An interesting subject on which I’ve been learning a lot in the last couple of months. Most probably because of the big boom of Ethereum in the media and the skyrocketing Bitcoin. In fact, there are a lot of cryptocurrencies, not only Bitcoin and Ethereum (which is not meant to be a currency by the way). If you want to have a quick look, you can refer to CoinMarketCap where you can find information on more than 800 assets and cryptocurrencies.
It’s like investing in small businesses, remember that these are small projects, that might not have all the potential the market is showing. Studying the whitepaper, the team and the goal is a must before even thinking about maybe putting money in. In addition, they are really volatile, sometimes you can see an upswing (or a downswing) of 30% in just a few hours. This is something a lot less common in the regular stock market. It seems like a lot of people are dumping large sums in there without knowing what the hell is going on.
One thing to remember is that money is not created here. To be able to get out with 100k $, there must be a 100k $ of losses somewhere. I call that, wealth redistribution from a lot of people to just a few.
Let’s Study the Market… The Real Issue
Here is a glimpse of the problem I see with the market especially when there are no dividends involved. To explain my point of view, let’s imagine I own a chair that cost me 15 $.
Alexandre = +15 $ – 15 $ (chair) = 0 $.
Person A = +15 $.
Person B = +15 $.
There are two people that want to buy my chair. One for 15 $ and the other one for 16 $. Obviously I’m going to sell it to the highest bidder.
Alexandre = +16 $.
Person A = -1 $ (chair).
Person B = +15 $.
A little while later, person A realizes that she doesn’t need it anymore and wants to get rid of it. Person B offers only 14 $ but Person A doesn’t care because she just want to get rid of the chair because she thinks it might be valued less later.
Alexandre = +16 $.
Person A = 13 $.
Person B = +1 $ (chair).
The idea is that money isn’t lost in the process, it just changes hand. Person A lost 2 $, I made 1 $ and person B made 1 $. In other words person A decided to sell the chair under the price she bought it and that’s why she lost money even if the price might have gone up later on. On the stock market it’s the same idea, for one person to get out with 1 million $, it must have been put in by many people. It’s wealth transfer.
If someone sells for 2 000 000 $, then people must buy for 2 000 000 $ worth of stocks. This assumption leaves me under the impression that when nobody wants to buy a specific stock, then its price is dictated by the price people owning it set. On the other way around, if nobody wants to sell the stock, the price is dictated by the people who want to buy it.
Not quite sure I’m right? Just take a look at this.
Dividends constitute amounts of money paid to investors by the number of shares they own at the payout. Its part of the profits of a company but in the world of cryptocurrencies, it does not seem to exist. At least for now.
Let’s say everyone starts to think their chair is worth a lot less than it’s actually is. Then all the people are scared by the fact that they might lose money. They, all at the same time, decide it’s time to sell but at pretty much any price as long as they get their money back! There you go, this is a market crash and lots of people are losing money while a small amount of people are buying chairs at a really discounted price! A lot of money goes from a large amount of people to not so many.
Maybe its in the markets nature to push money from a lot of people to a lot less…
So if we understand all of this correctly, if nobody wants to sell or buy, the price is not moving. In fact, it’s close to impossible but it can (almost) happen in the world of cryptocurrencies as there are not so many people buying and selling sometimes.
Cryptocurrencies Risk Factors
My point of view is that many people don’t really seem to know why they’re dumping money in and in what. This is closer to gambling than investing honestly. Here are a couple of reasons to support my argument.
Small Market Cap
The market cap is equal to the number of outstanding coins multiplied by their unit price. This works in the real market as well. Generally, the more coins outstanding, the less volatile is the currency or if you prefer, the harder it is to make it move. That because more force is needed. Let’s say that stocks in the stock market are a bit more controlled and in greater quantity but in the cryptocurrency world: it’s the anarchy! What I mean by that is that sometimes a small amount of people can have huge capital and are able to control the market. In addition, there might be a lot less coins in circulation which makes transactions affecting the price more. The market does not stop as well, it’s 24/7!
Double Edge Sword
What’s funny, but also quite sad is that’s a double edge sword. Here is what I mean: it seems fair to say that if we keep our position (not buying and not selling) we would not lose money but that’s not the case. By putting money in something that’s not giving returns, one: we lose money and two: we lose the opportunity of making more money somewhere else. One bad choice and two consequences. Moral of the story, it can pay to be careful in studying where money goes upfront and be patient before withdrawing because whatever happens, unless the company or goal of the currency changes, the price doesn’t matter.
There Is a Way Money Can Be Lost
On the opposite of the real stock market, money can be lost in the cryptocurrency world by losing what’s called a private key. The private key is like to key to a safety deposit box where you can withdraw money. The public key is used to add money to the safety deposit box. Imagine a bank account in which you would need two cards to be able to do operations. One that you can lend to others to add money and one that you keep to yourself to withdraw money. If you happen to lose your private key, the money is “lost” because no one can have access to it anymore.
How Does Cryptocurrency Works Then?
A cryptocurrency is based on an algorithm that dictates the production of coins and keeps information on the network. It’s like a big decentralized ledger of transactions that everybody has. Miners are the one that can verify transactions and create new currency by working on a complex puzzle to find new blocks. A new block will give a reward to the finder and that’s how coins are created in most cases.
The goal being to find coins at regular intervals, difficulty is increased as more and more miners get into the game of finding the next block. One more thing is that the more miners there are, the less chance one has to actually find the next block. Logically because there are tons of computers trying to solve the puzzle.
Generally, mining generates less and less gains as the currency matures.
I admit that my explanation is pretty generic and that it greatly depends on the currency itself as there are new ways to implement features and to make the currency fair to every miner. For example the “proof-of-stake” concept which implies owning coins like shares and voting for new updates can pay out as well.
The blockchain is the protocol on which cryptocurrencies are based. In overview, it’s a decentralized agreement on the state of the chain and the next bloc to be added. The blocks generally contain transactions but can contain pretty much anything.
Decentralizing the ledger (data) eliminates the need for the bank and creates a lot of redundancy which makes the cryptocurrency as hard to kill as the number of players maintaining the network. In addition, since there is no bank, I can communicate directly with the person to which I want to send money instead of needing to send the transaction to the bank and then back and forth until one day it reaches the recipient.
On the blockchain, the blocks need to be found at a certain interval of time to try to make the transactions as quickly as possible. The fact is, sometimes when there are too many transactions the currency simply cannot keep up and it might take a while for a confirmation of payment. That issue is addressed by some currencies by using other means than what the Bitcoin does.
Need more detailed information about the blockchain? Try this one.
The wallet is pretty much your bank. It’s composed of a private key and public keys that you can generate from your private key to receive payments. If you lose your private key, you lose all your coins, simple as that. And you should never give your private key to anyone, only your public key(s). I strongly suggest backing up that private key as you are your own bank after all!
When you install the wallet on your computer, the first thing it’s going to want to do is synchronize with the blockchain. This might take a while as it’s retrieving all the transactions ever completed.
Mining creates coins and maintains the blockchain by “approving transactions”. In practice, if we’re two people mining on the blockchain and the block reward is 30 coins, every 10 seconds or whatever the time for each block found, one of us will receive 30 coins. They will then be added to our wallet as a transaction. Ok, it’s pretty rare that only two people will be mining, we’re talking hundreds or even thousands of computers trying to find the next block. Good luck getting rewarded. Hey you still have much more chance than winning the lottery! But that’s not really reassuring isn’t it?!
Depending on the speed you’re mining at (calculating the hashes), you will have more or less chance to find the next block than someone else. For small miners like us, mining pools have been created.
Mining Pools: For Small Computing Power
The pools are used for people with smaller computing power to be able to get paid once in a while. Pools redistribute work to computers as if there was only one super computer. For example, if my mining speed is 1 700 Mhashes per second and the pool mines at 10 000 Mhashes per second, then I have a lot more chances to find a block than when I mine alone (5.89 times to be precise).
Pools know how much a specific computer has worked by giving shares for every unit of work. This will help redistribute the reward obtained by finding the next block.
Here is an example of a pool’s control panel. To have access to the pool, you must register and then login.
Stock.. I Mean Coin Exchange!
As in the real market, there exists exchanges in the cryptocurrency world. This is the place where you can exchange one coin for another type of coin. Most of the transactions are calculated in Bitcoin first so there is a great chance that you’ll have to buy Bitcoin before you can transfer it in the currency you want. To begin, you have to create an account on your favorite platform and then get approved. Then you will be able to transfer coins to the exchange wallet. Yes you will have another wallet on the exchange as well. Want some examples: Poloniex or Bittrex.
Remember that transferring coins costs a small amount of whatever currency you’re using.
How to Buy Coins with Real Money?
To buy coin from a specific currency using real money, you will have to use another service as the exchanges generally cannot do that. In addition, you will have to buy Bitcoin or Ethereum coins before exchanging them in your alt coin (whatever non-mainstream coin). If you want an example of such platform, you can go visit the coinsquare Website. Again, there are fees associated with buying cryptocurrencies from real money, you might want to shop around.
Too Expensive Commission
My point of view is that it can become very expensive to trade cryptocurrencies at the moment. Mainly because (as you could see in the last two sections), you have to deal with two or more parties to get these precious coins in your wallet. Transaction fees and other stuff makes it not worth the price if you’re not buying a minimum amount of let’s say less than 1000 $ in coins.
I agree that this might adjust with time as there will be more competition in this market.
Let’s say that cryptocurrencies are not my first investment choice and here is why:
- Requires multiple platforms to be able to buy and sell coins (might change in the future);
- some cryptocurrencies don’t really have much usefulness in the real world (I mean no one is using them);
- potentially over-valued small projects and businesses (not much control);
- no dividends (ok maybe except for proof-of-stake but it’s not all the currencies);
- can be hard to understand how the whole thing works for non-geeks;
- mining is not very environmental friendly as it uses a lot of electricity and computing powePr;
- very new and we don’t know all about the potential;
- not many laws or they can greatly differ from country to country;
- lot of potential gains but not so much for the investors I believe…
Take what you want of my opinion but I am not yet convinced that cryptocurrencies are mature enough for anything else but play money. It’s true that it has a lot of potential on the technology, but sometimes it’s just not enough to really take off. What’s your opinion on the subject?!
This post is mostly based on my researches, my own experience and my opinion. Cryptocurrency is know for being really volatile. Invest with your brain and by doing your homework.