The Tumultuous Journey of Bitcoin and How Cryptocurrencies Work, Ep #62

How Cryptocurrencies Work

You’ve heard about Bitcoin and other cryptocurrencies for the past few years now. “Nothing attracts the attention of the public like the possibility of missing out on the latest craze,” Larry Swedroe once said. The fear of missing out (FOMO) is extremely enticing.

As with all investments, it’s important to understand what you’re getting yourself and your money invested in. In this episode, you’ll learn more about what Bitcoin is, the risks involved, and how cryptocurrencies work.

What is Bitcoin and how do Cryptocurrencies work?

Bitcoin is a worldwide cryptocurrency and digital payment system. It was invented in 2009 by a person or group of people named Satoshi Nakamoto, and it is still unknown who exactly the founder was. There are now more than 1500 cryptocurrencies in the virtual world today.

Cryptocurrencies are different than regular currency because there is no bank or government backing them. Cryptocurrencies are created by mining and like gold, they have a limited supply which is where their value comes from.

What are the risks of Bitcoin?

The list of risks for buying or investing in Bitcoin and other cryptocurrencies include, regulatory, security, insurance, fraud, and market risks.

  • Regulatory Risk: One of the largest unknowns is the potential that our government could pass crippling regulations for cryptocurrencies if it so chooses.
  • Security Risk: There is also security risk in protecting your purse or online wallet. The wild wild west theme is evident here as the stories continue to pile up with someone hacking into a digital wallet or pursuing it the old fashioned way.
  • Insurance Risk: Your money at the bank is insured by the FDIC, but cryptocurrencies are not, so how do you know you are buying real Bitcoin?
  • Fraud Risk: Recognizing fraud risk can be difficult. Fraudulent companies pop up quickly around hot investment ideas and cryptocurrencies have seen their fair share already.
  • Market Risk: The price has see-sawed up and down dramatically over the past decade creating substantial market risks. After rising nearly 4,000% since the start of 2016, hitting a price of just under $20,000, Bitcoin is currently trading around $6,500 at a 67% loss.

This story is far from over but there are powerful lessons in the journey so far.

Is Bitcoin an investment or a speculation?

Investments are something you can estimate the expected returns of by researching the data of a stock or bond. By researching the growth rate and fundamental value of an investment you have an idea of what the future return could be. The value of Bitcoin is dependent upon what someone else is willing to pay you and the history of it is all over the map. Making cryptocurrencies more of a speculation rather than an investment.

What is blockchain and why is it important?

Although cryptocurrencies have stomach-turning volatility and it can be difficult to see what their future may bring, blockchain technology may have a big role to play in the future. Bitcoin is distributed by a blockchain which is a publicly distributed ledger. The technology of blockchain may completely change over time. The future of blockchain may include payment processing, money transfers, digital voting, and real estate or title transactions.

Cryptocurrencies may be a highly speculative investment but they have opened a new frontier in digital money and accounting.

Outline of This Episode

  • [0:27] Why you need to know about Bitcoin and cryptocurrency
  • [4:17] What is cryptocurrency?
  • [8:07] Risks of Bitcoin?
  • [13:40] Tax implications?
  • [14:20] Is Bitcoin an investment or a speculation?
  • [16:11] What is blockchain?

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