About two years ago, one of my friends hailed his belief in Bitcoin and explained how he moved his entire life savings onto a hardware wallet and memorized his private alphanumeric key. He sounded like a character from a Neal Stephenson novel — gritty, daring and irreverent of the world’s established banking systems. While Bitcoin has soared since then and made him a millionaire many times over, the question now is if it will continue to rise in value or if it’s already reached its height.
Cryptocurrency is digital currency that has no tangible paper or physical coin representation. Instead, encryption techniques using computers and open source software generate the currency based on mathematical proof, or blockchains. Cryptocurrencies such as Bitcoin are decentralized: There’s no one place like a bank where the currency is held, and a private security key tied to an open source ledger proves who holds the value. As an electronic payment system, cryptocurrencies are instantaneous and have low transaction fees compared to traditional banking systems, which are comparatively slow and have high fees associated.
If you are completely new to Bitcoin, check out this video explanation by one of my favorite publications, The New York Times, to kick-start your understanding.
According to Bitcoin.org, “Bitcoin is a consensus network that enables a new payment system and a completely digital money… Bitcoin is pretty much like cash for the Internet… the most prominent triple entry bookkeeping system in existence.” It began in 2009 by an anonymous character named Satoshi Nakamoto, who released a bitcoin whitepaper explaining the technology. It was the first decentralized cryptocurrency, has the highest awareness globally and has the highest value. A bitcoin digital token can be broken down to eight decimal places or .00000001, which is called a satoshi, bitcoin’s version of a penny. The price of a bitcoin fluctuates constantly akin to a stock exchange and market demand.
Critics, especially established banking systems whose foundations may be threatened by Bitcoin, aim to discredit cryptocurrencies as a volatile fad ready to crash due to overvaluation or a lack of propagation across the public. Also, some speculate that governing bodies will deem it illegal, or attempt regulation for taxation purposes. Most governments have a centralized authority for producing new physical currency and balance this process against inflation. The move from dollars sitting in private FDIC insured bank accounts to cryptocurrencies shifts power away from centralized governing bodies, and they are most certainly not going to allow it to continue rising in value without a fight to discredit or demolish it.
While it’s uncertain if Bitcoin will last the test of time (hint: it will), we have it to thank for developing the genius infrastructure of the blockchain. In the book Blockchain Revolution, Don and Alex Tapscott state, “The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.” Blockchain is a decentralized technology that records permanent transactions across millions of machines, promising extraordinarily strong cybersecurity through its growing list of public records or blocks. The blockchain ledger is managed via open source technology, although your private security key is obviously hidden so nobody can oppose the validity of any given transfer and, more importantly, everyone can validate its permanent existence. In summary, blockchain is a colossal ledger of transactions documented in a shared and decentralized database.
According to InvestingPR.com, blockchain technology faces a significant hurdle in its ability to scale effectively as user bases increase and ledgers expand. Often described as the fork problem, transactions may have to wait in a queue before they are memorialized into a block. According to TechCruch, Ethereum is experiencing a scalability issue as seen in the game CryptoKitties, a game where users buy and sell virtual kittens. Using 15 percent of Ethereum’s network traffic, and being the largest contract on the network, the CryptoKitties application exposes the biggest limitation of scalability within the Ethereum blockchain technology. As the game became increasingly viral, transactions slowed down significantly and users sometimes had to make multiple attempts at an action.
InvestingPR also insightfully points out that ether and blockchain technology can be cloned and a new cryptocurrency spawned, stating: “The only thing conferring value on any currency is the consensus of the community using said currency.”
The same transparency and open source technology that makes cryptocurrencies brilliant may also act as a significant risk in that they can be copied. With more than 2,000 digital currencies live in the market and seemingly no limitation on the number that can start up, the barrier to entry seems not to be the technological innovation, but instead marketing and user adoption. More problematic for Ethereum and Bitcoin are the chances that someone will not only replicate their technologies, but defeat their scalability issues.
However, there may be uses of the technology outside the commonly associated currency exchange, such as its use in the world of marketing. According to Digiday, one use of blockchain in advertising is via BitTeaser, a Danish ad network collecting ad revenue in Bitcoin. Digiday goes on to cite four areas where blockchain may be useful in the future of media:
- Ad-delivery verification decentralized and used to analyze delivery, prevent fraud, and blacklist in real time.
- Corporate social responsibility via the authentication of products and contracts, both public and digitally accountable.
- Marketing in new and creative ways such as personalized “one of a kind” products with a backstory and point of origin verifiable via blockchain.
- Manage consumer data with heightened privacy, anonymizing and decentralizing large amounts of transaction data.
Considering the hype around cryptocurrencies and probability that they will continue rising in value, with some predicting a single bitcoin could boom to one million USD, you may be excited to jump into the game. Caution: Keep a balanced and diversified investment portfolio with a maximum of 5 to 10 percent of your investments in high risk options such as cryptocurrency. Since there is no central governing body, there’s also no insurance or federally-backed guarantees on your investment, and no legal obligation for the exchanges to replace stolen funds or to provide support for hacked cases. Also, you may be tempted to invest in a new ICO, or initial coin offering similar to an IPO. Again, be cautious as new coins may have no long-term value. If there’s no wide adoption of the currency, if it has technical flaws or if it is priced solely on short-lived hype, there may be the risk of hyperinflation akin to what happened in Zimbabwe in 2008 when one US dollar was equivalent to more than two trillion Zimbabwe dollars.
Many have stated that blockchain is as revolutionary as the internet and establishes a level of trust via authentication and authorization far superior that of the traditional 20th century banking and credit systems. One of the easiest ways to buy the three most popular cryptocurrencies is through CoinBase, available on a desktop browser or smartphone app (the app I use — and, yes, that is a referral link that will give both me and you $10 USD value in-app if you sign-up and spend $100). Coinbase acts as the buying platform, storage wallet and performance monitoring tool. It’s so easy to use and transfer USD via bank account or credit card that it has become the most popular app to use on iOS for buying Bitcoin, Litecoin, Bitcoin Cash and Ethereum. Other prominent exchanges include Bittrex, Poloniex and Binance, where you can buy and sell alternative forms of currency such as Ripple, Neo and Stellar Lumens.
Remember to keep a diversified portfolio and consider only allocating 5 to 10 percent of your holdings into volatile cryptocurrencies. You should only invest an amount of money you are willing to lose, so create a long-term strategy that feels comfortable. For those of you thinking about taking out loans, maxing out credit cards or mortgaging your homes to buy cryptocurrency, I strongly advise you do not to proceed. The likelihood that cryptocurrencies will soar high is just as real as a significant crash in value.