block rewards’. For example, in 2019, 50 Bitcoins were rewarded.
Mining will continue until 2140, at which time miners will be rewarded with fees vs. coins for the mining process. It is anticipated that the total number of Bitcoins in circulation will reach a limit of 21 million, making the currency entirely finite and become more valuable over time (right now there are approx. 18 million in circulation).
Typical Mining Problem
The miners face the following problem. Guess what number I’m thinking of? However, the number is a 64 digit hexadecimal number. Now, you can see the complexity of the mining process.
A mining pool is a group of miners who combine their computing power and split the mined bitcoin between themselves. Most coins are mined this way.
Bitcoin vs. Government Issued Currency
People, for the most part, trust printed currency. In the U.S., the dollar is backed by a central bank, the Federal Reserve (aka The Fed). The Fed regulates the production of new money. Even digital payments using the U.S. dollar are backed by a central authority. For example, when you make a purchase and use a credit or debit card that transaction is processed by a payment processing company – but that transaction is backed by the Fed via its agreements with the credit card issuing financial institution.
Bitcoin is different. It is not regulated by any government authority. Instead, it is backed by millions of computers across the world called, ‘nodes’. This network of nodes performs the same function as the Fed and the payment processing company, but with key differences:
- Nodes store information on all prior transactions and help to verify their authenticity.
- Nodes are global and record transaction data in a public list that can be assessed by anyone.
- As of August 2020, nodes were processing four transactions per second. By comparison, VISA processes 65,000 transactions per second.
Up to $20k in value in less than 30 days!
The latest rally in Bitcoin saw the value double in less than a month – from $20,00 to $40,000. Smart money thinks it will go higher as institutional investors are looking for a hedge against global inflation and the decline of the U.S. dollar under the new Administration.
Added to this are droves of retail investors and traders coming into the crypto-market. So much so that several exchanges were overwhelmed and had to put a stop to transaction taking. FOMO (fear-of-missing-out) is in full-tilt by retail investors – which in itself will drive the BTC price higher.
The Bitcoin Purchase Journey
How hard is it for a retail investor (individual) to purchase a Bitcoin? Bitcoin can be purchased in increments, so say I want to invest $1,000. Following is the journey a friend took to purchase Bitcoin:
- She went to the Square (payment system) app called ‘Square Cash’ and downloaded it. Set up a biweekly purchase program for $50 worth of Bitcoin starting with a $1,000 investment. She received a “something went wrong” message five times.
- Next, she went to Coinbase (a cryptocurrency exchange) and opened an account – no problem. However, when she went to purchase the Bitcoin by using her Chase Visa and a Chase Debit card, both cards were declined.
- What’s the problem? Were these platforms completely overloaded with demand? Both Coinbase and Kraken (another exchange) had experienced outages due to heavy volume in the recent past.
- Next, PayPal. No luck! Then she realized that only individual PayPal accounts can be used to purchase Bitcoin and not business accounts. She accessed her individual account and the $1,000 purchase went through!
Newcomer investors of Bitcoin have overwhelmed the systems of many crypto exchanges. For most, the minimum order is $1,000 in advance of the transaction. It’s FOMO in mass on the part of retail investors and they are entering the world of cryptocurrencies in droves.
Purchase Journey Takeaways
- The first step is to download an app for one of the coin exchanges and open a ‘wallet’.
- You can purchase bitcoin via credit/debit card or bank wire transfer and send them to your wallet.
- The exchange platforms will require you to provide photo ID and other information (ie. social security number) to make sure you aren’t breaking any money laundering laws or tax fraud.
- Bitcoin is a new asset class and it is very volatile.
- Bitcoin’s tax status remains a question.
- Bitcoin balances are maintained using public and private ‘keys’ – long alpha/numeric keys linked through the mathematical encryption algorithm used to create them.
- The public key is the location where transactions are deposited to and withdrawn from. This key also appears in the blockchain ledger. Think username on social media. The private key is used only to authorize a transaction. You can protect your private key by encrypting your wallet with a strong password and by choosing ‘cold storage’ – storing the wallet offline.
Selling Bitcoin or other cryptocurrencies for U.S. Dollars. Selling is as important as buying, and as with any investment, there is a time when you will want to divest. Also, like buying, on the sale you want to do so for the lowest fees possible:
- Go to a crypto-exchange (the one where you made your original purchase would be your best bet). That is where your coins are resident – in your ‘wallet’.
- Login to your account and Select Buy/Sell on the Menu
- Select Sell
- Select Bitcoin – Verify the Deposit To (your Bank checking account)
- Input the amount of Bitcoin you want to sell
- Select Sell You’re Done!
Note: Exchanges, like CoinBase, allow customers to sell their cryptocurrencies immediately after purchasing them. Furthermore, you can have your bank checking account linked to your Bitcoin account so funds can go directly from one to the other.
When you sell, the transaction occurs directly between buyer and seller via the exchange. You set up a sell order and someone agrees to purchase at the agreed-upon price. Then the exchange alerts you that you will be receiving payment and the Bitcoins are sent to the buyer account (wallet). Some exchanges will convert your received funds into gift cards, cash-in-mail, or cash-for-pickup.
Public Key/Private Key
Your Public Key – is your address. This is used for the buying and selling of currency
Your Private Key – is your password. This is used to ‘sign’ your transactions. It is best to use ‘passphrase’ when setting up your Private Key.
The wallet is where you hold your currency. It is best to have a ‘cold-storage wallet, meaning it is offline and never exposed to the Internet.