The Ultimate Guide to Bitcoin

What is Bitcoin?

Bitcoin is the first decentralized and cryptography-based electronic cash payment system, where transfers occur peer-to-peer. It is a disruptor for the digital economy.

Unlike traditional payments through governments or central banks, Bitcoin does not require the need for a central control or authority. Instead, transactions and balances are stored on a public, shared ledger called the blockchain. This “blockchain” is verified by thousands of computers maintaining the network across the globe.

Example: Blockchain as Google Docs vs Microsoft Word

One of the best analogies for understanding blockchain, by William Mougayar:

The traditional way of sharing documents with collaboration is to send a Microsoft Word document to another recipient, and ask them to make revisions to it. The problem with that scenario is that you need to wait until receiving a return copy before you can see or make other changes, because you are locked out of editing it until the other person is done with it. That’s how databases work today. Two owners can’t be messing with the same record at once. That’s how banks maintain money balances and transfers; they briefly lock access (or decrease the balance) while they make a transfer, then update the other side, then re-open access (or update again).

With Google Docs (or Google Sheets), both parties have access to the same document at the same time, and the single version of that document is always visible to both of them. It is like a shared ledger, but it is a shared document. The distributed part comes into play when sharing involves a number of people.

What else is blockchain useful for?

By allowing digital information to be distributed but not copied, blockchain technology has created the backbone of a new type of internet. Originally devised for the digital currency, Bitcoin (which this guide focuses on), the tech community is now finding other potential uses for the technology. This has resulted in other cryptocurrencies known as “Altcoins”, with other uses and applications of blockchain. We will cover this in another guide. Until then, back to Bitcoin!

https://www.youtube.com/watch?v=G3psxs3gyf8

How are bitcoins created?

Bitcoins are created by “mining”. The mining process consists of computers solving complex math problems in order to be rewarded new coins. As a reward, bitcoins are created and rewarded to the miners. Many businesses have popped up to purely "mine" and earn coins.

This solving process doubles as the proof of work required to validate the blockchain (which is just a fancy way of saying that it confirms and makes permanent all the transactions which transpired since the immediately previous reward). Thus, bitcoins are created as computers confirm transactions (it’s a self-rewarding cycle!).

How many bitcoins are there?

The overall supply of Bitcoin (abbreviated as BTC) is increasing but finite at 21 million. The release of new BTC is on a fairly strict schedule and the last BTC will be mined some time in 2140. At that point there will be 21 million BTC in circulation. Some have argued that this is why Bitcoin’s aren’t in a speculative bubble that will pop soon. Unlike tulips from the 1600s (where mania over tulips caused their prices to skyrocket, but people could just grow more tulips), Bitcoins have a finite amount.

How do I buy Bitcoin?

Bitcoins and other cryptocurrencies can be bought on exchanges that have become more mainstream recently. Before buying bitcoins, however, it is important to know the investment reasons and risks.

You might see the price of BTC and wonder, “Do I need $17,000+ to buy Bitcoin?” Not at all. Since Bitcoin is digital, it can be subdivided and bought in small quantities. You can purchase Bitcoin with only a few dollars USD at exchanges like Coinbase or Bittrex.

However, make sure to understand and protect yourself against the upside and risks of digital currency.

Investment Thesis for Bitcoin

The reasons to invest in Bitcoin for the long-term view revolve around 1) network effects of the blockchain net and 2) the potential of disrupting current businesses and methods of storing value.

Why has the investment community been so intrigued by bitcoin’s rise? Just recently, the Chicago Mercantile Exchange (CME) launched bitcoin futures. Andrew Edstrom (Wescap Group) noted some investment highlights of cryptocurrencies:

Network Effects of Bitcoin

“There is a key reason that all of the top 5 most valuable companies on Earth (Apple, Alphabet/Google, Microsoft, Facebook, Amazon) are valued the way they are. There is a reason that the Winklevoss Twins (the ones who came up with the predecessor to Facebook, hired Mark Zuckerberg to develop it, and then watched him take their idea and build it into one of these giant companies ), are trying to launch a Bitcoin ETF. This key reason is network effects. Owning a piece of something that becomes more valuable the more people participate in it is a good way to make a lot of money.” (Andrew Edstrom)

Bitcoin and other cryptocurrencies offer a way to directly invest in this type of economy. More and more businesses are starting to accept bitcoin as a form of payment. In addition, with the rise of Coinbase and other such exchanges, it has become easier for individuals to buy into cryptocurrencies.

Potential Market Outcomes for Cryptocurrencies

Andrew sees four major market scenarios for cryptocurrencies (not just Bitcoin), and sees 2 of the 4 as likely:

• Cryptocurrencies become substitutes for precious metals, such as gold.
  
• Cryptocurrencies become substitutes for “offshore” assets beyond the reach of governments.
  
• Cryptocurrencies become new global currencies, or mediums of exchange.
  
• Cryptocurrencies become major economic platforms that compete with many existing companies.
  

“Whether the right upside potential is 5.5x (based on capturing significant market share from precious metals), 41x (based on capturing a significant share of the global offshore asset market), 21x (based on capturing a significant share from of global fiat currencies) , or 50x (based on massive industry disintermediation) is anyone's guess. But considering these possibilities, the potential upside for the value of cryptocurrencies is enormous.” (Andrew Edstrom)

These four scenarios outline what most long-term investors in Bitcoin or cryptocurrencies are hoping for. Early on, mainly libertarian investors considered Bitcoin as a viable vehicle for disruption like this. But the idea has begun to catch on as more investors and consumers open up to cryptocurrency use.

It is important to note that these probable market outcomes involve cryptocurrencies, not just Bitcoin. Like any currency, Bitcoin could fall out of favor if a better cryptocurrency starts to gain steam.

Risks of Bitcoin Trading

There are many risks of Bitcoin and cryptocurrencies that are not fully explored yet, and require caution when jumping in.

Bitcoin Cyberattacks

All cryptocurrencies have potential for a cyberattack. Four years ago, Mt. Gox, which was handling about 70% of bitcoin's trading volume at the time, was hit by a cyberattack. It cited the theft of 850,000 bitcoin (worth $8.9 billion today) and cash. In the two years following this cyberattack, bitcoin wound up losing more than 80% of its value.

To protect yourself, ensure to choose a trusted and safe exchange. Coinbase is generally accepted to be the easiest and more user-friendly exchange, and it also has options for two-factor authentication and email confirmations to provide extra security. If you’re really worried, check out cold storage as a potential option.

Bitcoin Volatility

Because Bitcoin is so new and fast-growing, there is significant volatility in Bitcoin trading prices. This is partly because Bitcoins are limited, no matter how much demand rises or falls. In addition, it is also highly vulnerable to news. A hacked exchange, a new government regulation, or even political opposition in China can make Bitcoin prices rocket or fall. To combat this volatility, you can either monitor Bitcoin prices very closely and be prepared to buy/sell at a moment’s notice. Or, if you believe Bitcoin’s prices will rise in the long-term, you can just hold tight. In either case, Bitcoin volatility is likely here to stay.

Other Bitcoin Risks

There are a few other Bitcoin and cryptocurrency concerns that have come to light. One is the energy consumption of Bitcoin. We mentioned before that bitcoin transactions requires computers to “mine” blocks or solve cryptographic puzzles. That computing requires electricity, and many articles have recently shown the energy impact of bitcoin. Based on some estimates, the bitcoin network uses up more energy than the entire country of Denmark.

Governments also have no idea what to do with Bitcoin. The policy attitudes range from indifference to apprehension, but there has not been any official US law passed to regulate cryptocurrencies. As for taxes, the IRS has started picking up its crackdown on people reporting bitcoin gains. US Magistrate Judge Jacqueline Scott Corley ruled that Coinbase must supply the IRS with the identities of all users in the US who conducted at least one Bitcoin transaction equivalent to at least $20,000. Magistrate Corley wrote in her judgment:

"That only 800 to 900 taxpayers reported gains related to Bitcoin in each of the relevant years and that more than 14,000 Coinbase users have either bought, sold, sent or received at least $20,000 worth of Bitcoin in a given year suggests that many Coinbase users may not be reporting their Bitcoin gains."

What do you think about bitcoin's rise? Add your thoughts or ideas in the comments below!

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