Cryptocurrency 101
New to crypto? Here are 20 questions you wanted to ask about Bitcoin, altcoins and ICOs
Photo by Andre Francois on Unsplash
I expand on some of these ideas in my book, The Cryptocurrency Revolution, which is available here and from other booksellers, online and offline.
1. What gives Bitcoin its value?
“Bitcoin is magic internet money.”
“Bitcoin is made up out of thin air.”
Many people seem confused about how a value can be attributed to a purely digital currency — especially one such as Bitcoin, which has no central governing authority.
But you could ask exactly the same question about the dollars, euros or pounds that are attributed to our digital bank accounts. All have a notional value that is conferred by a certain set of rules.
The rules that govern the price of Bitcoin (or any other blockchain-based currency with a finite supply) are easy to understand: they are the laws of supply and demand. Essentially, because there will only ever be a fixed number of Bitcoin tokens in circulation, this scarcity sets the price.
Some people claim that because — unlike national currencies — Bitcoin is not backed or issued by a government, it does not have value. But indeed, the reverse is true.
From Wikipedia: ‘Fiat money is a currency without intrinsic value that has been established as money’.
Here’s a fun fact. On the Micronesian island of Yap, there exist large circular stones, up to four metres in diameter and half a metre thick. These were quarried on nearby Guam and Palau, and transported to Yap for use as currency.
All transactions were recorded orally, and families exchanged the stones — or sometimes, a fraction of a stone — in payment for dowries, land or food. The stones were rarely moved, to avoid damaging them, and ownership records were passed down from generation to generation. But the interesting thing is that even when one stone fell to the bottom of the ocean, people continued to use it for payments, despite not being able to see it.
This says a lot about our ability to trust that money is ‘real’. And, in fact, the type of value that is recorded in a distributed ledger like Bitcoin, where anyone can participate in the network and can see the transactions that have happened, can be much more trustworthy than money that is created by the central bank of a country, and which does not necessarily obey the laws of supply and demand.
2. Who can use Bitcoin?
Anyone in the world with a connection to the internet can receive or send Bitcoin or any other cryptocurrency that is recorded in a public ledger. Indeed, you can even hold the keys to your balance without being connected to any network at all.
You don’t have a Bitcoin account, like a bank account, which is linked to your name or identity. Instead, you hold a key which allows you to access a location on the public ledger, and send units of value to any address on the network, without necessarily knowing who the other party is.
3. Do I have to buy a whole Bitcoin?
This is one of the popular misunderstandings about Bitcoin. Indeed, you can even buy T-shirts here with this very important message printed on them.
In the same way that you can purchase low-cost items by using cents or pence, a whole Bitcoin is divisible into one hundred million units. This smallest unit is called a Satoshi, after Satoshi Nakamoto, the network’s anonymous creator(s).
4. Bitcoin has been described as an alternative to gold. Why?
Because the supply of Bitcoin cannot be influenced or gamed by any single entity (a company, an individual, a country), and the design of its unique ledger makes the record of transactions immutable, a record in the Bitcoin blockchain showing that your address is the ‘owner’ of a certain number of Bitcoin tokens has a value that transcends the legal tender of a particular country.
5. Who runs the Bitcoin network?
People talk a lot about the ‘miners’ who run the Bitcoin network. The process of validating a block of transactions and then solving a mathematical puzzle to ensure that the computing power has been expended that was necessary to prove the transactions happened is more like book-keeping than mining.
The difficulty of the puzzle is adjusted to ensure that a block is created and new Bitcoins generated every ten minutes. It’s compelling to watch a visualisation such as this one which shows the blocks being discovered and new Bitcoins being mined in real time.
Anyone can run a node on the network which helps validate transactions (all you have to do is download and run the code, which is open source), but you will not be rewarded with Bitcoin unless you have enough computing power to compete with the more powerful participants in the network.
This video of a Chinese Bitcoin mine shows the size of one of the larger mining endeavours. Because of the expense of the hardware, which rapidly becomes obsolete, many people choose to contribute to a mining pool and receive a share of the rewards, rather than spend the vast amounts that would be needed to set up their own operation.
Other cryptocurrencies, however, can be mined without the use of specialist chips, and the tradition of home-made rigs run by individuals in their own homes is alive and well.
6. But Bitcoin was hacked, wasn’t it?
There have been many headlines over the years which talk about people losing their Bitcoins after their accounts were hacked. Because of this, it’s easy to jump to the conclusion that the Bitcoin network itself was hacked.
Bitcoin has never been hacked.
When someone robs a bank and steals dollars or pounds, no one thinks that the Federal Reserve or the Bank of England have become vulnerable. The same is true of Bitcoin.
There are many third-party services, apps and sites which hold your cryptocurrency for you, allow you to trade or which provide a fancy interface to help you manage your transactions. Because of the open source nature of the network, anyone is able to program one of these services and they are vulnerable to hacks in exactly the same way that any other software is.
Centralised cryptocurrency exchanges, where the exchange holds your tokens for you in a wallet, are fundamentally an unsafe place to store your crypto wealth.
This great piece by trading legend NotSoFast offers a great security primer that should protect you against being hacked and having your coins stolen.
7. How is Bitcoin different from a bank?
When you deposit your money in a bank, it is not your money any more. The numbers in your account represent a promise from the bank that it will pay you a certain amount. In other words, you are a creditor of the bank. Because the way retail banks operate means they do not keep a reserve of cash that equals what they owe their customers, it means that theoretically you do not own this money in your account.
In many countries, governments will step in and compensate you if a bank fails, but this means that you have to trust that the government will do this — and that the government has enough money to compensate everyone who is owed. The queues outside the failed British bank Northern Rock in 2008 show that people do not always trust that governments will honour their promise.
With the current financial situations in Zimbabwe and Venezuela, it is easy to see why people do not necessarily trust governments in this regard.
As many people have found out, banks are also able to refuse to make payments on your behalf and to limit the amount you can withdraw at any one time.
In contrast, if you hold Bitcoin or another cryptocurrency, and you have possession of the private key, you own those funds. You are free to transfer them to whomever you want, at any time.
Many new Bitcoin users choose to keep their funds on a third-party site, where they do not have access to their own private key. While these web wallets or custodial services are simple to use, they do not give you the same security as owning your own keys.
8. Bitcoin is illegal, isn’t it?
The Bitcoin network is global. While some countries may try to impose laws restricting its ownership, in practice this would be difficult to enforce. It is true that in some countries, states have chosen to limit the activities of some cryptocurrency businesses, like exchanges, many others have taken a more pragmatic approach, which fosters innovation.
Educating people to make better choices and to take responsibility for their own decisions is generally better than legislation — and better protection in the long term against fraudsters and scammers.
9. If Bitcoin is Bitcoin, what the hell is Bitcoin Cash? Or Bitcoin Gold?
One of the amazing features of a public blockchain like Bitcoin is that anyone can download the code and join the network. If someone wants to download a version of the code and make changes to it, and if enough people want to participate in running the network, then this will become a separate currency. This is known as a fork.
Forks such as Bitcoin Cash and Bitcoin Gold hit the headlines when they launched mainly because people who already owned Bitcoin received the same number of the forked coin.
10. Why do people want to use cryptocurrency?
Not having to rely on a third party to make payments can be fast and cheap. Western Union can take up to 18 per cent of international payments, and even making cross-border payments with a relatively favourable exchange rate can be expensive and slow.
It is worth noting that sometimes transaction fees for Bitcoin and other cryptocurrencies can make smaller transactions less viable, but there are already technological solutions being developed to mitigate this.
But more important than transaction costs, owning the private key to your own money gives you the assurance that if your bank goes bust or if the government declares a bail-in, nobody but you can access your funds.
There are some disadvantages, such as the need to keep your credentials secure and a certain amount of price volatility. But the recent situation in countries such as Zimbabwe or Venezuela shows us that it is not just cryptocurrencies which suffer from large swings in purchasing power.
11. What is Ethereum?
While you can use the Bitcoin network to validate that certain events happened at a particular time, the amount of information that you can attach to a transaction is limited. The Ethereum network is a public blockchain like Bitcoin, which anyone can help maintain in exchange for earning Ethers (the native token of the network).
But where it differs from Bitcoin is that it is a network specifically for executing small scripts, called smart contracts. Smart contracts mean that people can transact (for example, transferring ownership of assets, or insuring possessions) without having to trust or even know each other. Read more about Ethereum here.
Or, for a practical and fun example of how smart contracts can be used, check out CryptoKitties.
12. How many other types of cryptocurrency are there?
We carry 2k+ different cryptoassets on CountMyCrypto. Probably less than 1.4k of these are traded in any quantity worth recording. The list on coinmarketcap.com gives a good idea of the number of coins and their collective value.
13. How do I store my Bitcoin? Or Litecoin? Or Ethereum?
It’s never safe to store large amounts of crypto on an exchange, so you will have to download your own wallet software, use a hardware wallet such as Trezor or Ledger or create a paper wallet.
See our link to NotSoFast’s great security primer above.
If you really want to go down the cold storage (paper wallet) route, here are some instructions for safe creation. This is for Bitcoin but the same principles apply to other cryptoassets.
14. Who can create a cryptocurrency?
Anyone can either fork the Bitcoin code or write their own code to create a blockchain network that other people can join and start mining. If there is enough demand for the tokens and people start trading them, then a new currency will have been born.
If this sounds weird, bear in mind that private currencies were a feature of economic life in many countries until comparatively recently. We are used to states having a monopoly on currency issuance, but this has not always been the case.
15. When people talk about ‘tokens’, what do they mean?
In the case of Bitcoin, the token represents a unit of value that is generated and given as a reward to the person or entity whose computer secures the network. Tokens may be traded or exchanged for fiat currency. Other blockchains may have tokens that are distributed in different ways, as different types of reward. But the principle of being able to exchange or barter these tokens for goods, services and fiat currency is common to most networks.
16. What is an ICO?
An Initial Coin Offering is like an Initial Public Offering (IPO) — it is a way for a company to raise funds to allow them to grow. Instead of owning stocks or shares in the company, people who buy tokens generated during an ICO do not own a share of the company. Instead, they are effectively making a bet that the price of the token will rise. Often the ICO will happen before the company has a working blockchain of their own and are able to issue tokens to buyers. Instead, many companies issue ERC-20 tokens on the Ethereum network, which are later exchangeable for the native token of the network.
Some people intend to hold tokens from projects that have had ICOs for the long term because they believe in the project. Others are hoping to make a quick profit as soon as the token is listed on an exchange.
Popular exchanges where you can trade tokens for Bitcoin, Ethereum, Litecoin or even fiat include Binance, Bittrex, Bitfinex, Kucoin and may others.
17. What is a utility token?
A utility token is a token issued by an organisation (whether this is a company or a fully decentralised entity) which allows some kind of interaction with the blockchain on which it is issued. For example, the DOV token issued on the DOVU blockchain can be paid out in exchange for transport data that is recorded on DOVU.
18. When is a blockchain not a blockchain?
A blockchain is essentially a made-up word for a type of data structure that in its most general sense consists of blocks of transactions, linked together using cryptography. There are some other types of data structure that share some attributes of blockchains, but which are distinct. For example, IOTA’s and HashGraph’s DAG data structure is more like a cloud of nodes than a linear chain and works in a slightly similar but mainly different way.
Additionally, the digital ledger principle has been taken and applied to some data structures that operate inside businesses. These ledgers may only have a handful of nodes and do not solve the trust problem in the same way as a public blockchain like Bitcoin. Yet people often still refer to them as blockchains.
19. How do I get some cryptocurrency?
You can get hold of cryptoassets by mining, earning them in bounty programs or — if you are early — via an ICO. But an exchange is the most common way to buy and trade them. Asking to be paid in Bitcoin or Ether is a good way to acquire cryptos, as long as you are prepared to accept some volatility against fiat currency. Buying directly in person is also possible, especially if you live in a city. Or some exchanges allow you to buy for USD, EUR or GBP. Otherwise, try LocalBitcoins, Coinfloor (UK) or Coinbase.
20. How can I keep track of the cryptocurrency I own?
You can track your investments by entering your coins into CountMyCrypto or another app such as Blockfolio. If you would like more charts and historical data, check out coinmarketcap.com or cryptocompare.com. Some people prefer to use an Excel spreadsheet — check out this template.
