With the price of Bitcoin rising ever higher, the big problem that most people seem to have overlooked is whether this “currency” is actually a currency at all.
Indeed, many of the world’s most respected investment minds have openly questioned the veracity of the likes of Bitcoin to be considered anything other than hot air.
This tutorial is going to examine the landscape of “digital” / “crypto” currencies, what they are and how they work. Whilst NOT financial or legal advice, the underpin of this tutorial is to examine the effectiveness of “crypto” as an asset class… so let’s begin!
What Is ‘Crypto’ Currency?
Crypto currency is a new type of “digital” currency created off the back of the “blockchain” database system.
Blockchain is a new type of “decentralized” database which basically works by storing encrypted “chains” of data on networks of 100’s or 1000’s of servers (called “nodes”).
Part of the trick with “blockchain” is that the data stored within each database can be updated, edited and added-to by creating what are known as “blocks” on the chain.
In the world of blockchain, “blocks” are updates to the data held within the database. For example, if you’ve just added 3 new files and changed what 2 others say, you’d create a single “block” to update it all.
Irrespective of how it works, the real benefit of “blockchain” lies in its decentralized nature…
By synchronizing each database “chain” with 100’s or 1000’s of other servers around the world, the system is able to provide GLOBAL access to a set of data without the need for a central provider (business/government/bank). The implications of this are MASSIVE.
The main benefit of “blockchain” in the wider world has been the idea that decentralized applications could create a new wave of “Internet” adoption & application. In a nutshell, these are systems which both encrypt data stored in “blockchain” databases as well as providing processing facility to add new data to the system. You can even learn something about mining them here.
The main implication for this lies in the way in which they’ll decouple transactional applications from a central data provider.
Most notably with the “finance” / “payments” world, but also with the likes of Hotel/Restaurant/Airline booking systems, the idea that a huge network of “global” data that can either be accessed, edited or added-to by ANYBODY means that expensive network infrastructure can be done away with and a more transparent, integrated set of systems can take its place.
There’s only one problem… access.
Since “blockchain” is “open” by nature (it was originally released as “open source”), storing such delicate information as financial transactions and hotel reservations isn’t the wisest move… which is why several developers decided to create “encryption” algorithms for the system.
EVERY “crypto” (“cryptographic”) coin you see on the “blockchain” system is basically just an encryption algorithm. Some of the algorithms are designed to work slightly differently to the others… but, ultimately, they’re just there to encrypt particular data in various “blockchain” databases.
This is where the majority of these “currencies” originated – developers created an “application” on a blockchain “network”, and had to encrypt it somehow…
Bitcoin is an algorithm. Ethereum is an algorithm. Litecoin is an aglorithm – all installed on 100’s / 1000’s of servers around the world, processing various pieces of transactional data added to their central “chain” (blockchain database).
So rather than these “currencies” actually being valid vehicles of value exchange in the “real” world (they are NOT currencies), they’re just encrypted files living on servers.
Thus, you need to appreciate that in order to really discern how “crypto” (cryptographic) currencies work, you need to understand that – at their core – they are ALL just large lists of transactions. These lists (databases) are encrypted so that only people with the correct decryption token (“coin”) can view/edit them… but in the end, they hold no value at all.
This is where the contention has arisen with the “asset” class…
Why Has ‘Crypto’ Currency Become So Big?
This leads us nicely to the big myth…
“Crypto” currencies are NOT currencies.
They hold NO value and are thus worthless without the underlying technological infrastructure they’ve been developed on (“blockchain”).
The simple answer to why the likes of “Bitcoin” has become such a prized commodity is because of a HUGE misunderstanding in the wider public.
Crypto currencies are NOT going to “replace” fiat currencies.
They are NOT going to “replace” gold and precious metals. They are not going to “replace” stocks and shares. That’s a lie.
The reality of “crypto” currencies is they are the equivalent of the 21st century cheque, or perhaps even the likes of a debit/credit card (without the credit facilities).
The “coins” themselves have absolutely NO value beyond the transactions they’re able to facilitate. People have been “buying” the coins for two reasons – they want to piggyback its obscene price hike (especially in Q4 2017) and have also been told that it represents the “new Internet”.
Due to these misconceptions, it’s important to consider why the “price” has spiked so much…
- The “price” of Bitcoin, Ethereum and the rest is NOTThey’re “traded” in online “digital exchanges” which basically allow people to buy and sell the various “coins” (decryption tokens) as they see fit.The problem with this is NOT ONLY that people are getting scammed, but with the likes of the stock market (IPO’s etc), the SEC (or equivalent in your local country) has a VERY strict set of guidelines which dictate what can – and cannot – be stated by a company.SEC/FTC guidelines are meant to provide transparency to the accounting practices for the various companies / asset classes. Whilst many would argue this has not been achieved, the reality is that if a company or security is offered for sale through a regulated channel in a developed economy, their claims have to be verifiable.
Unfortunately, this does not extend to “Bitcoin” and the other “crypto” currencies.
- The ONLY way that these “crypto” currencies are sold today is through a secondary market.Secondary markets are not a problem in themselves…
eBay is a secondary market. Yard sales are secondary markets.The important thing to realize is that these “markets” are just other people selling their commodities to each other. “Primary” markets are when a company will sell securities directly to the public itself. Not so with the secondary market.As such, you need to consider that the “price” these “coins” are fetching has NOTHING to do with any central regulator or issuing country. It’s the price that two or more people think the “coin” is worth… typically because they want to try and sell it to someone else.
In other words, the “price” of the “coins” (at present) is almost entirely Real investors look for “intrinsic” value and work from there. Not so when it comes to hype and hearsay.
So Crypto Is a Scam?
No, it’s not a scam but it’s certainly overvalued.
The general rule of “investing” is to buy undervalued assets, hold them whilst the market realizes they are actually worth something, and then sell when the price peaks. Even CNN wonders the same.
The problem with all these crypto currencies is that people have got the wrong end of the stick. They’ve attributed the adoption of “blockchain” technology to the price of a “bitcoin”.
This is a false assumption and has lead millions down a path from which few will return unscathed. ONLY people who bought “Bitcoins” when they were $200 or $500 are the ones making money. They’re making money because when a truck driver empties his savings to buy a $9,000 Bitcoin, that money is going straight into the pockets of the guy who bought when it was low.
The problem that most people will see when they wake up is that the “coins” themselves have almost NIL practical value in the real world.
What has been said by a number in both the crypto and finance communities is that “blockchain” (and by virtue “crypto” currencies) are in need of a “killer app”.
Just like the early Internet had AOL, Google, eBay and Amazon – in order to spur adoption, the “decentralized” “blockchain” ideal needs a central company that’s able to bring together all of the value it possesses so that consumers can enjoy the benefits of wider data access without the need to change anything in their lives already.
The real money is looking for this type of company – which, by the way, will have NOTHING to do with whether “Bitcoin”, “Ethereum” etc is adopted.
Whilst this isn’t financial advice, our most ardent recommendation is to NOT buy any Bitcoin etc — don’t even think about it. If you have ANY coins, sell them. If not now, certainly within the next 3 months. Like gamblers in a casino, many people are sitting at the table hoping to beat the house. But remember… the house always wins.
What Does The Future Look Like?
The “future” of “crypto” is actually quite interesting.
Firstly, the current “crop” of coins won’t last.
There’ll be some event which sucks money out of the market. They’ll either be regulated in the US or something else to quash the dreams of a “digital” currency to rival the USD.
When this happens, it’s the people at the bottom of the pyramid who’ll be hit hardest. If you bought the coins early and put down say $350 per coin… you can afford to sell when the coins are $6,000 or even $3,000 and still be in a big profit. It’s those who bought coins at $5,000+ who’ll be in trouble.
As what inevitably happens with this type of hype, it will die down and a huge number of people will lose a lot of money. However, this would not mean the “end” of them. Find out more here with our intro to cryptos.
Remember, the real star of this show is “blockchain” – the decentralized database system. The value of this is what *should* allow any new coins to rise from the ashes like a phoenix and start afresh with a new set of value.
This is where things will likely begin to get serious – as the “real” money is only interested in assets & intrinsic value. With some of the new “coins” being produced having this quality, it could be suggestive of a move towards a more fundamentally sound financial model.
When this happens, you should still stay away from the market. You basically want to look for the “one” killer company who’s likely to rise through the noise and provide an application, platform or framework which brings ALL the “crypto” stuff together. Think Microsoft or Facebook equivalent. If you’re genuinely interested in the space, this is what you should be looking for.