Cryptocurrencies are a new and interesting evolution in how people trade value. It lets you take the concept of money and move it online with the ability to trade value securely through a token. They are essentially a line of numbered “code” (instructions used in computer programming).
Once purchased tokens can be exchanged for some goods and services, like normal money. It isn’t backed by any single government or organisation, and it’s only worth something because people are willing to trade it for goods and services.
There are a number of Cryptocurrencies including Bitcoin, Ethereum, LiteCoin, Neo and Monero (with non Bitcoin currencies often called altcoins) but the Bitcoin blockchain is the oldest and one of the largest blockchains in the world.
Bitcoin was created in 2009 by an unknown person using the alias Satoshi Nakamoto. In the original Bitcoin white paper, Nakamoto describes his creation as a “peer-to-peer version of electronic cash”, allowing “online payments to be sent directly from one party to another without going through a financial institution”. Transactions are made with no middle men – meaning, no banks! Nakamoto wrote that such a currency uses “cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party”.
Many marketplaces called “Bitcoin exchanges” allow people to buy or sell Bitcoins using different currencies. Coinbase is a leading exchange, along with Bitstamp and Bitfinex. Each Bitcoin has a unique fingerprint and is defined by a public address and a private key. Owners of Bitcoin do not own a physical coin, but instead a string of numbers and letters that give a specific identity. However, security can be a concern – Bitcoins worth tens of millions of dollars were stolen from Bitfinex when it was hacked in 2016.
People compete to “mine” Bitcoins using computers to solve complex maths puzzles. This is how Bitcoins are created. This sort of stateless, bank-free currency uses a distributed, cryptographically secure “blockchain” to record payment transactions. Recording of payments onto the blockchain is powered by users, who offer their computer power. They are rewarded with newly created Bitcoins, and this activity is referred to as mining.
The most successful miners have robust systems that can outperform slower miners. Early in its history, you could run the Bitcoin protocol and earn Bitcoins on a desktop computer. Now, in order to have any hope of ever receiving Bitcoins, you need to purchase expensive specialized equipment or use a cloud service.
Each network has a unique way of generating (mining) cryptocurrencies. Bitcoin, for example, rewards peers (known as miners on the Bitcoin network) for “solving the next block.” A block is a group or entries. The solving is finding a hash that connects the new block with the old one. This is where the term blockchain came from. The block is the group of entries, and the chain is the hash. Hashes are a type of cryptologic puzzle. Think of them as Sudoku puzzles that the peers complete to connect the blocks. Ultimately, blockchains are ledgers, which society has been using for thousands of years to keep financial accounts.
Bitcoins are stored in a “digital wallet,” which exists either in the cloud or on a user’s computer. The wallet is a kind of virtual bank account that allows users to send or receive Bitcoins, pay for goods or save their money. Unlike bank accounts, Bitcoin wallets are not insured or protected in any way.
Though each Bitcoin transaction is recorded in a public log, names of buyers and sellers are never revealed – only their wallet IDs. While that keeps Bitcoin users’ transactions private, it also lets them buy or sell anything without easily tracing it back to them. That’s why it has become the currency of choice for people online buying drugs or other illicit activities.
The fact that transactions are untraceable makes it a dream come true for drug dealers and money laundering, and it is the currency of choice for cyber criminals.
Online crooks who launched the massive WannaCry ransomware attack in May 2017, which crippled part of the NHS, demanded Bitcoin payments from organisations to regain access to their systems. It targeted computers running the Microsoft Windows operating system by encrypting data and demanding ransom payments in the Bitcoin cryptocurrency. The attack was stopped within a few days of its discovery due to emergency patches released by Microsoft. The attack was estimated to have affected more than 300,000 computers across 150 countries, with total damages ranging from hundreds of millions to billions of dollars.
The ill-gotten gains can be transferred across borders and withdrawn in any currency or spent on the dark web (a collection of hard to find websites where it is impossible to track the user).
The European Union has proposed treating cryptocurrency markets as a security threat due to its potential links to criminal laundering and terrorists.
What determines their value?
Like many things, it comes down to supply and demand. New Bitcoins are released at a rate of about 25 new coins every 10 minutes.
France and Germany’s Finance Ministers have both agreed to a joint crackdown on cryptocurrencies as the global fightback against the bitcoin boom continues.
In China and South Korea, in particular, initial coin offerings have rapidly become part of the local, and very popular, gambling culture. In July 2017 a breach led to 30,000 accounts being hacked on Bitthumb, a local exchange, with an unspecified number of Bitcoins being stolen.
South Korea has joined a number of regulators and governments attempting to dampen bitcoin fever, in the case of the Seoul government by considering banning digital currency exchanges in its jurisdiction.
In doing so, it would be going even further than China, which is planning to turn off cheap power for bitcoin mining and last September banned initial coin offerings.
China is said to be stepping up efforts to curtail Bitcoin trading, and was said to be looking to block access to mobile and online apps and sites that offer exchange services in digital currencies.
But the proposed move by South Korea would go even further, meaning an outright ban rather than restricted access, and is reportedly inspired by a desire to target “speculative frenzy and crime” associated with cryptocurrencies.
Mark Wilson, the CEO of insurance company Aviva said “One of the keys to sovereignty is control of currency and tax,” “Cryptocurrency interferes with both of those, so it’s inevitable there will be regulation. It is as inevitable as snow in Davos.”
“China has already taken action and banned it. Other countries will follow. They must regulate. You have to keep the Treasury in the countries satisfied and keep consumers safe,” Wilson added.
According to a report by Reuters, the Indian Income Tax Department gathered data from nine national exchanges in Mumbai, Delhi, Bengaluru and Pune.
The investigation revealed that $3.5bn worth of virtual currency had been traded in just 17 months, but few investors had included any of this information in their tax returns.
In response to the survey, the Tax Department sent tax notices to people dealing in Bitcoin and other major virtual currencies demanding they pay tax on capital gains. They also asked for details of investors’ total cryptocurrency holdings and the source of their funds.
The Indian Government has issued several warnings against investing in cryptocurrencies over recent months, saying they are similar to Ponzi schemes.
The volatility of Bitcoin and other major cryptocurrencies has seen governments around the world trying to grapple with how to regulate the trading of the alternative asset.
Earlier this month, the Gibraltar Financial Services Commission (GFSC) launched the world’s first regulatory framework for blockchain technology.
It means any Gibraltar firms that use blockchain to store or transmit anything of value belonging to others must now apply for a licence from the commission.
JP Morgan chief executive Jamie Dimon, famously called bitcoin “a fraud” last year, Bank of America Merrill Lynch has also banned Bitcoin for investment by employees and traders.
Spain’s National Securities Market Commission (CNMV) has joined the US Securities and Exchange Commission’s warning over cryptocurrencies and Initial Coin Offerings (ICOs).
The CNMV has published on its site the translation of a statement released by the chairman of the US Securities and Exchange Commission (SEC) Jay Clayton on 11 December 2017, in which he warned that cryptocurrencies and Initial Coin offerings (ICOs) investors enjoyed lower protection than traditional markets investors, sparking risk of fraud or manipulation.
So what is the Outlook for Bitcoin?
Bitcoin can be used to book hotels on Expedia, shop for furniture, houses and buy Xbox games, but much of the hype is about getting rich by trading it!
No one knows what will become of Bitcoin. It is unregulated and Governments are concerned about taxation and their lack of control over the currency.
Cryptocurrencies have no central bank that stands behind them and isn’t regulated in any country.
Bitcoin has a limit to the number of tokens it will release. That number is hard-coded at 21 million, so the flow will dry up as no more than 21 million will ever exist. Today, around 16 million are in use. The estimated date of Bitcoin issuing its last coin is believed to be in the year 2140. No one can predict what will happen at that point, but miners will always earn some profit from transaction fees.
Interest in Bitcoin is now greater than ever, it began in 2009 with a value of just a few cents and by mid Dec 2017 peaked at $20,000. This was followed by a sudden crash falling to half its record peak in mid-December 2017 to $10,000 – a 50% drop in little over a month – renewing a surge of trading, speculation and worry. People’s willingness and ability to utilize Bitcoin fluctuates a lot. It’s an unstable investment that should be approached cautiously.
In 2017 Ethereum – the second biggest cryptocurrency after Bitcoin – saw its value collapse from $317 a coin to $0.1 a coin in a day. It bounced back, and is now trading at $473 a coin, but the lesson is there.
Some have labelled Bitcoins what traders call a “fool’s asset”. Unlike investing in a house that can be rented out or a well-diversified investment portfolio designed for long term growth, the only way to make money from Bitcoins is to find a “greater fool” than you who’ll pay an even higher price than you will.
Legendary investor Warren Buffett says of Bitcoin: “Stay away from it. It’s a mirage, basically.”
Finance expert Martin Lewis said: “Bitcoin is a highly speculative investment. Putting money in it is a form of gambling.”
Many experts believe the bubble could burst; but what’s your opinion now you’re more informed?
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Andrea J Speed FPFS (DM), M.A.
Principal, Fellow and Chartered Financial Planner
Speed Financial Solutions
25 January 2018
Please note that the above does not constitute advice to invest – you should seek independent financial advice before investing.