What is Bitcoin and Should You Invest?
Bitcoin (BTC) has been around for years, but for some— it’s still a pretty hard concept to wrap your head around. Because Bitcoin is a cryptocurrency, every transaction happens entirely digitally. And because it's a decentralized currency that isn’t regulated by a central bank (or government) but by a set of anonymous individuals, this digital currency really can work in mysterious ways.
With all the recent hype surrounding Bitcoin and the big question of whether or not to invest, it seemed about time to create this nifty little guide. Here’s an overview of everything you need to know about Bitcoin, plus some helpful tips for investing.
- What is Bitcoin
- How Bitcoin Works
- How to invest in Bitcoin
- Should you invest in Bitcoin?
- The bottom line
What is Bitcoin
Bitcoin is considered by many to be the first modern cryptocurrency, and also one of the leading peer electronic cash systems, that is, a system that allows people to send and receive cash without involving any middle-man financial institution.
Bitcoin was first created in 2009 by an anonymous person (or group of people) that operates under the pseudonym Satoshi Nakamoto. Unlike most traditional currencies which are regulated by the government (also called fiat currency), Bitcoin is considered to be a decentralized open-source currency. Rather than being regulated by one governing body that may manipulate the currency at-will, bitcoin transactions are controlled by a decentralized system known as blockchain technology.
As the name would suggest, you can think of blockchain as a series of blocks, each holding a collection of transactions. Because these transactions are transparent and readily visible to anyone within the Bitcoin network (and backed by peer-to-peer technology), it would be pretty hard for anyone to cheat the system and get away with a fake transaction. In fact, you’d need to control roughly 51% of that peer-to-peer computing power in order to get away with such a thing— pretty unlikely to say the least.
Bitcoin blockchain is managed by a collection of computers, or nodes, that all run and store their code. These nodes are operated by a global team of anonymous individuals and companies who engage in cryptography (the act of encoding and decoding strings of information), and are often referred to as miners. Bitcoin miners (sometimes called ASIC miners) are the people who process bitcoin transactions and are granted rewards (like the release of new bitcoin) for their efforts. Every time a miner takes an action to unlock a new block in the chain (which leads to more bitcoins), it’s called proof of work.
Although new bitcoins are periodically released as a result of bitcoin mining, the virtual currency is also periodically halved— as in, the amount given to miners is cut in half. Halving the currency helps simulate a sort of inflation, and will continue until all the bitcoin has been released, which by current estimates will happen in 2040.
So why halve the bitcoin and release it so slowly? Because bitcoins are in finite supply, staggering their release (and slowing it down the closer we get to the last release) is thought to help drive demand by lowering the supply. The hope here is also that Bitcoin will continue to increase in value.
Some people consider Bitcoin to one of the most secure assets available — this is known as the store of value thesis. This thesis is widely believed due to the fact that Bitcoin is not susceptible to typical rates of inflation, and that it’s operated by a decentralized group rather than controlled by the government.
While all that may be true, it’s important to remember that Bitcoin is also known for its extreme volatility, which I’ll dive into a bit later.
How Bitcoin Works
As complicated as it may sound, bitcoin is relatively easy to use when it comes to transactions and how the payment system works. Because bitcoin is a cryptocurrency, bitcoin balances are stored using private and public keys, which are strings of numbers linked through an encryption algorithm.
Public keys can be thought of like bank account numbers, while private keys should be kept safe, much like an ATM pin. You can use bitcoins to buy just about anything online — from furniture on Overstock to groceries at Whole Foods. You can even send and receive bitcoin payments using QR codes, or transfer bitcoins directly to others directly via your digital wallet.
For convenience's sake, many bitcoin users choose to become members of digital currency exchange like Coinbase or Bitstamp. These companies can help bitcoin users buy and trade bitcoins, and also manage their public and private keys.
In theory, all bitcoin transactions are anonymous. While every bitcoin transaction is publicly recorded, the names of the people behind those transactions are not. Instead, public keys are what gets shared during each and every bitcoin transaction.
The caveat here is that for most people, buying something with bitcoin will rarely actually be anonymous. For example, if you were to buy or trade bitcoins on an exchange like Coinbase, the company has all of your information on-hand.
Similarly, if you were to try and buy something online, you’d most likely need to enter your name or contact information in that store’s system— thereby wrecking any anonymity associated with your bitcoin transaction.
Bitcoins are stored in something called a digital wallet (or bitcoin wallet), which allows users to easily send or receive them as payment. Unlike normal bank accounts, bitcoins are not insured by any regulating government and if the currency is lost, it’s lost. In fact, all Bitcoin transactions are considered to be like cash in the sense that they are irreversible.
Because there’s no third party or middleman overseeing the security of your transactions, if something goes badly — game over, your bitcoins are gone. Whenever bitcoin is stolen (and the bitcoin network is disrupted) it's sometimes referred to as double-spending. The most notorious case of bitcoin theft happened in 2014 when a bitcoin exchange known as Mt. Gox went under after millions of dollars worth in bitcoins were stolen.
One of the biggest security risks for the average bitcoin user has to do with their private encryption key. Much like an ATM pin, this key essentially allows a user to access their cryptocurrency balance, and if left in the wrong hands or discovered by a third party, could allow that balance to be stolen.
How to invest in Bitcoin
There are two main ways to invest in Bitcoin. The first is simply to buy bitcoin on a digital currency exchange like Coinbase or Binance. The second way is to invest in something called Bitcoin Futures.
Much like other futures contracts, Bitcoin Futures allow investors to speculate on the future cost of bitcoin without actually trading the currency itself. Since these investments are regulated by the Commodity Futures Trading Commission and settled in regular cash, this gives investors a certain amount of confidence that they wouldn’t necessarily have when investing in actual bitcoin.
Should you invest in Bitcoin?
Should you choose to invest in Bitcoin the old-fashioned way (ie. buying actually bitcoin), there are a few things to keep in mind. The first is that you don’t need to buy an entire bitcoin to invest. This is especially important right now since at the time of writing this one bitcoin is valued at roughly $34k. Each bitcoin can be broken down into one-hundred million units (called satoshis) and can be sold by the satoshi. Meaning, if you wanted to buy just one satoshi, you could.
Another thing to know about bitcoin is that it’s considered to be an incredibly volatile investment. While the current price of bitcoin is sky-high, this wouldn’t be the first time in Bitcoin history for the currency to be thought of as extremely overvalued. Bitcoin has a significant history of soaring high and falling hard, and often more dramatically than other types of investments.
If you’re still wondering whether or not to invest in bitcoin, the only possible answer is “maybe,” but with two conditions. First, be conservative in your investment. Financial advisors typically tell clients to limit their investments in cryptocurrency to 5% of their portfolio or less. The reason for this is that although cryptocurrency could keep performing well, it could also crash. And more likely than not, it might just continue on its current trend of doing both these things pretty intensely.
The second condition is to consider your cryptocurrency investment as a long-term one. By keeping your investment relatively small and having the patience to wait it out for many years, you're more likely to have a positive outcome with minimal losses. Finally, don’t be in a rush to invest in bitcoin. With current prices the way they are, you may just lose money by buying when prices are this high. Stick to the old adage: buy low, sell high. Although we’ll see new coins being released at increasingly smaller increments, you’ve still got plenty of time (until 2040, to be exact) before they’re all gone.
Other cryptocurrencies to consider
Often considered to be the second-most popular cryptocurrency after Bitcoin, Ethereum was actually created to complement Bitcoin, not compete with it. Ethereum is a decentralized software that allows programmers to collaborate and build applications.
The financial aspect of Ethereum comes in because it uses something called Ether tokens, and this is how it came to compete in the cryptocurrency space with Bitcoin.
If you’re considering investing in Ethereum, you’ll need to get a digital wallet on an exchange platform. While Ethereum is often cheaper than Bitcoin, it also hasn’t received the same level of hype. This could mean good or bad things for the cryptocurrency, but again, making a small investment to start would be best.
Ripple is technically not a cryptocurrency but the company behind the digital currency known as XRP.
While Bitcoin is mostly for individuals and small companies, XRP is primarily used in transactions between banks, often on an international scale.
To invest in Ripple, you’ll also need to set up a digital wallet on an exchange platform like Coinbase, which will allow you to buy and trade XRP with other investors.
Pros & Cons of investing in Bitcoin
Diversify your portfolio with cryptocurrency
Having a diversified portfolio is always a good idea, and a small investment in a cryptocurrency like Bitcoin can be an exciting way to get your hand in the game, with minimal risk involved. Because Bitcoin investments are inherently risky, it’s important to view any investment as a long-term one and to be mentally prepared to embrace whatever happens.
Bitcoin is more interesting than your average investment
By now it’s no secret that Bitcoin has an almost cult-like following. All types of people are attracted to Bitcoin investments and for a variety of reasons. By buying into Bitcoin you’ll have a real reason to follow along on all the latest Bitcoin news and drama, which is quite literally, a world of its own.
It could be a really great investment
While no one actually knows what’s going to happen with Bitcoin, there are some people who swear by it. Will it take over all other forms of currency? And what the heck will happen when the last bitcoins are mined? Nobody knows the answers to these questions, but one thing’s for sure— it certainly has the potential to be a really great investment.
Cryptocurrency comes with a learning curve
If this list made your head spin, here’s the bad news: it just barely scratched the surface of everything there is to know about Bitcoin. You can think of Bitcoin as entering some fantasy realm created by an anonymous genius with the world-building skills of Game of Thrones creator George RR Martin. Which is all to say— there’s a lot going on here. If you plan on investing in Bitcoin, you’ll most definitely have to overcome a significant learning curve.
The market volatility is real
Investing in bitcoin isn’t for the faint of heart. This cryptocurrency is up, and down, and all over the place. If you can’t handle the heat of cryptocurrency exhcanges, it might be best to stay out of this particular kitchen.
The bottom line
There’s a never-ending number of things to learn and discover about Bitcoin for any investor, and that will only continue as the currency matures. If you’re intrigued by Bitcoin and considering becoming an investor, spend more time reading about it, and even take the time to talk to people who have already invested.
They’ll be able to tell you honestly about all the positives and negatives of dabbling in digital currency, and the more you know— the more you’ll be able to decide if Bitcoin is the right investment choice for you.