A lawyer friend asked me about bitcoin… Part 2: Picking and Buying Coins
In the last article I explained what bitcoin is and why it might be something interesting. Hopefully, after reading it you’ve done a lot of research on your own and decided it actually makes sense for you. Or you decided it’s a scam; a bubble; a conspiracy. This is OK too. If this is the case you can stop reading this right now. I don’t feel like convincing anymore.
Before you read any further, please be aware of the following:
1. I am a great fan of cryptocurrencies and blockchain tech in general. So, you might say I’m biased in this way.
2. Crypto is new, complicated and difficult in the beginning. The learning curve is steep. So, if you are really interested, do your own research. A lot of it! Don’t take anything I, or anyone else for that matter, says at face value. (you too J!). Trust no one. Including me. I can only present my thoughts and opinions on the subject. I don’t even try to pretend I know THE truth or THE answer.
3. If you are looking for investment advice, here it is: invest in yourself, in your knowledge, understanding of the technology and economics, and in experience.
4. I will discuss some very complicated and complex ideas and technologies in the simplest way possible. But this requires (over) simplification and using analogies that are not always perfect or accurate. Luckily, with the internet you can find plenty of resources on the subject.
More than bitcoins
Besides bitcoin, there are about 1300 other cryptocurrencies out there. They share a lot of similarities with bitcoin — run on a distributed, peer-to-peer network, use cryptography to secure transactions, and use open source code. They are also very different from bitcoin in many ways, offering different functionalities or using different algorithms to secure the network. I decided to look into coins other than bitcoin (some call them altcoins) because of their growth potential. The price of Bitcoin, the most popular coin with the biggest market cap (the price multiplied by the total number of coins), grew from around $1k a year ago to about $16k now. This is a 16 fold increase in price. Ethereum, the second biggest by market cap, grew from $8 to about $750 in the same period of time. This is a 93(!) fold increase in price.
Generally speaking, there are 3 ways of getting cryptocurrencies: 1. you can buy them from someone who already has them (on an exchange, from a private seller or a company). 2. You can earn them doing something for the network that issues the coins. A good example is bitcoin mining: selling your computing power to the network in exchange for newly created bitcoins. (this is an oversimplification, but if you want to know more about mining read this 3. Buying newly issued coins from someone who is creating a completely new coin during an ICO (initial coin offering). This article will focus on buying existing coins from someone else.
I will not describe here the mechanics of buying the coins. I will not answer questions like what is the best website to buy bitcoin, what is the best exchange, wallet etc. First of all, there are plenty of great resources answering these questions. Check out https://www.buybitcoinworldwide.com/ and https://www.coindesk.com/information/how-can-i-buy-bitcoins/ . Use google, reddit (well, depends how old you are — not for everyone’s taste ;-) ) and quora. Secondly, your specific case is different than mine. The best solution for your case depends on where you live, how much money you’d like to invest, how are you planning on dealing with your taxes, how comfortable you are with technology etc. Finally, the market situation, regulations and available products/solutions change very rapidly. What worked in December 2017 might now work at all in January, or there might be even something better out there.
What I will do is share some observations and tips based on my personal experience. Here’s the list:
- Most cryptocurrencies can only be bought with other cryptocurrencies (not with $ or £). This means that in order to buy them you first have to buy bitcoin (most cases) or Ethereum. You can use this website https://coinmarketcap.com to determine where to buy a specific coin (which exchange). Click on the coin and then click on the Markets tab. This will give you a list of markets/ exchanges that trade which specific coins (for example: https://coinmarketcap.com/currencies/cardano/#markets )
- Because of item 1 above, you’ll probably need several accounts with different exchanges/websites: one to convert your cash into bitcoin and another to convert your bitcoins into other coins.
- Make sure you are comfortable with the level of security and compliance of every website/exchange you are using. Is practically impossible to hack the bitcoin blockchain, but if you are using a third party service to keep your coins, your account with them can be hacked, just like with a paypal account or online banking. Also, you don’t want to have your accounts frozen because the service is incompliant with Know Your Customer (KYC) and Anti Money Laundering (AML) regulations in your country (or maybe you don’t care, but be aware of this risk).
- Check the fees the websites/exchanges will charge you. Check the exchange rates they offer. Check it both ways, i.e, converting $ into crypto and the other way round, crypto into $. I learned that in the UK, for example, you can convert £ into bitcoin relatively easy, paying with a debit card, but converting it back to £ is more difficult, as many banks don’t want to deal with anything crypto. So you end up in a situation where your bitcoins are converted into EUR and then you still need to send them to the UK £ account. This costs a lot in conversion rates and fees.
- Make sure you understand how crypto-wallets (let’s say an equivalent of a bank account) work. Read about the options and implications (maybe here: https://www.coindesk.com/information/how-to-store-your-bitcoins/). Please remember that if you are using a website/exchange, they effectively hold your coins for you in their wallet, like a bank holds your money in their account for you. You might also decide to keep your coins in your own wallet that you have on your phone, laptop of even completely off line. The second option means there’s no custody risk (an exchange being hacked or going bankrupt) but there’s also no one to call if you forget/lose your private key or someone else gets ahold of your key.
- Be very vigilant when sending coins to another wallet/address. There’s no ‘undo’ button. The addresses are difficult, if not impossible, to remember and hardly user friendly (so be very careful when copying-pasting or scanning the QR code).
- If you send your coins to a wrong address, or you send a wrong type of coin (bitcoin to Ethereum wallet) the coins will most probably be gone.
- Due to the above, I’d recommend starting with small amounts first. Try out several websites, apps, exchanges or wallets with small amounts. See what the fees are, how comfortable you are using the service, what it’s like to buy bitcoin or Ethereum and then trade it for a different coin. It is a completely new industry and a completely new experience. It has hardly anything to do with shopping on Amazon or using Paypal. So you might make a mistake in the beginning (this is ok, just a natural part of learning). Making a small mistake with a smaller amount hurts less than making a big mistake with all of your investment money.
- Investing into crypto is very, very, very risky. Only invest money you can comfortably lose without causing any major drama in your life.
- (Keeping the above in mind,) Once you are comfortable with the services you are using and have a good idea of which coins you’d like to buy, invest an amount that is somewhat meaningful to you. Investing, say 0.1% of your monthly income will not make a difference if you lose all this money. But it will not make a difference either if your investment gains 1,000%. You’ll end up with assets worth just 1% of your income (vs 0.1%).
- Keep track of your coins. Use a simple spreadsheet (or a fancy one like here: https://jbuty.com/how-to-get-crypto-currencies-rates-and-more-in-google-sheet-1a57e571bc14 ) or a website/app (https://cointracking.info/ for example) to record the amounts you spent, what was bought, dates and prices. This way you’ll be able to see how your coins are performing, what works, and what doesn’t work.
- Do it. There is no substitute to experience. Reading about cryptocurrencies, following prices on line, and thinking and talking about it has nothing to do with actually putting your money on the line.
As mentioned above, I decided to invest in bitcoin and other coins having in mind diversification (not all eggs in one basket) and growth potential. I started by pulling up the list of all the coins and reading about them one by one, starting from the top. I noticed pretty quickly there are over 1,300 coins, so I need a system to filter them, as I don’t have enough time to do thorough research on each coin. And with the amount of new coins created every week, new coins would show up on the list faster than I’d be able to go through the list.
The first step for me was to divide all the coins into the following categories:
- Coins. Like bitcoin, their only function is to be a simple coin, an account entry. You can have it on your account and send to someone else. This is it. Just like $.
- Platform coins. Like Ethereum, they offer more than simple coins. They exist on a network that offers additional functionalities like the ability to write and run custom software. The coins are usually used to pay the network for its resources, like computing power, bandwidth, storage or memory. This ability of the Ethereum network makes it possible for anyone to issue their own coins/tokens and contributed to the recent explosion on the ICOs.
- Utility coins/tokens. These coins are linked to a specific service. They can be used to pay for a specific service (cloud storage), receive a discount on a service or allow access to a service. They are often issued on another network, like Ethereum.
- Other. Everything else not being 1–3. From coins that represent equity in an investment fund to coins (supposedly) 100% backed by $.
The second step was to realize there are 2 types of projects/ventures out there: the ones truly embracing the open source, decentralized, distributed approach and the others, that are really closed, centralized and only use blockchain as a marketing stunt and/or get cheap, unregulated capital.
Next, I found this website: https://www.coingecko.com/en . On top of prices, it publishes information about development activity and community and public interest for each coin. The website explains in detail how the data is gathered and how the score in each category is calculated.
Finally I was looking into the teams behind each project/coin. I checked their websites and Linked In to see who is on the team, what is their background, experience and how many people in total are involved.
I decided not to invest in any coins from category 4 above (other) and focus primarily on category 2 (platform) then on category 1 (coins) and consider category 3 (utility) only as long as I have a clear understanding of where the value of the coin/token come from. I also decided to focus on projects that are as open sourced and decentralized as possible (this is why Ripple is not on my list), with a high development rank and strong teams. I didn’t care about the community and public interest score. Actually, the lower the score the better, as I wanted the coins to be discovered by the masses after I buy them. Finally, I didn’t buy any coins that I don’t understand. If there’s a team issuing coins to launch a project, I want to be able to understand the idea and technology behind it, at least in general (this is why Iota is not on my list. I don’t understand the tangle technology or the Internet of Things — IoT industry in general).
After doing all of this I ended up with a list of 10 coins. Before I decided to buy them I went through the list once more and asked myself is this something I want to support with my money? If nothing else (say the value goes to 0), will it feel good knowing I was (indirectly) a part of this? The answer was yes. I believe in every one of these projects. Here’s the list, with a brief description, explanation of why I picked it and the price I paid.
ADA — Cardano, I paid $0.21 per coin
A new smart contract (custom software) and payments platform in development that aims to solve issues of scalability (more transactions and users) and interoperability (connecting to other blockchains and financial services). I love their energy efficient Proof of Stake protocol, their scientific, peer-review based approach to development and transparency. But my favourite aspect is that they put so much emphasis on governance, thinking ahead about the socio-economic implications of their protocols. And they have a great, experienced team.
BTC — Bitcoin, $16,676.10
The king of cryptocoins. In my opinion it is no longer a currency. This year bitcoin emerged to become a global value storage instrument. I don’t like how wasteful the bitcoin protocol is in terms of energy consumption (more on this aspect there: https://medium.com/the-mission/crypto-mining-icos-whitepapers-review-hydrominer-ice-rock-miner-and-envion-d6a50c1ba781 ) or the incentives for centralization, but it is the first, oldest, most tested and used cryptocoin, with a huge community, resources and momentum behind it.
ETC — Ethereum Classic, $30.63
A continuation of the original Ethereum blockchain. In July 2016, the current Ethereum (ETH) blockchain branched off (or ‘forked’) from the original blockchain in the aftermath of the DAO hack. The original blockchain was no longer supported by the official Ethereum Foundation, but it wasn’t abandoned by the community, who started calling it Ethereum Classic.
ETC is a smart contract and payments platform. It is (obviously) similar to ETH is many aspects, but different in many aspects, the most important being governance. It was born out of belief that transactions on the blockchain can’t be reversed (this is what happened with the ETH fork: transactions deemed to be the result of the DAO hack were reversed). The supply of ETC is also finite now, so ETC is a deflationary coin now.
I like the fact that there’s a big community and a lot of smart people (like https://iohk.io/projects/ethereum-classic/ and https://twitter.com/IOHK_Charles) backing up this project and their approach to governance and introducing changes.
ETH — Ethereum, $670.00
Ethereum is a smart contract platform that gave us the explosion of ICOs. It is, itself, one of the most successful ICOs ever, has a growing community, a lot of smart people, momentum, money and experience behind it. Oh, and it’s the second biggest coin by market cap. It is currently the biggest, most popular smart contract platform. It is the benchmark for any other platform out there. Some say that the Ethereum killer is… Ethereum
LSK — Lisk, $10.47
Lisk is also well funded (after a successful ICO) and is creating a strong development team.
NEO — NEO, $67.91
Another smart contract platform. This one is made in China and focuses on creating the environment for digitizing assets and digital identity. It has been around since 2014 and there are already working apps on the network and more are being developed. Once the ICO ban in China is lifted, NEO will most probably be the first choice platform for all Chinese projects (and it’s a big market).
RDN — Raiden Network Token, $3.78
This project aims to solve the scalability, latency (speed of transactions), transaction fees and privacy issues of the Ethereum network. It is supposed to work as an add-on to the Ethereum network and is compatible with all Ethereum coins/token (so currently serves most of the 1300 tokens with more coming). It is also supposed to be a solution for IoT. If done right, everyone using Ethereum will use the Raiden Network.
SNT — Status, $0.17
A mobile operating system on Ethereum. RDN solves issues with ‘the piping’ (backend), SNT solves the issue of the user experience (frontend) and helps with the seamless, (potentially) mass adoption of Ethereum as the standard for a private operating system for mobile devices. If done right, this can be the AOL moment of blockchain
XMR — Monero, $319.36
A simple coin (not a platform or anything else) that is private and untraceable by default. All Bitcoin transactions are public and can be traced. Same with wallets. The balance and transactions can be seen by everyone. Not with Monero. I believe privacy is a very important feature that adds a lot of value to the coin. Additionally Monero uses a Proof of Work protocol that promotes distributed mining.
It is not my goal to convince you to buy the coins I listed. Quite contrary. I’d love you to challenge me. To point out flaws in my logic or suggest other, better coins. More importantly, I’d like you to start doing your own research, because this is the essence of decentralization, open-source and the crypto-currency revolution happening now: no more trusted third parties, brokers or experts, who know better. You can be your own expert, broker, bank and investment fund!
So again, start doing your own research. Educate yourself. Work on understanding the technology and the logic behind it. A great way to start is reading/watching the following people:
Just keep in mind they are not gurus. They are just some people on the internet, like everyone else, who are just a bit smarter and more experienced than the average with cryptocurrencies.