The Bitcoin Phenomenon (and How to Profit from It)
I’ve never been an early adopter of new technologies.
While cell phones started to become popular in the 1980s, I didn’t buy my first one until a decade later. I also didn’t see what all the fuss was about the internet. So I didn’t start using it for research until the late 1990s, although I did use email for several years before that.
I was also skeptical about the Bitcoin phenomenon. When Bitcoin burst onto the scene several years ago, I thought it would soon be forgotten. My belief was that any digital currency that could replace those issued by central banks would need to be backed by gold.
Obviously, I was mistaken. Bitcoin has rapidly gained acceptance as a medium of exchange because it offers low to non-existent transaction costs and, with the proper implementation, virtual anonymity. It’s also become quite the hot investment, as the chart below demonstrates.
To put this chart in perspective, if you had purchased $100 of Bitcoin when it was worth $10, your investment would be worth $20,000 today.
Of course, it hasn’t been a straight trajectory. What this chart doesn’t show is the spike in 2013 when the value of Bitcoin rose to about $1100. But the price only stayed above $1000 for ten days. Then prices stumbled in 2014, were mostly flat in 2015, and didn’t recover to the 2013 peak until 2016. Indeed, Bitcoin lost 75% of its value from its peak in 2013 to its low in late 2014.
But in 2017 Bitcoin has made enormous gains. Since the start of the year, Bitcoin has gained a stunning 141%. And that includes some significant downturns, including a heart-stopping 25% decline in a single day in May. Since then, Bitcoin has recovered about half the ground it lost, although it’s still down 12% from its peak.
Bitcoin is an electronic digital currency. But unlike traditional currencies, it’s not printed or created out of thin air by a central bank engaged in “quantitative easing” or similar operations. Instead, Bitcoins are produced by “mining” them using computing power on distributed networks.
The rules that make Bitcoin work – the protocol – limit the number of Bitcoins that will ever be mined to 21 million. That means it’s impossible to debase or otherwise manipulate its value.
For those who are mathematically inclined, the software on which the Bitcoin protocol is based is open-source. That means anyone can review it to confirm that it works the way it’s supposed to work.
Another characteristic of Bitcoin is that it’s decentralized. There is no “Bitcoin master” or other authority to oversee operations. Instead, every computer that mines Bitcoin and processes transactions becomes part of the Bitcoin network. That means no central authority can “bail-in” Bitcoin. It would be impossible for anyone to do with Bitcoin what the European Central Bank did to bank deposits in Cyprus in 2013. That bail-in cost depositors up to 100% of the value of their uninsured bank accounts.
In an era when opening a bank account requires running the gauntlet of due diligence procedures, it’s refreshingly easy to open a Bitcoin account. When I set up my first Bitcoin account, the whole process took about 15 minutes.
Every single Bitcoin transaction is stored in what amounts to a gigantic general ledger called a blockchain. Because the blockchain is protected by heavy-duty encryption, it’s highly resistant to tampering. One consequence of the blockchain is that if you have a Bitcoin address, anyone can see how many Bitcoins are stored there. But, unless you tell them, no one will know that you’re associated with that address. And it’s possible to set up multiple Bitcoin addresses so that your holdings are distributed throughout the network.
Because Bitcoin transactions are peer-to-peer (between individual users – not through a central authority), they’re far more private than transactions through a bank. The transactions are functionally anonymous. Because of the blockchain, the details are traceable, but the identities of the persons involved are not.
Bitcoin isn’t perfect and is experiencing some growing pains. As Bitcoin becomes more popular, merchants that accept it must expend more time and fees. This problem can be solved by upgrading the blockchain, but there are divisions within the Bitcoin community as to the best way to do it.
Theft is a concern as well. Depending on how you store your Bitcoin, hackers may be able to steal it. If a hacker manages to access the “key” to your bitcoin address, he can transfer your holdings anywhere he likes. You can prevent this by practicing good computer hygiene. This includes updating security settings and also taking the data security precautions I wrote about in this article. And for ultimate safety, you can also store your Bitcoin offline, on a flash drive, for instance.
Want to know if Bitcoin is for you? Wondering how to start out with it? Read the Bitcoin report written by Paul Rosenberg, president of the virtual private network Cryptohippie, and the most knowledgeable person I know on all things Bitcoin.
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