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A simple easy-to-understand guide to cryptocurrency

Over the past month, I have received quite a number of questions on cryptocurrency.

Everyone keeps asking what If I think it’s a viable investment option

As I always say, I do not invest in what I do not understand and cryptocurrency is one of those options

However, I took up the challenge to do some research in a bid to understand how it works.

A little knowledge does not hurt, right?

So today, I’m going to try to break it down in simple English so when you get into a conversation about ‘Crytocurrency’, you won’t bite your tongue  (Lol…it’s a tongue twister, right?) but speak intelligently

Here goes…

 

What exactly is cryptocurrency?

Cryptocurrency is simply a digital currency that uses encryption to generate money and to verify transactions.

Let me break it down. 

digital currency‘. It’s a medium of exchange but it is digital. Digital coins are stored in digital wallets and transferred digitally to other peoples’ digital wallets. No physical object ever exists. It was created as an alternative currency to traditional currencies such as the U.S. dollar or Naira.

uses encryption‘ . This means it is created with the use of an extremely complex code system to protect sensitive data and transactions.

Cryptocurrency developers build these systems using advanced mathematics and computer engineering principles. These principles make the currencies virtually impossible to break, duplicate or counterfeit.

These protocols also mask the identities of cryptocurrency users making it difficult to know the specific individuals or groups you’re trading with.

What’s the difference between cryptocurrency and other currencies, apart from it being a digital currency?

A key difference between cryptocurrency and traditional currencies is while traditional currencies are backed and monitored by a central monitoring authority such as a Central bank, cryptocurrency is not.

To give an analogy, when you purchase an item, you pay cash right? or you do a transfer from your bank account to another.

Before your payment gets to the other party, it has to go through a central system (a regulatory authority that monitors that currency). This central system reviews the transaction, approves it and sends it to the other party

With cryptocurrency, the central system is a public network.

  • If you want to make transaction, you simply broadcast to the cryptocurrency’s network that you’re transferring ownership of some cryptocurrency of yours to someone else.
  • The network verifies your transaction (that you do own the cryptocurrency your spending and that you haven’t spent it before), and adds it to the public ledger

What is Bitcoin?

Bitcoin is the most popular and widely-used cryptocurrency. It was created by an unknown programmer or group of programmers under the name Satoshi Nakamoto in 2009.

Bitcoin is increasingly viewed as a legitimate means of exchange. Many well-known companies (Microsoft , Dell ,Wordpress and Time Inc)  now accept Bitcoin payments, though what they do is to partner with an exchange to convert Bitcoin into U.S. dollars before receiving their funds.

Litecoin is the second most popular by market size.

Ethereum was introduced in 2015 and is gaining ground because of it’s improvements on Bitcoin’s basic architecture

There are hundreds of other cryptocurrencies and more are getting created every week.

 Is it Bitcoin really a currency or  a speculative asset?

I had an argument with a friend recently. I didn’t really understand how Bitcoin, or any other cryptocurrency, is a currency in the true sense of the word.

and that’s because of two key reasons;

It’s value is too unstable. think about it, one of the key issues we’ve had with Naira (here in Nigeria), for a while now, has been the volatility in value and the effect on the economy. It was quite difficult to plan purchases or predict future earnings because of this.

An economist will tell you that the most important feature of a currency is it’s use as a stable store of value. On May 24th 2017, Bitcoin hit an all time high of $2,791.69 but dropped 18% in less than a week.

I honestly do not think it can really become a currency without a stable value

Secondly, you have to find someone else willing to buy from you before you can sell. It’s not easy to facilitate a transaction with cryptocurrency unless the other party is willing to trade. Currencies are used to facilitate transactions, and not just to make more money.

Given these drawbacks, the only reasons to own cryptocurrencies is not to use them as a currency, but to either speculate on their asset value or use them to shield transactions from others.2

Should I invest in cryptocurrency?

Hmm…The BIG question.

Should I invest? It looks profitable and most of us just want to make the quick buck but please ‘Shine your eyes’ (local slang)

Cryptocurrency is an exciting innovation but be cautious. Invest in what you understand and study the risks involved before you invest.

There are so many new digital currencies and I see quite a number of people rushing to invest.

Don’t be in a hurry to invest in any new currency, there might not be adequate demand to drive the value up and you’ll be stuck with a digital currency nobody wants to buy

Have you invested in any digital currency? What was your experience?

 

 

Notes.

  1. http://www.moneycrashers.com/cryptocurrency-history-bitcoin-alternatives/
  2. https://www.forbes.com/sites/jeffreydorfman/2017/05/17/bitcoin-is-an-asset-not-a-currency/#2e0bd2a42e5b
  3. http://cryptocurrencyfacts.com/what-is-cryptocurrency/
  4. http://www.wired.co.uk/article/bitcoin-101

4 Comments

  1. Thank you for helping to break down this cryptocurrency gist.
    As advised, it is best to invest in what you have good knowledge of and steadily too. All these rush for a quick buck calls for caution. Have a great weekend!

    • You’re welcome Seyi. I’m glad you understand that investing is a long-term play and every rush for the ‘quick buck’ should be handled with caution

  2. Cryptocurrencies/Bitcoin(s) is/are not ‘a quick buck’ scheme; it is just a different means of transacting that is new and that many are wary of because they do not understand it. Also EVERY currency in the world fluctuates either due to macro or micro forces. The top companies in the world who trade in cryptocurrencies have done their homework.

    Is it safe for investment? Obviously, there are considerations like if the investor is looking to play for the short or long term, as well as the amount of knowledge the investor has on the cryptocurrencies market – AND, very importantly, how to secure these currencies.

    Finally, global “banks” (a term that is now becoming more fluid) are beginning to be more open to bitcoin and blockchain technology, which provides a degree of information on who is trading what.

    Cheers

    • Hi Ken Long
      Thank you for your comment.

      I totally agree. Cryptocurrencies should not be seen as a quick buck scheme, however, that’s what you’ll find if you ask 70% (that’s being conservative) of those who have invested in it, especially in Nigeria.

      and you’re right, every currency fluctuates either due to macro or micro forces and that’s why we have Central authorities who participate in an attempt to influence or protect the value of their floating currencies. That’s not available for cryptocurrencies and i’m not saying that’s bad. I’m just saying that’s why it’s a speculative asset. In fact, the Ethereum flash crash, last month (June 2017) shows how super risky the cryptocurrency market is.

      I agree it is safe, as long as the investor knows enough about the cryptocurrency. Big failures such as Spacebit, Dodgecoin show you can’t invest based on market hype alone.

      Yes, the block-chain technology is the future and that’s why global banks are becoming more open to it. The block-chain technology is currently driving financial inclusion in great ways in Singapore and Kenya.

      Cheers

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