Cryptocurrencies like bitcoin and ethereum have gotten a lot of attention in the investing world in recent years due to their massive gains—bitcoin is up 48,000% over the past five years, for example. Some traders see cryptocurrencies as a long-term disrupter of traditional fiat currencies, others see cryptocurrencies as a speculative bubble, and others are simply content to profit by trading the short-term volatility.
Here are five questions (and answers) about cryptocurrencies you may have been too afraid to ask.
1. What is bitcoin?
At this point, it may seem like a dumb question to ask, but how cryptocurrencies work isn’t necessarily intuitive. Bitcoin was the first digital currency to get mainstream attention. In a nutshell, bitcoin is a digital currency that is not controlled by a government or other entity. Every single bitcoin transaction is recorded in a public ledger called a blockchain, which serves to help prevent fraud and manipulation.
One of the major appealing qualities of bitcoin is that, unlike fiat currencies like the U.S. dollar, the total number of bitcoin that will ever be mined is capped at around 21 million.
2. What is bitcoin mining?
In lieu of a central government that maintains the security and supply of the currency, bitcoin miners increase the circulation of bitcoin and maintain the blockchain. To do so, bitcoin miners—or people who use look for bitcoin—must collect and verify blocks of bitcoin transactions to add to the blockchain. To do so, they use their computer to solve cryptographic equations of potential blocks until they meet certain criteria.
For their troubles, miners are rewarded with a predetermined amount of bitcoin. As the amount of mined bitcoin approached its predetermined cap, the equations get more and more difficult to complete making mining coins harder and harder.
3. What is the difference between bitcoin and ethereum?
Bitcoin has grabbed most of the headlines, but it is one of thousands of cryptocurrencies that have popped up around the world in recent years. Another popular cryptocurrency, and potentially bitcoin’s biggest rival, is ethereum.
Bitcoin was designed and has been primarily used as a currency for consumer payment transactions. On the other hand, the ethereum blockchain was designed specifically to include features than appeal to the corporate world.
One of its most appealing features is its ability to support something called smart contracts, which are computer algorithms that automatically execute deals when certain conditions are met. Bitcoin’s market cap currently stands at $95.1 billion, and ethereum is a distant second at $29.8 billion.
4. Why do people use cryptocurrencies?
Once you understand what cryptocurrencies are and how they work, the next natural question to ask is “so what?” Most traders’ cash and credit cards work just fine and require little to no effort to use. There are several unique advantages to using a cryptocurrency like bitcoin, however.
First, it is completely anonymous. All bitcoin transactions are recorded on the blockchain, but users are not required to identify themselves when completing a transaction. Second, because its supply is capped, bitcoin is not subject to the same inflation value loss as most traditional currencies. Finally, bitcoin is universal, and users can spend it online and all over the world without the need to pay fees or taxes to banks and governments.
5. How can someone invest in bitcoin?
Unfortunately, buying bitcoin or investing in cryptocurrency is not as easy as buying a stock or ETF. To buy the currency directly, traders must choose a downloadable digital currency wallet and then select an exchange, such as Coinbase, to use to buy and sell the currency.
Alternatively, investors can go to one of thousands of physical bitcoin ATMs across the world, but ATM fees can make these transactions unappealing. Finally, while there is no bitcoin or cryptocurrency ETF currently listed on a major U.S. exchange, the Bitcoin Investment Trust (OTC: GBTC) trades on the OTC market in the U.S. The Winklevoss twins—of Facebook acclaim— are also working to get a bitcoin ETF approved by the Securities and Exchange Commission for trading on a major exchange.
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