Headline: Intro to Crypto
Date: 1/22/2022
Body: First, I want to say a big THANK YOU to all of my readers!! My blog has been operating for a year now, and I have the urge to press on, in a slightly more detailed story arc. I conducted an exhaustively unscientific poll of my Facebook friends (and others) and realized how much interest there is in cryptocurrency. I also discovered that there is a HUGE amount of misinformation out there too. So, over the next few weeks, I will be looking at the history of cryptocurrency, how to possibly make money from it, and where it might be headed.
Caveat: I do not believe that ANYBODY should put a lot of their investable funds into cryptocurrency. Even writing these entries is making me very squeamish. True, it CAN make you a lot of money if you are exquisitely lucky, but it could also LOSE you a lot of money quickly!!! Caution is the watchword here.
Why am I so squeamish about this?
There are many risks when investing. When you invest in a company, there is always a risk of loss of value of your principle. Said another way, the value of the stock WILL change over time, sometimes to your benefit, other times, not to your benefit. But, for a certain company, this variation is usually within a pretty defined range, and happens pretty slowly, usually. When you invest in cryptocurrency of any type, the valuation is likely to fluctuate MARKEDLY. One day, your investment may be down, and the next day, your investment may be significantly better in valuation. Truly, “What a difference a day makes,” has never been more applicable. This volatility makes me squeamish.
When you make an investment in stock of a company, there is always the risk they could go bankrupt, and you could lose all of your money. But, when you invest in stock, even if the company declares bankruptcy, there will usually be some hard assets that the company can sell off to attempt to make their investors closer to whole. When you invest in a cryptocurrency of any type, they could declare it closed at any point and you lose ALL of your money. This risk makes me squeamish.
Finally, even if you place your money under a mattress, you do face a risk that inflation will eat away at the value of that money. But, those $100 bills are backed by “The Full Faith and Credit of the United States,” and regardless of your level of cynicism, this has been proven to mean something significant, over centuries. If investing in cryptocurrency, they have no real history, upon which to base their trust, so investors are trusting in the trust of millions of people around the world. Not to say that the U.S. has platinum bona fides on everything we do, but compared to many of the countries around the globe, our “Faith & Credit” mean something significant.
By the way, lest we forget, if you forget your password to your cryptocurrency wallet, you’re out of luck. Even if you have the equivalent of millions of USD in the wallet. If you forget your password (and this is VERY easy to do when changing computers, moving and dealing with real life) you are irrevocably out of luck.
But, seeing that so many people want to get into this space, I will approach it. I think the most instructive way to learn about many cryptocurrencies, is to focus on one of them. Because of this, I will begin with an abbreviated history of Bitcoin.
The Grand-Daddy of them all.
The introduction of Bitcoin can (and does) fill multiple textbooks. But the basics are a good place to start
For thousands of years, coinage has been made and usually linked back to an emperor or some kind of government authority, to represent a store of value. Bitcoin was started to phase out the need for this central authority to stand behind the coinage. It is known as a cryptocurrency because the use of bitcoin cannot be traced to a particular person, only a digital wallet Now, to be a store of value, there had to be some way to verify that the transactions were actually done. So, its backbone is called the blockchain, basically a distributed ledger which is open to all. They did need people to verify the transactions, and for this service, they were awarded a certain amount of bitcoin in compensation. Recently (especially as the value ratcheted up) more people are starting to accept trades of USD and other currency, in exchange for bitcoin. Despite some of these businesses being legitimate, hucksters, bamboozlers and frauds abound, so care must be taken. (Yes, a lot of the history has been eliminated here because it doesn’t seem too relevant.) Somewhat akin to currency from a government, the amount of currency has been capped.
A quick chronology of headlines might help get some context.
| Year | Headlines RE: Bitcoin |
| 2011 | The Electronic Frontier Foundation began accepting bitcoin as payment, and then suspended the program until 2013 citing legal concerns. |
| 2012 | Bitcoin Foundation was started with a mission to accelerate the global growth of bitcoin. |
| 2013 | Coinbase reported selling over $1 Million USD in bicoint within one month. The entire network was temporarily shut down when two groups used different versions of the software. FinCEN developed some regulatory guidelines. |
| 2014 | Newegg and Dell began to accept bitcoin payments. Mr. Buffett called bitcoin, “a mirage.” |
| 2015 | The number of merchants accepting bitcoin exceeds 100,000. |
| 2016 | The Cabinet in Japan formally recognized Bitcoin as having some properties like money. |
| 2017 | There is now a law in Japan to formally allow Bitcoin payments in normal commerce. |
| 2018 | George Soros refers to bitcoin as “a bubble.” |
| 2020 | PayPal announces that it will allow people to buy and sell Bitcoin, but not deposit or withdraw it. |
| 2021 | El Salvador now uses both USD and Bitcoin as legal tender. |
As can be seen in this brief chronology, Bitcoin has had some very sharp ups and downs in its acceptance. As volatile as that was, the valuation was even more volatile.
| Year | Value as of December 31st of that year. |
| 2011 | $4.25 |
| 2012 | $13.45 |
| 2013 | $754.01 |
| 2014 | $320.19 |
| 2015 | $430.57 |
| 2016 | $963.74 |
| 2017 | $14,156.44 |
| 2018 | $3,742.70 |
| 2019 | $7,193.60 |
| 2020 | $29,001.72 |
| 2021 | $45,819.95 |
As eye-popping as these valuations are, the variability is even more impressive (read, SCARY.) In point of fact, sometimes during the overnight period, Bitcoin prices can easily change by $1,000 or more. If it’s to your advantage, then, Kudos!! If not, then your potential gain could turn into a very real loss.
How does one obtain Bitcoin?
Well, this is easy, or VERY hard. Let me explain. You could go to a reputable buyer/seller of Bitcoin and purchase it directly from them. Or, you could “mine” for Bitcoin.
What is Bitcoin Mining?
Before we start, I should say that Bitcoin mining is a VERY expensive process. It is quite likely that it will not be profitable for most people.
OK, Bitcoin mining is a procedure in which new bitcoins are brought into circulation, and it is related to how new transactions are confirmed by the network. The mining procedure seeks to solve very complex mathematical problems, and the first system to solve them gets the new block of Bitcoin. In the beginning, a person’s Zenith computer in their dorm room could be left on with software running, and they might occasionally have a shot at some Bitcoin rewards. But, it is important to note that Bitcoin miners these days have the equivalent of supercomputers working night and day (consuming A LOT of electricity) and frankly, the lone home computer or laptop has more chance of getting hit by lightning than being first to solve anything of consequence. The bottom line here is that you stand a lot better chance of getting Bitcoin by purchasing it.
This picture is from an article online about police in Malaysia shutting down illegal Bitcoin miners. (Link to story below.) But, it does get across the concept that your laptop doesn’t stand a chance.
The Verdict
The verdict on Bitcoin is very much akin to your parents’ ideas on ice cream. A little might be ok, but a lot and you’ll probably have a terrible headache. The valuations are out of sight, and as the markets recover normality after COVID, it seems likely that valuations could increase. The problem I have is this. What if one large pension firm gets nervous, and pulls their Bitcoin investments. Then a second. And a third and fourth will certainly follow. (all of this could take less than a day, mind you.). At the end of this very bad day, what is the individual investor left with but dreams of potential glory, and a very upset partner? Please join us next week when we look at metaverses.
REFERENCES
https://www.investopedia.com/tech/how-does-bitcoin-mining-work/
https://www.businessinsider.com/malaysian-police-steamroll-1069-bitcoin-mining-rigs-video-2021-7
Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice. Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.