Introduction to Cryptocurrencies from a non-tech early adopter
I know this is the x-th such introduction online; I have myself written countless of these in private and I am not sure there is additional specific value in my own view on what an introduction to crypto should include, but since I am being asked by too many people to write up individual emails, I will put it in writing here.
In my view there are three types of Crypto assets:
This was the first use case for crypto and remains its most established. Cryptocurrencies aim to offer a digital, decentralized medium of exchange and/or store of value. Decentralized in this case means that instead of having a central clearing house (like a Bank) that holds your assets and confirms transactions are valid, there is a network of computers that constantly confirm every transaction on the decentralized ledger (a process called “mining”). Therefore, at least in theory, cryptocurrencies cannot be hacked and enable “trustless” transactions. The main cryptocurrencies are Bitcoin, Litecoin, Dash and Zcash. There are numerous others as well.
2. Protocols / Platforms / Blockchains
Separate blockchains differ from cryptocurrencies in the sense that they are really trying to enable different blockchain based projects instead of functioning as a medium of exchange. Typically they will try to improve on the existing public blockchains to offer more functionality. The most important such Blockchain is Ethereum, which enabled “smart contracts”. While Bitcoin enables transactions from A to B, Ethereum enables IF THEN loops. By extension it enables applications to be hosted on Ethereum, so called dApps (decentralized apps) and you could well think of it as the backbone to the future Internet. Other such platforms are Lisk (enabling programming in JAVA on the blockchain), Stratis (similar to Ethereum, more advanced in mining method currently), 0x or Tezos (smart contracts with a priori verification).
Token are the main outlet of the current cryptocraze. I classify as a token any kind of early participation in a start-ups product or profits. This is the vast majority of the number of crypto assets out there. Token will generally be ICOed (initial coin offering) on one of the blockchains above, similar to an IPO on the stock exchange and will either carry the promise of a future use to pay for a company’s products or even carry a right of income participation. In essence, token are (as the SEC has confirmed) often similar to securities, but the space is currently almost entirely unregulated. Most token currently get launched on the Ethereum network. It is important to note that only a tiny, tiny fraction of token actually offer equity status. Maybe 3–4% offer a participation in income and the vast majority offers nothing but a future promise.
Becoming part of the Cryptoworld
People who want to become a part of this world should, in my view, read a lot of other posts next to this one and maybe even pick up the book “Mastering Bitcoin” at some point. There a lot of more qualified people out there that share their knowledge on Twitter or Medium or other platforms. It is easy to find. In any case there are a few basics I can explain here.
Bitcoin is the first (some would say that was Digicash) cryptocurrency. It is a medium of exchange and a store of value. Bitcoin was started in 2009 and has since appreciated in price from a fraction of a USD cent to more than $4500 per Bitcoin. In essence, you can think of Bitcoin as a version of digital gold. Like gold, its ultimate supply is limited, like gold it is “mined” and like gold it is only worth anything if other people believe that it is. With gold, you can be certain that people keep believing in it based on history. With Bitcoin you need to take a leap of faith. The big advantage over fiat money is that there is no central authority that can increase the supply and nobody can control the network in any way. Also, given its technical properties and decentrality it is immutable and no government is able to interfere with it. Bitcoin has already achieved the status of digital gold and it is unlikely, despite its volatility, that it will lose this status in our life time (opinion!). In terms of valuation, there is no doubt in my mind that we are in a short term bubble (see an earlier post in my history), but just as an idea if Bitcoin were to become as valuable as gold, each coin would be worth c. $350.000.
As discussed above, Ethereum is a blockchain like Bitcoin but represents a technological advancement in the sense that it allows IF THEN loops (smart contracts). It’s supply is not as limited as Bitcoin’s and in my view it derives most of it’s value from actual economic application and use of the Ethereum blockchain for dApps (which if they run on it will need to use ether, its “currency” to pay for transactions) as well as a platform for the token discussd above (the main one anyways). Importantly, it is not technically a cryptocurrency. It also should not really be confused with a store of value. Another key difference to Bitcoin is that Bitcoin’s founder (Satoshi Nakamoto) is anonymous. Ethereum however does have a central organization “the Ethereum foundation” that wields considerable influence. Of course in Bitcoin you have large miners and exchanges that also influence others, but as Ethereum’s main founder, Vitalik Buterin, is known, his influence can be compared to that of Steve Jobs over Apple followers. This is a weakness and a strength at the same time.
Despite the name, which implies that this is a place where you actually hold your coins, a wallet is closer to an internet browser. Instead of browsing the web, you are browsing and interacting with a blockchain. That means your coins are never “physically” stored in a wallet, instead they are on the blockchain on a public address. Every wallet can create unlimited numbers of such addresses that are all anonymously (though there is technology to reduce this) connected to each other. What is stored on your wallet is your private key or mnemonic. This is the actual piece of value that you need to protect (you can export this with most wallets). Anyone who has your private key can interact with any of your public addresses. That means that person controls your coins. If you lose your private key you have no way to recover your assets. There is no “I forgot my password” in crypto.
Some wallets that I believe to be of high quality (note I am not an expert) are Jaxx.io (for mobile phones; great user interface BUT YOUR KEYS ARE STORED ON YOUR PHONE, you lose your phone you lose your keys) for almost all the major crypto assets, myetherwallet.com (note httpS://) for ether and ether token and the individual ones for other blockchains (ie lisk for lisk). In terms of more secure but still easy to use solutions I prefer Ledger Nano S, but other people like Trezor. Both are considered good options.
Proof of Work vs Proof of Stake
These are ways in which the decentralized ledger (the blockchain) gets confirmed. In Proof of Work, participating “miners” have to solve difficult tasks and confirm each transaction that was ever done to get rewarded with new coins. This involves very high energy consumption and is currently the main method of confirming the ledger in Ethereum and Bitcoin. Proof of Stake is an alternative method where “miners” bid on the correct version of this ledger and if the majority agrees they are rewarded and if not they lose their stake. I am not sure exactly as to whether these are truly on equal footing in terms of security, but that seems to be the majority opinion. The only way you could “hack” the blockchain is by owning 51% of mining power which is by now considered impossible. Ethereum is planning to switch to Proof of Stake at some point, while others like Lisk already use it.
Blockchains are mostly decentralized and nobody owns the majority of coins or mining power. Therefore people will disagree from time to time. When this happens and incentives are structured in a certain way, a chain will split. This happened several times. There is an “Ethereum Classic” (which is not classic at all in the sense that most people would use this word here) and there is a “Bitcoin Cash”. However, neither are the “right” Bitcoin or Ethereum. This mechanism of having to build consensus for improvements is a great positive attribute of blockchains but certainly a risk when looking at it as an investment. When a chain splits you will hold both coins in your wallet and the sum can be larger or smaller than what you started with in terms of fiat money. It always comes with uncertainty.
The easiest way to buy coins is via an exchange. Most exchanges are by no means anonymous anymore and the notion that you will forever be anonymous holding bitcoin is false. Sophisticated software can track your coin as it jumps from one address to another and ultimately gets converted to fiat at some exchange at which point your name can be found out by authorities. It is not therefore as much of a black market tool as people generally seem to think. However, just like with cash, it can be used illegally. Anyways, an exchange is very much like a stock exchange where all kinds of cryptoassets get traded for fiat or other cryptos. Most exchanges provide “markets” for each asset in USD, BTC and ETH. It is important to note that the “largest” exchanges only capture 10–15% of trading in a given coin, so that trading is still very scattered and by extension illiquid in crisis situations. This is important to bear in mind. When everyone heads for the exit, you might not even be able to reach the server of your preferred exchange. There are centralized exchanges (which hold parts or all of your private keys and are generally vulnerable to hacks; they usually try to mitigate this issue via cold storage solutions where the keys are offline) and decentralized ones. Notably, centralized exchanges have physical addresses and can be targeted by governments just like any stock exchange. Decentralized ones do not have that and exist only online, but usually do not offer fiat conversions. Note that USDT (Tether) is NOT equivalent to US Dollars. They claim it is backed up but audits are hard to come by and after all they might or might not be in line with regulations with what they do, so just don’t assume it is the same as actual US Dollars.
The main exchanges I find useful are Bittrex, Kraken, Bitstamp and Etherdelta. All of them offer account opening and verification on their websites. You never want to leave your coins on an exchange. It can be hacked (google “Mt Gox hack”). Always send them to one of your addresses to which you have the private keys (a wallet).
Finally, as this is a typical follow up question: Would I invest into cryptocurrencies? Yes I would. Noting that this is my private and unprofessional opinion and it is not investment advice. It also means you need to be aware of your local rules and regulations before. Also please read my earlier post on this topic: https://medium.com/@dennyk/updated-cryptothoughts-bubblemania-95229aed7639 as I do think we are in a bubble at this point and there are many, many risks that you need to be aware of and it might make sense to stretch out any investment you decide to make.
A short word on Crypto funds and other ways to invest in an “easier manner” than by handling all the above yourself: It is not a good idea in my opinion to actively help other people to invest (ie by providing a vehicle or by doing the transactions for them) and by the way, the “Bitcoin Trust” is selling for TWICE its value that is actually backed up by Bitcoin. Do your own research and read this great article: https://medium.com/@twobitidiot/losing-alpha-why-most-new-crypto-funds-are-a-sh-t-deal-98ea0013971a
1) Regulations to manage other people’s money = nightmare
2) being the one who lost the assets of your friends because he chose the wrong exchange to park them when he wanted to trade, managed cold storage wrong = nightmare²
3) being the one who helped all your friends get rich on paper = great
4) experiencing when all these guys who have zero clue about crypto see that assets are tanking because of a 2x split, an SEC letter or anything else (tulips) = nightmare³
ICOs are initial coin offerings. There are multiple good posts on them on Medium and I do not really have anything to add instead of DO YOUR OWN RESEARCH. If you participate in an ICO you are giving a start up potentially a lot of money in exchange for vague promises. Not always, but often that is the case…
Thank you for reading and do let me know if anything here is completely wrong. Cheers are appreciated if you found it useful.