It would be pretty hard to have gotten through the last five years without ever hearing or talking about cryptocurrency or the blockchain. The explosion of Bitcoin, Ethereum, and other cryptocurrencies onto the national scene means the price movements of these digital currencies are reported on national news. However, if we peel back the surface, most of us don’t really understand cryptocurrency or the blockchain it’s built on. I won’t be giving you an investment opinion on cryptocurrency, but rather my focus is on helping you understand some of the mechanics behind cryptocurrency.
At a high level, Bitcoin is an anonymous way of sending and storing digital currency via a decentralized exchange. It’s decentralized in that there is no government oversight of Bitcoin. Instead, Bitcoin miners around the world verify transactions by solving complex mathematical equations. Once a number of transfers have been verified by Bitcoin miners, those transfers are packaged in a block, and the miner is rewarded with Bitcoin. In other words, Bitcoin miners create more Bitcoin by verifying Bitcoin transactions.
The block is added to what is functionally a ledger of other previously verified transactions (blocks) to form the blockchain. The theory behind the blockchain is that while the data is publicly available, it’s encrypted and secure. However, there have been some significant crypto-hacks, and cryptocurrency has been stolen from companies that store or transfer cryptocurrency. According to Bitcoin.org, Bitcoin itself has never been hacked. Due to the semi-anonymous nature of cryptocurrency, once cryptocurrency has been lost or stolen, it’s nearly impossible to recover it. While the ledger is publicly available, stolen crypto could be exchanged quickly for cash.
Many people wonder, what is the purpose of Bitcoin? Bitcoin is designed to be used as a way to securely transfer money. Of course, it’s hard to stomach the idea of using Bitcoin to buy a Tesla when one coin was worth approximately $36,930 on February 3, 2022, and by Friday, February 7, it reached $43,668. It makes you wonder, did your Tesla cost $73,860 or $87,336? As it currently stands, it’s probably not realistic for most people in the U.S. to use Bitcoin as a way of paying for goods and services because it’s so volatile. One thing to keep in mind, if you pay with Bitcoin, there’s no one to adjudicate a dispute. A transaction cannot be reversed, but it could be refunded by the person you paid as a new transaction.
That doesn’t mean there’s no use for Bitcoin or the blockchain. There could be a time where the value of Bitcoin settles down and it isn’t so volatile. That may make it more attractive for people to use as a way to purchase goods and services. Blockchain is already being used in a variety of industries. There are valuable uses for the blockchain technology within finance and supply chain management. Blockchain could be used to quickly and securely send money abroad or facilitate instant payments. Blockchain technology could give more people access to the financial system.
According to Bitcoin founder Satoshi Nakomoto (that’s not their real name, it’s a pseudonym), the number of Bitcoins available is limited to 21 million. Nakomoto says the last Bitcoin will be mined around 2140 because Bitcoin will get increasingly harder to mine. When we talk about mining in terms of Bitcoin, we’re talking about solving mathematical equations – there is no physical Bitcoin. We should note here that mining Bitcoin takes tremendous amounts of energy that has a very real effect on the environment. This is appealing to some people because they believe that process makes it a limited resource, unlike the currency of countries where more money can be printed.
However, it’s important to note that Bitcoin is not backed by any government (with an ability to tax residents to raise revenue), no business earnings to pay dividends, and there is no expected cash flow that comes from owning Bitcoin. You would buy Bitcoin purely if you thought the price was going to go up because more people were going to view Bitcoin as being valuable. The value of Bitcoin is dependent on the value that other market participants (Bitcoin buyers and sellers) believe it is worth. This means the price of Bitcoin can move around in large swings from day to day.
Some people have suggested that Bitcoin is a hedge or alternative to other more standard investments like stocks, bonds, and commodities. So far, Bitcoin has not served as an effective hedge to stock market volatility. It’s important to note that Bitcoin has only been around for a little over a decade, so its relationship to stocks and bonds may shift over time.
One final note, your private cryptocurrency key is the secure code you need to access your cryptocurrency, and it can not be recreated. It can be lost, thrown away, or die with you. If that happens, there will be no way to recover those assets for your heirs. If you are interested in owning cryptocurrency, make sure you research reputable brokers, consider how you will digitally store the cryptocurrency, and make sure you let your CPA and attorney know. You need to do some special planning around your cryptocurrency in your estate.
[vcex_divider_dots color=”#dd3333″ margin_top=”10″ margin_bottom=”10″]
BBB Central Virginia reports that Bitcoin is part of the second riskiest scam of 2021. Read more here.
