Everyone’s talking about cryptocurrencies, even if they don’t fully understand them. Some people are even investing in them.
Joining the craze is only getting easier. Apps like RobinHood and exchanges like CoinBase make investing in bitcoin, ether and a dizzying number of other digital currencies as simple as pointing and clicking. Even banks and brokerages are cashing in.
Although some people get rich, many more do not. That’s because cryptocurrencies are so volatile that a chart of their value looks like an EKG printout. The price of bitcoin rose more than 2,000% in 2017 to a record $20,000, but by early 2018, it had fallen more than 50%. For most of September, bitcoin was trading at just over $6,000.
The rollercoaster nature arises from sudden changes in the perceived value of a given cryptocurrency. Although their prices are, like traditional stocks, determined by supply and demand, hype also plays a role. News coverage can influence prices, too. Any mention of someone hacking a cryptocurrency exchange sends prices plummeting, for example, while even the rumor of greater regulation reassures investors and drives up prices.
Adding to the uncertainty, the space is largely unregulated and bad actors abound. While companies face many regulatory hurdles before an initial public offering, launching an initial coin offering is much easier as the space is so unregulated. That makes it easy to place ill-fated investments in poorly conceived or dubious companies that haven’t been vetted, let alone required to meet any financial, accounting, or ethical standards. That leads some people to argue that no one truly invests in cryptocurrencies, they only speculate on it.
“Their only value is in the belief that someone later will pay more,” says Nicholas Weaver, a senior researcher at The International Computer Science Institute.
None of this leaves people any less eager to bet on bitcoin and its ilk. But anyone thinking of doing so should think twice. And perhaps think twice again.
Still interested in trading? Here are a few things you need to know.
So what is cryptocurrency, anyway?
Cryptocurrency is essentially digital money traded from one person to another through the use of pseudonyms. There are no intermediaries like banks, no governmental oversight or authority, and no fees. The “crypto” in cryptocurrency refers to the use of cryptography to ensure the security and privacy of every transaction.
New coins are created through a technique called mining. The process requires powerful computers that solve complex math problems. Each problem should take about 10 minutes to solve, and results in the creation of a predetermined number of coins. The total number of coins that can be created is fixed — there’s a limit of 21 million bitcoins that can be created. The number of coins rewarded for solving each problem dwindles as time goes on.
Bitcoin is believed to have been created in 2009 by Satoshi Nakamoto, an enigmatic figure who has so far proven all but impossible to definitively identify. By using cryptography to control the creation and tracking of a digital currency, Nakamoto took that power away from central authorities like governments.
Bitcoin was the first and most famous digital currency, but you can choose from more than 1,500, including ether, litecoin and even cryptokitties. For awhile, you saw these currencies only in the darkest corners of the internet, where people used them for all sorts of questionable, even illegal, activities. Drug dealers liked them because they made transactions all but invisible, and trolls at the Kremlin-backed Internet Research Agency used bitcoin to finance their campaign to influence the 2016 election.
That started to change in 2014, when Overstock became the first major US retailer to accept bitcoin. Companies like Expedia and Microsoft followed suit. Cryptocurrencies have moved to far into the mainstream that even Starbucks wants to find a way of letting customers use bitcoin to pay for their pumpkin spice latte.
One of the biggest misconceptions about cryptocurrencies is that you need thousands of dollars to invest. It’s an easy assumption to make, especially in the case of bitcoin, which stayed under $1,000 from about 2010 to 2017. But then it took off, surpassing thousand-dollar milestones at a pace that seemed quicker than you could refresh your phone.
The staggering value is off-putting to many. But unlike most stocks, you can buy a fraction of a bitcoin so you don’t need thousands to get into the crypto game.
And what’s this blockchain I keep hearing about?
Blockchain is the underlying technology that makes the whole thing work. It is kind of a public, digital ledger of transactions. An analogy might help.
Think back to when people used a checkbook register to keep track of purchases and payments. Now extrapolate that to include countless transactions by millions of people, and imagine that copies of the register are held by thousands of computers. Each computer must verify a transaction before it can be noted in the register. Once verified, a transaction is written in permanent ink and can’t be erased. When the register is filled, a new checkbook is started and stapled to the first. Eventually there’s a chain of registers.
That’s essentially what a blockchain is. And every transaction is pseudonymous, making cryptocurrency an ideal option for people looking to trade in private.
So far blockchain technology has been used to track financial transactions, but people are starting to explore its record-keeping capabilities in banking, sports, health care and even food safety. But that’s another story.
I want in. How do I get started?
You’ll need two things to start trading crypto: An exchange and a wallet.
An exchange is what you need to convert your local currency, like the US dollar, into crypto. Think of it like the NYSE where cash is converted into stocks or other securities. A wallet is where you store your crypto and it’s what allows you to send and receive crypto.
There are two main types of wallets: software and hardware. Software wallets run on an app or device and are useful if you want to actively trade. Hardware wallets are physical storage devices designed for holding crypto over the long term. It’s a bit like a vault. The thing to know about hardware wallets is that, while they’re highly secure, they’re not ideal for people looking to make quick trades as it takes several hours or even days to get crypto out of them.
Many companies provide wallets or exchanges. Some, like Coinbase, the largest crypto exchange in the United States, offer both.”We think it’s the best way to offer a new person in the ecosystem an easy entry point,” said Dan Romero, the GM of Coinbase Consumers.
But before you consider making a major investment, it’s important to remember that cryptocurrency is new technology. Tread lightly. “You shouldn’t put your life savings in it,” Romero warns.
It’s also important to realize that once you make a trade, you can’t reverse it. Be absolutely sure you are sending to the right person or institution. Mistakes cannot be undone. Oh, and there’s no insurance, either — if someone hacks your wallet and swipes your bitcoin, tough luck. Some exchanges, like Coinbase, offer insurance against company-wide hacks though.
Trades are made using public and private keys. A public key is like an email address and a private key is like the password for that email account. If you have someone’s address, you can send them an email, but you can’t access their emails unless you also have their password.
That’s how trading crypto works: You send and receive by giving out or using your public key but you have to keep your private key protected otherwise anyone can access your crypto.
What could possibly go wrong?
The biggest problem with cryptocurrencies is also what makes them so attractive to some investors: Their lack of regulation and decentralized nature provide buyers and sellers a degree of privacy they don’t get from traditional investments.
But that also means there’s little oversight or security and your investments are largely unprotected. That’s prompted many central banks to warn against using cryptocurrencies, and Warren Buffett went so far as to say bitcoin is “probably rat poison squared.”
Even Goldman Sachs, which announced in May that it would launch a bitcoin trading desk, recently seemed less sure. Its mid-year economic report said cryptocurrency is “neither a medium of exchange, nor a unit of measurement, nor a store of value.” UBS has voiced similar concerns, saying cryptocurrency is too “unstable” to go mainstream.
Investing always carries some risk, but for now the world of cryptocurrency seems more Wild West than stock market. Anyone thinking of doing so should think twice. And perhaps think twice again.