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10. Crypyocurrency – Risk and Volatility

It pays to remember that Bitcoin and crypto-currency is in it’s infancy. The value of a Bitcoin is highly volatile and is highly unpredictable over the short term, so it should not be regarded as a way of saving money. Only try it out with money you can afford to lose. Personally I believe it will evolve to the point where financial control is wrested away from the banks, governments and a clutch of super rich with the power to manipulate the market. Like all investments, anyone getting on the ride early could reap the benefits as it grows. However, we are breaking totally new ground here. It is also likely that cryptocurrency could out perform fiat currency and be a lousy investment but useful only for short time transactions as an “on the spot” measure of value, rather than an investment instrument. For all we know, it could have passed it’s investment peak now. For my money, there are better investments that conserve the value of your hard won savings.

Initially the concept of Bitcoin took off and other cloned versions vied for leadership. It was viewed as shady and branded as a way crime would launder money, in it’s early days. Banks refused to recognise it, effectively making it valueless in the real world. Today several banks are looking at participating in Bitcoin. These ups and downs in perception have reflected in the price of a Bitcoin.

Recently several European and Australian Banks have quietly begun to purchase Bitcoins. The Commonwsealth Bank of Australia is looking into Bitcoin at the moment.

I believe that it’s only a matter of time and crypto currency will take over from the banks, leaving them to be expensive safe deposit houses. The world needs a universal currency and nationalistic pride will never accept any one currency. The answer is a cryptocurrency like Bitcoin. Currently we lose millions in transfer fees to transact overseas. Why? We’re not loading gold onto ships any more; it’s purely digital data these days (the price of an international, micro seconds long, phone call)  but we are still paying the fees fixed in the pre-computing days when it was shipped in a flotilla with armed escort vessels. With Bitcoin it will cost no extra to transact at home or overseas. The banks require staff to do this, so they can never compete with Bitcoin.

The important consideration is, there is a maximum number of Bitcoins. There can only be 21 Million Bitcoins. Unlike currency, no-one can make any more. Over time as more and more businesses come to accept Bitcoin, the demand will increase and being capped at 21 million means the value of Bitcoin should rise proportional to the demand. If the same happened with the US Dollar, for example, the Federal Reserve could print more money which would drop the value of the dollar. No-one can do this with Bitcoin.

As in all digital matters, with time any system becomes open to vulnerabilities, so you need to keep your software up to date. I would not suggest you transact in Bitcoin on a system using Windows XP, Windows 7 or Ubuntu 13.04 Linux. These operating systems are no longer supported for security updates and would invite hackers to steal your wallet. If you prefer these old stalwart systems, transact using a smartphone with updates and store your stash in a cold store,  hardware wallet that is removed from your system, the moment the transaction is complete.

8. Cryptocurrency – Digital Wallet

Every financial system, whether cyber or real, has a weaker link. The weakest point in Bitcoin is the owner of the digital wallet. It relies on you as owner to secure your stash of Bitcoin, your digital wallet.

Your digital wallet should be treated the same as your real world wallet. Because Bitcoin is able to transact anywhere in the world, without exchanges, it can also be targeted from anywhere in the world too. The Blockchain is digitally more secure than any bank, both through it’s encryption and the fact that it is visible worldwide, so any tampering is easily spotted. In a bank, we rely on our inhouse security people to spot a digital attack. In the Blockchain we have millions of people at any one time, many of them extremely competent programmers, watching for any hint of attack.

A hacker would have to be very brave to successfully crack the Blockchain, even if they could find a way. They would have every one of the world’s top hackers and security expert after them.

If a hacker was able to get to your digital wallet, they can only steal the bitcoins stored there in that one wallet. Unlike a bank, where many accounts are secured by one blanket security system, allowing the cyber theif to steal from multiple accounts. In the Bitcoin system, each wallet is completely stand alone – not connected to another wallet.

There are services that claim they can store your wallet on line. Be very wary. Very few have sufficient security to withstand a concerted cyber attack. Remember they are not banks.

You should only keep a small amount of Bitcoins in your digital wallet, on your computer or smart phone. Just like your real wallet, you wouldn’t put your life savings all in there. Should anything go wrong, like you phone get stolen and hacked, your computer get hacked, a hard disk failure and any similar disaster, you will only lose a small portion of your Bitcoins.

The remainder of your Bitcoin should be kept in what is called “cold storage”. This is kept off line, off your computer on a flash drive or some other removable memory device. This is important because any electronic device connected to the Internet (including a phone network) has the potential to be attacked. Hackers are getting more and more talented all the time. It’s not practical to say any system is foolproof.

You need to keep multiple backups of your digital wallet and cold store. I don’t mean keep a second copy on your computer on D drive, when you computer has two hard drives. Usually this is a second partition of the same disk as C drive. I mean you keep a backup copy on more than one media; say a memory stick and a removable hard drive of memory card and then remove these from your phone and or computer. DVDs and Cds will degrade with time and can be easily scratched. Memory sticks can suddenly not work. The safest practice is to use two different media (eg two memory sticks) and place a copy on each.

Passwords should be complex, not simple dictionary words and use two layers of security to identify you, eg, password and PIN or security question.

If all this sounds complicated, it’s because we are at the infancy stages of crypto-currency and the amount you think is tiny today cold be a fortune in 5 years time. If it is, you’d be grateful the today, you took these steps to make it secure. To put it into perspective, if you opened a bank account today, for the first time, the rigmarole would be worse.

Remember when Lazlo Hanyecz bought his pizza back in 2010, with Bitcoins, they were worth 0.0041 cents each, today(8th September 2016) those Bitcoins are worth over $825.13 NZD or $802.24AUD each.

7. Cryptocurrency – The basics before you start.

If you are considering exploring Bitcoin there are a few things you should know first:

Because it is a bit Geeky, there’s a few con-artists and scams that claim to have a secret formula to earn (or mine) Bitcoins or some other alternative crypto-currency. Generally the price you will pay for their secret is far greater than what the secret will earn you.

Originally, mining bitcoin was very profitable but as more and more of bitcoins are mined, the profitability of the process decreases. The algorithm that creates bitcoin grinds to a halt at 21,000,000 bitcoins. There can be no more in circulation. This is the main reason why bitcoin is the ideal cyber currency – no government can manipulate the value by creating more bitcoins, like they currently do with fiat currencies. Thus it is universal for all countries. With fiat currency the value is adjusted by the treasury. If it wasn’t, you be paying around $75 for a loaf of bread today. A despotic or incompetent treasury can ruin the value of their currency.

Bitmining -cold store wallets
Bitmining -cold store wallets

Transacting with Bitcoin is different, rather than talk of whole coins, we tend to use decimal fractions of a coin. Unlike physical money, cyber money can be cut up into smaller pieces easily, with no loss in value. If I wanted to pay you 50 cents, pulled out a hacksaw and cut a dollar coin in half, it would not be worth two pieces of 50 cents each now. However the same is not true for cyber currency; it is simply divided up with each part retaining it’s proportional value. So if one bitcoin is worth $97USD a transaction of 0-010309 BTC would be equivalent to one US dollar.

Using Bitcoin you exchange funds a little differently than you would with online banking but the actual transaction process is every bit as secure as any online banking, probably more so because it is so visible and cannot be reversed or in any way tampered with. The system is self auditing for every transaction, unlike fiat money (folding stuff backed by the government) transactions.

It’s important to realise that Bitcoins are valuable and targets for theft, the same as real money in your bank account would be. The difference is, your digital wallet is the equivalent of your bank account. The onus is on you to secure your digital wallet. Use a two password recognition system with non dictionary words. Do not store access codes on your computer. Keep your malware and antivirus ware up to date. Back up your digital wallet onto a flash drive or removable disk.

Your digital wallet is a software program that requires a password or two to access. Lose the password(s) and you lose access to your wallet permanently! There’s no way to recover the password(s).

Recently you may have heard of hacks that broke into the companies that were brokering/trading bitcoins. Millions were stolen because of their weak security. The real losers (aside from the companies that went into bankruptcy) were the people who relied on them to store their bitcoins and those doing transactions at the time the company data was stolen. As I have said all along, this is a totally new way of transacting, there’s no precedents to rely on for advice, so we are learning as we go. The lesson is, don’t rely on any company to store your bitcoin and don’t store them on your computer. Store your bitcoin in your wallet on a flash drive (memory stick etc.) and physically remove it from your computer when you are not transacting. Should any one try and hack an exchange etc. you have proof that your bitcoin was not used. If it sounds scary, it’s no different to your bank, except if they get hacked, they have your records and can take up to 90 days to investigate it. With bitcoin, you have proof the transaction did not come from you.

There are a few different varieties of digital wallet software. Some back up your digital wallet to a secured server (like the secured ones that were hacked recently). If your computer crashes, you can retrieve a backup copy but it required typing in 25 words in the exact order you were given them when you created the digital wallet. Not an easy task!

There are no free lunches and this is very true with Bitcoin mining or working online to earn Bitcoin. If you treat it as a financial system rather than a get rich quick scheme, it will serve you well. Treat it as an investment at your own risk.

Unlike currencies, purchasing with Bitcoin is simpler because there is no exchange rate, however there is a delay in the transaction going through as it gets verified.

6. Cryptocurrency – What is Bitcoin really?

It’s hard for some of us to get our head around cryp-tocurrencies like Bitcoin because although we see pictures of Bitcoins on the Internet, the coin itself is really only exists in cyberspace. It’s not even a coin, it’s a number. If that makes it sound shonky, take another look at that $10 note and ask if it is really worth $10. It’s just a bit of paper. Even with all it’s security tricks and special paper/plastic, it’s real value is around $0.005 or half a cent. It’s nothing more than a symbol of value. If you bank that $10 and then use your Eftpos card to buy something for $10, do you really think some bank guy races out the bank’s back door to the place where you made the purchase and hands over the $10.00 note? The simple fact is, the transaction is simply data on line.

That’s the first shift in thinking that people have a problem with. It might sound strange to us, used to the folding stuff, but it’s really what money has been all along – a symbol for a transaction. If you get your wages deposited directly into your bank, do you really think your employer piles all those notes in a briefcase and trots it off to the bank before Thursday? It’s a cyber transaction. No notes or coins physically change hands.

The second mental stumbling block is actually easier to understand. Because a single Bitcoin is so valuable, we tend to use fractions of the coin. Imagine we are back in the medieval times when coins ar made of precious metal. If I had a 100 dollar coin and needed to pay a dollar, I could cut a peice of metal off the coin that was one hundredth of it’s value. So it is with Bitcoin. While there is a dollar amount for one Bitcoin, most transactions are conducted in fractions of a Bitcoin. Currently, while a Bitcoin is worth over $900, many transactions are conducted in tiny fractions of a Bitcoin eg. 0.0025 Bitcoin.

The value of a Bitcoin is volatile but that shouldn’t be too hard to digest either because so is every other currency. Given that Bitcoins are so new and to most people not understood, it shouldn’t be surprising that the value oscillates with every rumour. In all honesty Bitcoin is more volatile than most other currencies however the number of Bitcoins was fixed when the original algorithm was designed, at 21 million Bitcoins, so I think we can safely say, if Bitcoin does become the universally accepted crypto currency, it’s value will eventually increase.

However therein lays the catch – ” if it is accepted as the universally accepted currency” . There are other crypto-currencies there. As far as I can tell, they don’t seem to be faring as well as Bitcoin at the moment.

4. Bitcoins for pizza

Laszlo Hanyecz, a programmer, in Florida USA conducted the first real world Bitcoin transaction. He had mined’ 10,000 Bitcoins and wanted to test their real worth in the real world. He decided to use them to buy a pizza but his local pizza store did not accept Bitcoins. At that time, no commercial institution accepted Bitcoins, they were like Monopoly money.
On the 18th of May, 2010, Laszlo posted a request on the Bitcoin forum asking if anybody could use his 10,000 Bitcoins (then worth about US$41) to buy two large pizzas (then costing about US$25).

A hand holding a piece of pizza pie.
Probably the world’s most expensive pizza now but it verified Bitcoin’s real value for the first time.

As Laszlo said, ” … what I’m aiming for is getting food delivered in exchange for Bitcoins where I don’t have to order or prepare it myself, kind of like ordering a ‘breakfast platter’ at a hotel or something, they just bring you something to eat and you’re happy.”
It was an experiment as Laszlo put it, “I just think it would be interesting if I could say that I paid for a pizza in Bitcoins.”
After a few days, he was contacted by Jeremy Sturdivant, who was then 18 years old, and also living in the USA. After a bit of back-and-forth, the deal was finalised. Laszlo sent the 10,000 Bitcoins to Jeremy, who contacted a pizza store in Jackson, Florida, which delivered the two pizzas.
On May 22, 2010, Laszlo joyfully posted, “I just want to report that I successfully traded 10,000 Bitcoins for pizza.”
By August 4 that year, the value of the Bitcoins had risen to US$600, and by 29 November had reached US$2,600. Laszlo said, “I don’t feel bad about it. The pizza was really good.” By November 2013, those 10,000 Bitcoins were worth US$12.4 million. Lazlo broke two world records; the first Bitcoin trade in the real world and the world’s most expensive pizza.
To commemorate that first commercial Bitcoin transaction, May 22 is now called Bitcoin Pizza Day.

2. Cryptocurrency – a natural evolution

Civilisation has, always run on the Law of Supply and Demand. When we needed some way of storing value in some trasportible form, every culture has used something rare. In ancient Western civilisations it was in the form of metals. In polynesian culture it was rare shells. When nations began to trade with each nations, they faced the problem that rare and precious in one land, was plentiful in another. Because metal was rare, required mining, smelting, and expertise to work it, it was the logical material to represent value. Fashioned into small discs for ease of handling, it became coinage over time. Over time, with attempts at counterfeit and corrosion, gold and silver proved to be the best metals. They were rare, did not corrode, were valuable in every kingdom, and required enough labour and skill to produce coins, that they were difficult to counterfeit. They could easily be worked into intricate designs that were difficult to copy.

However the transport of this precious metal posed a problem. Not only was it heavy and bulky in large quantities, but it was a target for robberies too. Transporting it required guards and specially constructed vehicles, all of which added extra costs. The solution was to write an IOU or a cheque as it eventually became known. Eventually though, the treasure had to be delivered to balance the books.

The cheque system was too cumbersome for traders who had to keep records of who’s cheques cancelled out each other. The whole system relied on the buyer , seller and the trader who transferred the goods all keeping honest matching records.
The solution was fiat money – these were peices of paper , parchment, vellum or silk, that the rulers agreed were equivalent to a certain amount of precious metal. They had to be decorated with designs that were difficult to copy and harsh laws were introduced to punish any who tried. We still use this system today. The English Pound is a relic from the early days of fiat currency. It used to have a sentence in fine print saying “The Royal Treasusry agrees to pay the bearer one pound of gold”, hence the name, “Pound”. Of course as gold prices soared, the English had to replace these notes with others without the promise of gold.

1814 Gloucester Pound Note
An 1814 One Pound note issued by the Gloucester Old Bank
(Photo courtesy of Wikimedia Commons)

Over time as people travelled more, especially with the advent of air travel, it became pointless to ship large quantities of gold around to balance international payments. We accepted digital data recording transactions. this evolved into memory chips in the plastic cards we use today

In each evolution we moved further away from the physical valuable item into an idea, a promise of value. This modern day digital system still requires a value adjustment when the transaction moves from one nation to another, a concept we call foreign exchange. Early in the 20th century some forward thinkers started to question why? If it’s digital information being transferred, it’s the same wherever it goes. Why not use a common currency?

It’s great idea in theory but you are competing with patriotic pride. The USA had always had the benchmark currency because it has the world’s largest stable economy. But China has the most transactions and Russia resents anything American. When it comes to converting their old currencies to the universal one, who decides on the value?

Europe debated it for 100 years and finally came up with the Euro but that’s as far as it went.

Fiat money relies solely on confidence in it’s governments for it’s values. We didn’t realise just how fragile these values were until 2008 when Lehman Brothers, the fourth largest investment bank in the USA, collapsed, sparking the whole infamous global financial crisis. Suddenly we weren’t as confident in the US economy any more. To maintain that level of confidence, the US government poured billions of dollars in, to prop up the confidence in their currency. Huge fees were secretely vanishing into bankers pockets in the form of fake performance bonuses and inflated salaries, that should have been going back to the people depositing their savings.

This created an interest amongst some people, especially in information technology field, who felt it was time for data to become a cryptocurrency, a virtual currency that was beyond the manipulation of the banks and governments. If every transaction was published openly, for all to see, who needed bankers to act as policemen?

1. Cryptocurrency

Crypto-currency, cyber-money or virtual currency is something we all need to get our head around. To many people it’s a Geek thing that they don’t understand and is probably shady, at best one of those grey areas in tax law that will soon be closed and it will all come crashing down.
In fact if you are in business, it’s something you will have to come to terms with eventually, like it or not, because it’s another step in the evolution of finance and sooner or later will be the way you trade.
In the next articles we’ll look at the conceptual formation of crypto-currency, how to use it (both the benefits and the pitfalls) , how to convert it to fiat money (the folding stuff we use today) and how to get it.

Bitcoins
Bitcoin

Because Bitcoin was the original cryptocurrency, we’ll use it as our model but there are other currencies as well.
Until recently it has received a lot of bad press, mainly due to it’s volitility. People who valued it lowly have felt cheated when they got rid of it and then the price soared. Today the price is hovering in the $1,000 range. The fact it is so new is adding to it’s volatility.
To most it’s viewed with scepticism, like some Geeky ponzi scheme. Few people outside the Geek community understand anything about it. It’s seems so strange but in fact it is a natural development and evolution of the old fiat currency system that will eventually render banks redundant and take finances out of the hands of manipulative governments.