Things to consider before investing in bitcoin.
Bitcoin is a decentralized, peer-to-peer cryptocurrency system designed to allow users to process transactions through digital units of exchange called bitcoins. The key difference between bitcoin and fiat currencies is that it is decentralized and not controlled and regulated by any central authority.
The creator of Bitcoin is Satoshi Nakamoto; it was invented in 2008 and released as open-source software in 2009. The first transaction took place between Nakamoto and an adaptor of Bitcoin in 2009.
Bitcoin mining is the process of creating new bitcoin, performed by high-powered computers that solve complex computational maths problems. These problems are so complicated that they can tax even the most powerful computers. Mining is necessary to maintain the ledger of transactions on which bitcoin is based and has become very sophisticated over the years using complex machinery to speed up the operations.
Why are the Governments afraid of Bitcoin?
Bitcoin is a decentralized peer-to-peer payment network with no central authority or middlemen. There is no central authority to regulate it so the governments are afraid of cryptocurrencies.
To understand this it is necessary to understand conventional currencies which are also termed fiat currencies. These are issued by the government and have value as the government says that they do. The fiat currencies are not backed by any tangible asset but only the full faith of the government that issued them.
The government controls the fiat currencies through monetary policy using central banks to issue or destroy money and thus have a complete economic influence. They also decide how money can be transferred, which enables them to track currency movement, collect taxes and trace any criminal activity. When parties other than the government create their own currencies then the control of the government is lost.
The control over currency has much impact like in the fiscal policy. The governments increase or decrease the amount of money circulating in the economy which has an impact on jobs, inflation, recession, investment, and spending.
Bitcoin is not affected by the banking system. It is created when the miners solve complex algorithms and create a cyber currency that is digitally passed between buyers and sellers.
If the use of bitcoin and other cryptocurrencies increases the banking system would become irrelevant. Then the question arises is where would people go when there is a problem with a mortgage payment or there is a technical glitch or even for the interest people earn on their savings.
The other issue is that the banking fees generate a lot of jobs across the globe. This would all be lost along with the tax revenue of the bank and revenue which the paychecks of the employees generate. Money transfer business will also disappear leading to further job losses and no one will need a Western Union bank.
One other worry is that these untraceable transactions would lead to an increase in crime like drug trafficking, terrorism, money laundering, prostitution, and many other nefarious activities that thrive on the movement of money in untraceable ways.
The other side of this argument is that the central banks meddling with the money supply has many times led to recessions and increased unemployment and the whole system is based on corruption and the only motive is to make profits.
Myths Surrounding Bitcoin
Photo courtesy Coindesk.
There has been a tremendous rise in the price of bitcoin in the last decade. But still, a number of rumors and myths prevail around bitcoin. The most common myths are enlisted below-
· It has been difficult to classify digital currencies and investors are not sure how to treat them as regards taxation. Many people think that these currencies don’t have value and are a fad that will soon get over. But all of this is not true and bitcoin is being increasingly used for exchanging goods and services i.e. they have value.
The bitcoins have a value as there is a cost associated with producing them. They are produced through the mining process that involves the use of electricity which has a real cost. The market value of bitcoin tends to move around this cost, which increases as the mining network expands and the block reward is reduced over a period of time.
· There is a myth surrounding bitcoin that it is used for illegal activity. It is true that it has been used for illegal activities, but the same can be said about other currencies too. There are criminal elements that can manipulate any currency and misuse it.
Bitcoin provides anonymity to transactions that are helpful to criminals for illegal business; but the transactions are illegal, not the cryptocurrency. There was a period of time when bitcoin use was mainly in black markets but that has reduced over a period of time and is now only a fraction of total flows.
· People have a feeling that cryptocurrencies are not secure. There have been many scams and thefts in the past. The digital currency exchanges were hacked and the criminals thrived on the vulnerabilities of the wallets.
But all this can be prevented by the investors if they change their behavior in order to protect their holdings. Many financial institutions have evinced a keen interest in blockchain technology as it is seen as a secure tool having vast potential.
· Many people consider cryptocurrency to be a scam and are cautious. Many scams have taken place in the past. But people should treat bitcoin investment in the same way as they would treat any other investment. In other financial asset classes, we keep hearing of scams a number of times. It is the responsibility of people to through all the details to reduce the chance of being taken for a ride.
· There is a concern for the environment as the number of mining operations for cryptocurrencies has increased around the world. Each rig requires a massive amount of computational power which is dependent on electricity.
Many cryptocurrencies have put a cap on the number of tokens that can be mined. After a point, individuals will no longer be able to mine for new tokens and coins and the cost of computational power for mining will be reduced. It should be remembered that the modern banking system also requires a lot of power to sustain the servers and electronic equipment.
What is a bitcoin exchange?
A bitcoin exchange is a digital marketplace where traders can buy and sell bitcoins using currencies or altcoins. It acts as an intermediary. You can deposit money by bank transfer or other means of deposit by paying a price for the service. If it is a trade between cryptocurrencies then you have to pay a currency conversion fee as in institutional banks.
Important cryptocurrencies other than bitcoin
Many cryptocurrencies have arrived after bitcoin and bitcoin has become the standard for other currencies.
The word crypto in cryptocurrencies refers to the cryptography process that is required for the creation of digital currencies and their transactions. It is virtual money that takes the form of coins or tokens. These currencies modeled after bitcoin are collectively called altcoins. The other important cryptocurrencies are:
· Bitcoin Cash.
· Binance Coin.
Ways to store bitcoin:
Cryptocurrency wallets are a place to store digital assets securely. There are two types of wallets for storing Bitcoin; a hot wallet or a cold wallet.
Hot wallets run on internet-connected devices like mobile phones, tablets, and computers. These wallets generate the private keys to the coins on these internet-connected devices and are vulnerable. When you store your private key on an internet-connected device it makes it susceptible to an attack. In the event when your account is compromised your funds can be lost.
The best way to describe a cold wallet is that it is not connected to the internet. This is an offline wallet, so it has a lesser risk of being susceptible to an attack. These wallets store a user’s private key at a place not connected to the internet so that a user can observe his portfolio without risking their private key.
Ways Blockchain can disrupt banking
Blockchain is transforming many things from payments to how money is raised in the private market.
It can disrupt the banking industry by disintermediating the services that banks provide:
By establishing a decentralized ledger for payments blockchain technology can facilitate faster payments at lower fees than banks. Cryptocurrencies are built on a public blockchain that people can use to send and receive money Public blockchains cut down the need for third parties to verify transactions and give people access to faster and cheaper payments.
· Clearing and settlement systems
Distributed ledgers can reduce costs and bring us closer to real-time transactions between financial institutions better than existing protocols like SWIFT. Ripple an enterprise blockchain services provider, is the most prominent player working on clearance and settlement.
Blockchain technology removes middlemen in asset rights transfer, lowering the exchange fees and removing the instability of the traditional securities market.
· Trade Finance
Replacing the inconvenient paper-heavy bills of lading process blockchain technology can create transparency security and trust among trade parties globally. With 80–90 percent of world trade relying on trade finance the influence of blockchain on the market would be felt globally in all the industries that use cross-border trading.
· Customer KYC and fraud prevention.
Blockchain technology can store customer information on different blocks thereby helping to prevent attacks on customer information. This can bring down costs for the banking sector.
Adoption by Institutions
Bitcoin is now being considered as a safe haven asset against market volatility and inflation. There is a trend where companies are converting their cash into cryptocurrencies. Square an American company bought $50 million worth of Bitcoins. The confidence of corporate giants had added more weightage as a currency and many companies have followed this trend.
Paypal has announced that it would be introducing cryptocurrency buying and selling features on its platform which would include Bitcoin, Bitcoin Cash, Ethereum, and Litecoin. Paypal has 350 million users who will now be able to use crypto as a payment means.
Bitcoin halving happens every four years and the last one was in 2020. The impact is that the number of bitcoins mined per day will fall from 1800 to 900 and daily revenues of miners will reduce by half. This decrease in the rate of bitcoin creation tightened supply and led to a bullish market. The reduction of revenue for miners will squeeze out miners who are less efficient and the computing power connected to the bitcoin network may fall significantly.
Easy accessibility to public
Cryptocurrency has established itself as a new asset class over the past decade. Many people want to convert their cash to crypto because they believe that its deflationary nature makes it a better store of value and a hedge. As it is becoming more accessible to the public more retail investors want a share of the asset class.
Investment of $1.5 billion by Tesla
The announcement of an investment of $1.5 billion by Elon Musk saying that they will invest in bitcoin and accept them as payment for their vehicles pushed the price further northwards.
Unless a user publishes his Bitcoin transactions, his purchases are never associated with his identity like the cash purchases and can’t be traced back to him. Digital currencies allow users more autonomy over their money than other currencies. They are able to spend without using any intermediary authority like a bank.
Peer to Peer
The bitcoin payment is peer to peer which means that people are able to send and receive payment anywhere around the world without the need of requiring approval from any authority.
Low transaction fees for the international payment
While the cryptocurrency exchanges charge maker and taker fees but they don’t charge any other fees like account maintenance or minimum balance fees as that of a bank. As bitcoin transactions have no institutional or government involvement the costs of transactions are very low; this is an advantage to travelers. The transfer in bitcoins happens immediately not requiring authorization and wait periods.
The personal information of a user is not necessary to complete any transaction. Bitcoin is available to users without access to banking systems, credit cards, and other methods of payment.
Bitcoin is a viable currency for the future. The incumbent financial system is feeling threatened by its increased use. Its use is as revolutionary as the invention of the wheel or electricity. Who would have thought that in the 1990s that the use of the internet would be so widespread? The thing is that there is no need for a money-printing machine like a bank and anyone with knowledge can start a cryptocurrency.
The attitude of the government as usual is to reward friends and punish enemies. Many a time the bailout of a bank happens due to the inefficiencies involved. The military and government are afraid to relinquish power.
The cryptocurrency creates a level playing field. Just think of the incident of Robinhood and Gamestop where the big guys were given preferential treatment. Big guys are rarely made accountable like the small guys. There is the hope of a level playing field with cryptocurrency. But small investors should invest amounts according to their risk profile.