Ladies and gentlemen, it’s time we have a long overdue conversation here on I Will Teach. A conversation about one of the most heated financial trends of our time:
You’ve heard of it before. Maybe you read all the headlines when bitcoin hit $20,000 in 2017. Maybe you have a friend who won’t stop talking about it. Maybe you even opened a Coinbase account yourself and are not sure what to do with it.
Whatever the case, we want to help you understand what exactly cryptocurrency is and—most importantly—what it isn’t.
Cryptocurrency: Investment or Speculation?
It’s important to make a difference between the technology and the investment of cryptocurrencies. On the tech side, we don’t have a lot of strong opinions. Innovations in blockchain are interesting and have potential to serve a lot of uses outside of crypto.
However, as an investment compared to “boring” stocks and bonds, crypto isn’t a good one at all. Due to its volatile nature, relative lack of history, and high chance of failure, we consider cryptocurrencies speculation.
Investment means you own a portion of cash flow. Speculation means there’s no future cash flow, you’re merely hoping the price increases. It’s basically gambling.
That’s not to say that you shouldn’t ever buy into crypto. We just suggest you get your financial house in order (e.g. invest in simple index funds, open a savings account, get a good credit card) first and then purchase crypto.
Even then you should keep the total amount of speculation in your portfolio to 10% or less.
If you built a solid financial base and still want to invest in crypto. Here’s how you can start:
What Is a Cryptocurrency?
Cryptocurrency is a digital currency that leverages blockchain technology to manage transactions.
They are also decentralized. That means that the currency isn’t managed by a bank or economic system. As such, governments and corporate bodies can’t manipulate it.
Instead, it relies on a blockchain. A blockchain is a public ledger managed by a peer-to-peer network of computers that manages and organizes all the transactions of cryptocurrencies.
Understanding exactly how it works is a bit complex—which brings us to …
How Cryptocurrency Works
To explain how cryptocurrencies work, let’s take a look at an example.
Imagine two people: Andrew and Bea.
Andrew wants to buy a painting from Bea, who accepts Bitcoin (the most popular cryptocurrency) as payment. Andrew transfers the amount owed to Bea by logging into a digital wallet.
These are online platforms that contain your private key (a unique series of numbers and letters that record how much money you have) and can interact with the blockchain to record transactions.
The two must then wait 10 minutes for the transaction to process. During this time, the payment information is analyzed by a network of peer-to-peer computers that work to verify pending transactions (much like a bank does). Once it is verified, the transaction is added to the block chain.
Once the transaction is added to the block chain, Bea receives her money!
In a nutshell, that’s how cryptocurrency transactions work.
Most Popular Cryptocurrencies
Cryptocurrencies come in a lot of different forms. Below are the most common ones you’ll see out there today:
Bitcoin is the first decentralized cryptocurrency and it’s also the most popular. It’s likely you’ve heard of this one before. It leverages blockchain technology to transfer money from one wallet to another.
The creation of Bitcoin itself reads like a spy novel. The currency was created back in 2009 by a mysterious developer(s) who went by the name of Satoshi Nakamoto. The real identity of this person has not been discovered.
Since its creation, Bitcoin has attracted tech enthusiasts, entrepreneurs, drug dealers, and entrepreneurs alike for its commitment to privacy and decentralization. As of 2020, there are more than 7 million active Bitcoin users.
Litecoin was first created in 2011 by developer Charlie Lee. In many technical aspects, it’s nearly identical to Bitcoin.
Like Bitcoin, Litecoin relies on blockchain technology to complete transactions. The difference is that Litecoin processes transactions faster than Bitcoin. Where Bitcoin takes 10 minutes to process a transaction, Litecoin takes 2 minutes and 30 seconds.
This crypto also has more currency available than Bitcoin with 84 million Litecoins total (compared to Bitcoin’s 21 million).
Ethereum is another popular cryptocurrency that leverages blockchain technology to complete transactions.
Created in 2015 by developers Vitalik Buterin and Gavin Wood, Ethererum includes a few features that set itself apart from their crypto-counterparts. One of the biggest differences is the currency’s “smart contracts.”
These are computer generated contracts that help enforce a transaction. For example, you might want to use a smart contract when buying a car. It gets rid of the paperwork needed and you can transfer ownership of the car without a middleman.
Investing in Cryptocurrency
Now that you know a few of the basics, you might want to start investing in crypto.
Doing so is much like any other investment:
- Step 1: Buy it.
- Step 2: Let it appreciate in value.
- Step 3: Sell it.
Guess which step is the hardest? That’s right: Letting it appreciate in value.
The reason behind that is because of how volatile cryptocurrency is as an investment—which brings us to …
Crypto is High Risk: Here is Why
Cryptocurrencies are an incredibly high risk investment. We have more than a decade’s worth of evidence from the market to show this.
Take Bitcoin for example. At the beginning of 2017, Bitcoin was trading for around $900 / Bitcoin. By December, it had rocketed to nearly $20,000 / Bitcoin.
That means if you had invested $10,000 in Bitcoin in January, that initial investment would have grown to $172,966.546 in a year’s time.
(I’ll give you some time to pick up your jaw from the floor.)
But then the market corrected itself, and Bitcoin fell back down to $6,800 in April followed by $3,700 in November 2018.
Which means if you invested $10,000 in Bitcoin at its height in December you would have lost $6,810.35 by November the following year.
Why is that? It’s because there’s no real way to put a value on cryptocurrencies. It’s all speculation, which makes it risky and volatile.
With a typical currency, the money is backed by something. If not a commodity like gold then it’s backed by a government or bank.
It also differs in a lot of crucial ways from typical investments such as stocks. Where with stocks you know you’re investing in a company or corporation. You can take a look at corporate balance sheets and investor reviews. This isn’t the case with crypto.
How to Buy Cryptocurrency
But that doesn’t mean you should never invest in crypto. There might be a lot of reasons why you want to.
Maybe you like the technology, or perhaps you want to make a purchase, or maybe you want to dabble in speculating. (Remember: We recommend you keep the amount of speculation in your portfolio to 10% or less.)
To buy cryptocurrency you need two things:
- A place to buy it
- A place to store it
There are a ton of different places you can buy cryptocurrency called “cryptocurrency exchanges.” These exchanges allow you to purchase cryptocurrency using regular old fiat money (e.g. the US dollar) or other cryptocurrencies.
If you’re just starting out and are looking for a good way to dip your toes in crypto, we suggest using Coinbase.
It’s one of the most popular cryptocurrency exchanges out there—and for good reason. The platform allows you to easily buy and trade cryptocurrencies such as Bitcoin, Litecoin, and Ethereum from the platform.
Coinbase also provides you with a wallet to store your cryptocurrency—which brings us to …
Crypto Storage Options
Cryptocurrency is typically held in wallets.
No, this isn’t like your dad’s old tri-fold. This is a digital wallet used to hold all of your Bitcoin.
Each wallet comes with a public key and a private key. These are a randomized set of numbers and letters that is unique to you and your wallet (and therefore your funds).
You use your public key to receive money from other wallets. As the name suggests, you can share this one publicly. Whereas your private key is used to sign off on transactions related to your public key. You want to keep this key as secret as possible and never share it.
And there are three different types of wallets:
- Software: These wallets exist digitally only such as online, mobile, or desktop (e.g. Coinbase). Since they’re digital, you can access them virtually anywhere. But you run the risk of it being vulnerable to cyber attacks.
- Hardware. These wallets exist on a piece of hardware such as an external drive or USB stick. Though users with these wallets still need to make their exchanges online, they can keep their cryptocurrencies on a physical piece of media to store for extra security. Though you do run the risk of losing it all forever if you misplace it.
- Paper. This form of storage involves you printing your public and private keys on a piece of paper and using it for any transaction. As such, it makes it one of the safest forms of storage for your cryptocurrency. After all, you just need to take care of a piece of paper.
No matter what you choose to do, remember that there isn’t a 100% effective solution for everything. Each storage option comes with its benefits and disadvantages.
Should you buy crypto?
Cryptocurrency can be a fun way to use your money once you have everything else in your financial house in order. The technology behind it is no doubt interesting and offers an exciting future.
Just keep in mind that it’s speculation—not an investment.
A Cautious Guide to Cryptocurrency in 2020 is a post from: I Will Teach You To Be Rich.