What is cryptocurrency and is Bitcoin a good buy?
Read this guide to learn how cryptocurrency, blockchain, and bitcoin work, and why some people think bitcoin price will go above $200,000.
I’ll also share my advice on whether you should invest in Bitcoin.
Bitcoin: What Is It?
Bitcoin is a type of cryptocurrency.
There are many cryptocurrencies, such as Ethereum, XRP, and Tether.
Bitcoin is the first and still the most valued cryptocurrency today.
Before we talk about Bitcoin, let’s talk about what is cryptocurrency.
Cryptocurrency is made up of two words: (1) crypto and (2) currency.
Crypto is short for cryptography. And currency means money.
What is Crypto?
Crypto stands for cryptography, which is basically a math puzzle.
You might have heard about cryptography in high school world history, where the U.S. tried to decrypt encrypted messages from the Nazis using cryptography during WWII.
Specifically, cryptography is a math puzzle that is (1) hard to solve, but once resolved it is (2) easy to verify.
Why is this relevant to Bitcoin?
It turns out “hard to solve, easy to verify” is basically what makes Bitcoin a currency that is harder to fake than the U.S. dollar.
Bitcoin specifically uses a kind of cryptography called Hashcash.
You don’t need to know how hashcash works. Just know that it’s a kind of proof-of-work system that fits what we describe above: a puzzle that is hard to solve, but easy to verify.
How does hashcash, bitcoin’s cryptography come into play?
Well, Bitcoin uses the hashcash algorithm to “mine” new bitcoins.
What does it mean to mine bitcoins?
Anybody can attempt to solve the hashcash algorithm, if they solve it, then they’re randomly selected to get new bitcoins.
We call the process of solving and getting new bitcoins “mining” and we call people who do this to get new bitcoins miners.
We’ll get more why mining matters later; it’s important.
Now that we know about cryptography and how it’s used in bitcoins, let’s talk about the currency itself.
Cryptocurrency is a type of currency that follows the rules of cryptography.
All cryptocurrencies, including bitcoins, follow the following three rules:
- Owners of cryptocurrency are impossible to impersonate.
- The cryptocurrency is impossible to fake.
- Transactional records of the cryptocurrency are impossible to edit.
A lot of things in this world already fit into the above criteria.
Take the example of a passport:
- A passport is hard to impersonate (you can’t take my passport and attempt to leave the country).
- It’s pretty hard to fake a passport (it’s very hard to make a fake passport and get through customs, despite what the movies say).
- If you ever renew your passport, this record is kept by the U.S. government (you can’t continue to use your expired passport).
The U.S dollars, your retirement fund at Vanguard, and your grades in college also fit these above rules.
But none of these things are cryptocurrencies.
So what makes a cryptocurrency different? It has to do with how cryptocurrency enforces these rules.
All of my examples above enforces the rules via a central body: a company (Vanguard), a government (United States), or a nonprofit (University).
Cryptocurrency enforces these rules without a central body. It utilizes a decentralized manner to enforce these rules by allowing all of us to enforce the rules together and for one another.
Bitcoin uses public and private keys to make bitcoin owners impossible to impersonate
How does bitcoin ensure I can’t impersonate you?
Every bitcoin owner has a uniquely identifiable public and private key. When used together, you can send and receive money.
The public key is used to identify who you are so that others can send money to you.
The private key only belongs to you and is used to access your bitcoins.
Your private key is mathematically related to your public key, but it’s impossible to reverse engineer thanks to a strong encryption code base.
Bitcoin is impossible to fake because record-keeping is decentralized
Instead, bitcoin transactions are recorded in a decentralized manner.
This means instead of a central body that keeps record, everybody is keeping a record.
And therefore, the truth is always public.
Bitcoin does this by keeping a copy of every bitcoin record and its transaction history on every server that mines bitcoins.
If you claim to have a lot of bitcoins but your records differ from everybody else’s records of how much you have, then your records are fake.
Bitcoin transactions are impossible to edit because all servers are updated frequently to maintain the record accuracy
A cryptocurrency’s past transactions can’t be edited and it’s always accurately reflected in the present.
That is, you fake a transaction that says “oh last month, I got 3,000 new bitcoins.”
How does it happen? Let’s talk about miners and their role in keeping the bitcoin transactions running.
New bitcoins are made every 10 minutes.
This is something the founder of bitcoin, Satoshi Nakamoto has put into motion since the beginning.
(By the way, nobody knows who Satoshi is, or whether he is a he, a she, or they…)
The number of bitcoins made every 10 minutes decreases over time. This number is cut in half every 4 years until the year 2140 when the number of bitcoins stops growing.
On that day, we’ll have 21 million bitcoins and that’s it. No more new bitcoins.
(Side note: this essentially makes Bitcoin a deflationary currency compared to the U.S. dollars where the money is always being printed by the U.S. government.)
Mining bitcoin means solving the math puzzle.
And since the math puzzle is hard, therefore mining is energy-intensive and time-consuming.
Once a miner solves the puzzle (the hashcash), new bitcoins are randomly awarded to these miners.
Once miners discover new bitcoins (every 10 minutes), all the records for bitcoin transactions since the beginning of time are then updated on all computers.
Every 10 minutes, bitcoin miners are incentivized with free bitcoins to mine, and mining ensures bitcoin records are updated every ten minutes. Mining keeps records updated.
What I just described is a process that we now call Blockchain.
(By the way, Satoshi has about 1 million bitcoins. So he’s worth a couple of billions right now. )
What is Blockchain?
Blockchain is a technology that decentralizes the power of record-keeping to all of us.
It can store facts, such as
- Citizenship status
- Financial status
- Social Security Number
Blockchain is also proof-of-work, which means it tracks when these facts are updated, such as
- When I send you 1 bitcoin
- If your citizenship status is updated
- When your family changes
Blockchain is the process that makes cryptocurrency possible.
Without blockchain, there will be no cryptocurrency and no bitcoin.
Is Bitcoin Worth It?
You might be wondering – great, I understand how blockchain works and what a cryptocurrency is.
But why is Bitcoin worth so much money?
It’s just a bunch of stupid code and people doing very dumb calculations that aren’t even fun or hard, but just time-intensive!
Well, you’re kind of right.
The truth is many people believe that bitcoin is worthless and a scam.
Warren Buffett famously said,
You can’t do anything with bitcoins except sell it to somebody else. Cryptocurrency basically has no value
So let me explain why some people believe bitcoins have value and have a lot of value.
But first, we have to understand how money works today.
The Value of a Dollar
For a long time in U.S. history since its founding, the U.S paper dollars were backed up by gold.
So back then, the U.S. dollar is basically gold and is just lighter to carry around.
And gold, for millions of years, is a precious metal that is valuable.
Why is gold valuable? For starters, gold doesn’t corrode, so it has lasting value.
Gold also is abundant enough to create coins and tools but rare enough that not everyone can have them.
Lastly, gold is highly malleable.
You can buy a golden vase, keep it for many years, and when vases go out of fashion, you can melt the gold and make jewelry out of it.
Because the gold has value, and because the dollar is backed up by gold, the dollar also has value.
In 1933, Congress decided that you can no longer exchange gold from paper dollars, even though dollars are still fixed to gold.
Then in 1971, with inflation on the rise, President Nixon decided to no longer fix the dollar to the Gold, thus ending nearly 100 years of valuing the U.S. dollar based on the value of gold.
Since 1971, the U.S. dollar has no real value. It’s just papers.
The U.S. dollar has value because we. all agree it has value.
But if a meteor destroys the United States and we all die, the U.S. dollar might cease to become valuable.
Similar to paper money, a cryptocurrency also has no intrinsic value. But that doesn’t mean it won’t be valuable.
The Value of Cryptocurrency
A cryptocurrency like bitcoin only has value if we all agree it should have value.
And because bitcoin has a very limited amount that will max out at 21 million coins, it is much more like gold than the U.S. dollar.
In some sense, bitcoin is a reserve currency for people that hate the federal reserve and don’t trust the gold supply.
Is Bitcoin a Good Investment?
Oh boy, this is a loaded question.
So we know that Bitcoin wanted to replace the dollar, but it failed at replacing the dollar and for the right reasons.
It takes about an hour for an entire bitcoin transaction to complete.
That might be fine if you’re transferring a lot of money to a friend.
But we can’t use bitcoins to, say, pay for Starbucks coffee. The transaction takes too long to validate.
Bitcoin also has a limited supply, it will max out at 21 million coins and there is no flexibility to this.
Some people say that bitcoin is a good replacement for gold, which today acts as a reserve currency.
During economic recessions and times of volatility in the stock market, people tend to buy more gold as a way to reserve their cash.
And bitcoin loyalists continue to predict that bitcoins will replace gold to become the global store of nongovernmental monetary value.
If this becomes true, then it would represent a huge growth potential in the bitcoin market.
Bullish Case for Bitcoin Going Up
The total global stock of gold has a value of around $7.5 trillion, which is 50 times greater than the bitcoin’s total market value today.
Assuming bitcoin maxes out at 21 million coins and matches the global value of all of gold, we are implying that each bitcoin will be worth $357,142 (7.5 trillion divided by 21 million).
Indeed, many people on Twitter claim that bitcoin will reach $200,000 in the next few years.
Some are even more bullish, claiming bitcoin is better than gold and could be worth $700,000.
On the contrary, other people argue that this will never happen because bitcoin and the blockchain are actually not as safe as people claim it to be.
An economist argued that if and when bitcoin becomes trillions of dollars in value, the benefits to attacking it will be higher than the benefits of maintaining it.
And when that happens, a country like China could deploy its entire data center to take 51% of the entire decentralized bitcoin network, and thus able to edit, fake, and manipulate bitcoin.
Which one is correct? We will never know until it happens.
Should I Invest in Bitcoin?
So what does this mean for you?
It means that we don’t know if bitcoin is going up or down.
My advice? Really, you should expect nothing from bitcoins. It is a huge gamble.
The upside is big, but also unlikely.
If you want to invest, I recommend putting no more than 2% of your net worth into bitcoins and no more than 10% of your net worth into all of crypto.
In other words: you should invest as much as you are comfortable burning that money in fire.
For me: that number is 5% net worth. It might be lower or higher for you.
But why invest? Because the upside is extremely appealing.
It is okay to lose 1% of your net worth if the upside is millionaires of dollars.
So… maybe it’s still worth a try as long as you invest only 5% of your net worth.
How to invest in Blockchain?
You can invest in a cryptocurrency, which means it utilizes blockchain.
Or you can invest in a business that builds blockchain technology (aka, decentralized applications) for other use cases, not limited to currency.
These are all investing in blockchain technology.
But the easiest? Invest in bitcoin.
Bitcoin is the best example of using blockchain technology today, and it is still the most likely to succeed, despite its impossible path forward.
How Many Bitcoins are There?
Today, there are about 16.7 million bitcoins out there, and we’ll never have more than 21 million bitcoins.
We’ll only reach 21 million bitcoins by 2140.
How Many Satoshis in a Bitcoin?
You can buy a fraction of a share of a bitcoin, or a satoshi. Think of it like cents on the dollar.
There are 100 million satoshis in one bitcoin.
Is Bitcoin Legal?
Yes, bitcoin is legal. It’s just a thing you trade.
Just like how you’d trade beanie babies, you can trade art, you can trade bitcoin.
When is Bitcoin Halving?
So from time to time, bitcoin will go through a process known as the halving. It’s an event in cryptocurrency circles that cuts new bitcoin creation by 50%.
Remember that these new bitcoins were given to miners when they solve the hashcash, or when they complete these complex cryptographic math problems.
After a halving event, miners receive fewer bitcoins in reward for helping create new blocks.
Previously when miners produce a new block, they receive 12.5 BTC. After the most recent halving event in April of 2020, miners will receive 6.25 BTC.
In 2009, mining rewards started at 50 BTC.
The first halving brought rewards down to 25 BTC on Nov. 28, 2012, when bitcoin’s price was near $13.
The second took place on July 9, 2016, when bitcoin was around $660.
Don’t hold your breath for the very last halving, which will take place well after 2100.
True to BTC form, there isn’t a central authority pulling a lever to initiate the halving. The process was put into motion when Satoshi Nakamoto, bitcoin’s pseudonymous creator, released the protocol in 2009.
How to get Bitcoins
You can get bitcoins today by buying it using the U.S. dollar. You can buy it no a number of exchanges, the easiest is coinbase. Just login, create an account, transfer money from your bank and buy bitcoins and other cryptocurrencies to your heart’s content.
But these bitcoins are not free – you have to buy them using dollars. And according to Warren Buffett, bitcoins are worthless, so you might be wondering if bitcoins are worth it.
How to Get Free Bitcoin?
The only way to get free bitcoins is through mining.
There are a lot of scams out there promising you bitcoins – none of them are real, do not fall for these scams.
I repeat: the only way to get free bitcoins is through mining. And by now, don’t even think about mining them yourself.
Bitcoin mining used to be possible for smaller players maybe ten years ago. But today, bitcoin mining is only possible for large mining farms.
We are talking about people with thousands of servers located in a huge data center, using their collective power to achieve economies of scale.
Only these miners are equipped to stay online and mine free bitcoins these days.
Is Bitcoin Mining Profitable?
As bitcoin’s price increased, mining became more expensive and sent electricity bills skyrocketing.
Now, mining has moved from DIY and dorm room setups to industrial operations.
Canaan Creative, a Chinese bitcoin mining company, IPO’d in October. Bitmain, another competitor, tried to go public around the same time.
But even for these large companies, it is becoming hard to make money mining bitcoins.
Ebang, a company that creates bespoke chips that handle the complex cryptographic legwork required to “mine” new cryptocurrencies, earned $109 million in revenue in 2019 but did not make a profit; it lost $31 million.
How to Mine Bitcoins?
Technically anybody can mine if you have specialized hardware called ASICs.
ASICs stands for an application-specific integrated circuit, it’s a microchip designed for all kinds of protocols, including solving hashcash, the bitcoin-specific cryptographic puzzle.
But buying ASICs and mining bitcoins in your house is no longer realistic.
For one, the machine is super loud, it’s like having a giant vacuum on 24/7.
Secondly, it can get super hot. The sheer power of the ASICs can heat up an entire room, requiring you to be constantly running air conditioners on the highest level nonstop to not overheat computers.
And thirdly, your little ASICs are not going to be able to compete in the speed and power of a huge data center with powerful ASICs.
So just don’t even try.
Where to Buy Bitcoin?
While there are many places where you can buy bitcoin. I highly recommend Coinbase.com.
Coinbase is the world’s largest Bitcoin exchange.
It is also a company based in San Francisco, and backed by trusted investored from the United States.
Coinbase is currently the largest Bitcon broker.
Straight from the Coinbase dashboard, you can buy bitcoin with a debit card, wire transfer, or bank account.
But you can’t buy bitcoin with PayPal or credit card yet. But you can buy bitcoins using a debit Visa or Mastercard.
How to Sell Bitcoin with Coinbase
Coinbase makes selling bitcoins super easy in the click of a button.
Kind of like selling stocks.
You can also bitcoins and withdraw your money from coinbase directly into a PayPal account.
How to Make Money with Bitcoin
You can make money with bitcoin as a miner, or by buying low and selling high.
And since I’ve already said that it is too late to become a miner, really, the only way to make money with bitcoin is by betting on bitcoin’s value increasing in the future.
So should you buy bitcoin today and hold it and wait for it to become the default reserve currency?
I don’t know. It is a huge gamble.
If you want to invest in bitcoins, do it. But you should never invest more than 1% of your net worth in bitcoins.
Here’re the various outcomes based on your net worth and a 1% investment strategy into bitcoin:
|Net Worth||BTC Investment||Bull|
Why Most Cryptocurrencies are Worthless
Most cryptocurrencies are worthless.
In fact, the vast majority of cryptocurrencies will go to zero regardless of how talented the team is or how flawless the quality and execution of the blockchain is.
Because cryptocurrencies have value only when we think it’ll have value – otherwise it’s truly worthless.
When there isn’t enough momentum, these assets will unwind and fall very quickly.
In this sense, most cryptocurrencies are like tulips in Belgium.
Have you heard of the tulip bubble speculation?
There was a period in the Dutch Golden Age during which contract prices for tulip bulbs reached super high levels because people started to speculate.
But then it drastically collapsed in February of 1637.
This is a classic example of a speculative bubble where the price skyrockets due to speculation with no real value behind it all.
The tulip mania will be the outcome of most of the cryptocurrencies out there, each containing billions of dollars of real investments.
Bitcoin is so far the largest cryptocurrency, perhaps the most likely to come out replacing gold as a reserve currency.
But we are a long way off, and you definitely should not bet your roof on this becoming true.
How much net worth should you have for your age? Read: Average Net Worth by Age: What Is Considered Rich?
Read how much money I spent in 2019 and why: 2019 Expenses Review: Principles & Budgeting
Are you ready to start investing? Already investing? Check all the boxes with How to Start Investing: A Step-by-Step Guide