A framework for understanding CryptoCurrency aka. bitcoin
Since entering mainstream public knowledge a few years ago, interest in cryptocurrency has skyrocketed. In 2011, one bitcoin was worth $1.00, today its value is near $3000. Not surprisingly, the astronomical value of bitcoin has caught the attention of speculators seeking to capitalize on cryptocurrency as an alternative/compliment to trading ETFs. Yet despite being the worlds most valuable cryptocurrency, limitations in its technological implementation (http://fc16.ifca.ai/bitcoin/papers/CDE+16.pdf), philisophical divisions in its programming communities (https://blog.plan99.net/the-resolution-of-the-bitcoin-experiment-dabb30201f7), and the control of its future feature set resting in China, has inspired numerous alternatives (altcoin). To date, there are over 700 digital currencies, many of which claim to offer significant benefits over Bitcoin and other alternative cryptocurrencies. Some currencies utilize the same protocol as Bitcoin, some use something completely different. Some currencies focus on transaction speed, some on privacy, and some have different philosophies. So how does one make sense of it all?
Where does one start?
For the beginner who has just heard about bitcoin and cryptocurrency and is interested in trading it for profit, the difficulty in learning to do so is very real.
First, how does one select a currency to purchase? In ETFs, one can research a company, its CEO, its sales/revenue performance, and product line and/or services. If one decides to trade an ETF, one just signs up to a brokerage and makes the trade. Online brokerages such as e-trade make things incredibly easy and related documentation accessible on the internet is for the most part up to date and straight-forward to follow. The process for the most part, is well defined and in line with expectations.
With Cryptocurrency, things are not so straightforward. Information on a currency is sometimes sketchy if it exists, with information offered sounding more like a startup pitch deck than real facts. There are no easily offered frameworks to vet one competing currency over another. Turning to bitcoin discussion forums also seems to be counterproductive, as advice offered by members tend to trigger more doubts and confusion rather than quell it. If one manages to educate oneself on the merits of one particular currency and desires to purchase it, he may find the process convoluted as limitations on purchases, requirements for verification, and the immaturity of the various platforms involved leave much to be desired.
Well, that was my experience when I started to research bitcoin/digital currency…It was so frustrating, I figured I would write an introductory guide on how to get started to help others who were just like me and wanted to get started despite knowing very little about the digital currency landscape.
A framework for understanding digital currency
For the beginning investor in cryptocurrency, it may help to know a few things:
- There is no universal regulatory standard for digital currency to which providers must adhere
- The value of any digital currency is not tied to its utility (important to keep in mind!)
- The value of any digital currency is tied to its perceived value and in many cases, is pure speculation.
- The emotional value of a digital currency seems to be worth more than the merits of the currency’s technological benefits.
- Some currency is backed by an underlying business (such as ripple – xrp)
- Some currency is just a open source program maintained by unpaid programmers (bitcoin)
- Currency software can be very insecure and buggy
*Something to consider: Bitcoin was never intended to be an investment, but rather just an alternative currency. This can probably be safely applied to all cryptocurrency. Never purchase more than you can afford to lose.
The current landscape
In order to illustrate some of these points lets take the most currently popular crypto currency, Bitcoin (Satoshi Nakamoto) and ask ourselves why the current value of a bitcoin nearing $3000
- The satoshi Bitcoin was the first to become popular within news, social media, and nerd talk. It’s only recently where talk of other alternative digital cryptocurrency is being highlighted in the media. Because it was the first and now most popular, interest in it has skyrocketed.
- Due to its popularity. Investors are taking notice of cryptocurrency, some are even trying to create a bitcoin exchange traded fund (http://www.cnbc.com/2017/05/30/bitcoin-price-hedge-funds-not-investing.html).
- Governments are legitimizing Bitcoin (http://asia.nikkei.com/Markets/Tokyo-Market/Bitcoin-getting-interest-paying-accounts-in-Japan) which lend credibility to it as an asset or commodity. This also influences the increases the receptivity of the currency for the mainstream population.
- Bitcoin is currently the central point of liquidity in the purchase and exchange of other digital crypto currency. Being one of the first and most popular, the currency is commonly used to change to and from another altcoin. For example, coinbase, one of the largest Bitcoin platforms for buying, selling, and storing digital currency, only allows one to purchase Bitcoin, Ethereum, or Litecoin from regular Fiat currency (ig. USD). In order to buy another altcoin such as monero (if just using coinbase), one needs to buy bitcoin from coinbase then head over to another website to exchange the bitcoin for the monero. If one wants to exchange Monero back to regular fiat currency using coinbase, one would need to convert monero back to bitcoin then sell it (using coinbase).
*However with new sites such as shapeshift.io, other currencies can be exchanged between each other.
- Despite its popularity, the Satoshi Bitcoin has scalability limitations rooted in its technology which undermine its widespread adoption. Currently, the currency can only process 7 transactions per second (27 TPS if a larger 4mb block is used). Compare this to a Visa credit card which confirms a transaction within seconds, and processes 2000 transactions/sec on average, with a peak rate of 56,000 transactions/sec. This technological limit should be a very weighty negative blight on the adoption of the Satoshi Bitcoin. However, this isn’t the case as the value is still many times higher than other altcoins which do not have this technological limitation.
- The comunity of bitcoin developers have also run into ideological differences and have for all intents and purposes, split (https://blog.plan99.net/the-resolution-of-the-bitcoin-experiment-dabb30201f7).
- Bitcoin implementation is guided by a concept where miners (those who create bitcoin and contribute to its blockchain) can vote on which new features are implemented. This voting system gives miners with larger hash power control of its technological improvements. However, most of the miners are located in China whose interests are counter to the technological improvement of the currency. To change and improve on the currency may lead to the the destabilizing of their income stream (https://blog.plan99.net/the-resolution-of-the-bitcoin-experiment-dabb30201f7).
There is no reason why Bitcoin should be valued so highly considering its technological limitations, its own community of developers at war with each other, and its future resting in the hands of another country. However, the popularity and legitimization by governments has given a reason to place a high value on the currency despite it being technologically flawed. Much of it however, is hype and emotional value vs true utility based on superior tech and legitimate development.
At first, I viewed the digital currency landscape as one where technology nerds who knew lots about the product and took part in the development of the coin were the ones raising the value of the coin. However, upon deeper research, it seemed to me that the biggest contributor to the value of digital currency tended to be the emotional and capricious nature of the market rather than the merit of the coin. Despite this, I believe there is money to be made in the crypto currency market if one has the right perspective.
A framework for selecting digital currency for trade:
In my opinion, a digital currency should be selected on three main criteria depending on a short or long position:
If long term
1. The niche of the currency (security, anonymity, transaction speed)
2. Its technological benefit to alternative currencies (smart contracts, more efficient banking transactions, etc.)
3. Its adoption in the market (heavily related to the niche and technological benefit).
If short term
1. Price – What is the current price on chart and whether or not its just beginning to be covered by the media
2. Hype – Has the coin gained too much coverage and is now at the peak of its media coverage and hype? There may not be any more room to grow…
3. Usage – who is using the coin? Honestly, I haven’t seen much correlation between who is using the coin, to the price/value of the coin. However, I have seen that the higher the adoption of the coin by the mainstream population, the higher the media coverage, and thus the higher price/value of the coin. Essentially, the resulting media coverage generated from more widespread adoption whether in mainstream or niche markets, ultimately pumps the price of the coin higher, rather than the adoption/usage of the coin.
*Watching the behavior of various cryptocurrency, it seems as though the majority of current investors are holding short term positions and seeking to pump and dump for a quick profit. Because of this, one will see volatile behavior on the beginning/end of the month as speculators may be seeking to cash out their profits.
Cryptocurrency values depend on many factors, however certain factors weigh more heavily on the price of the coin. From my experience, hype and media coverage account for the majority of its perceived value compared to its technological benefits or development performance. Even the adoption and usage of the coin is not a major motivator for the price, but contributes to the media coverage of the coin which in turn raises the coins price values instead. As well as it seems to me, the fundamentals which tend to be evaluated when investing in traditional stocks are ignored when observing the behavior of cryptocurrency trading as ive noticed volatile behavior in daily and monthly cycles. This could be a strong indicator that the majority of current investment in cryptocurrency tend to be short term positions.
I feel that by evaluating the frameworks in their respective positions (short or long term), one will have at least a starting point in evaluating the many crypto currencies out on the market today. As of writing this, the currency Monero has jumped from $49-$50 to $93 within two days. The reason being that the currency was listed on an exchange…once again we see the effect on public visibility o nthe price of a coin rather than its technical merits.
If you would like to try your hand at trading crypto currency, try using coinbase. By using the link below youll receive $10 free to play with!