The Basics of Bitcoin and Cryptocurrency—and How to Invest

If you’re like us, chances are you hear the word “Bitcoin” and your eyes glaze over a little. But as with much of the finance world—which deliberately uses obfuscating language—you just have to chip away at a few of the core ideas and suddenly you find you’re not as out of the game as you thought.

Before we met Bill Barhydt, founder and CEO of the cryptocurrency-exchange app Abra, we also felt like we had very little reason to care about Bitcoin. But Abra—which is part user-friendly investing app, part Venmo for crypto—was initially created to allow people to use Bitcoin to easily and cheaply send money across borders. “Our main use was for remittances, or money that is sent home by workers earning a living in other countries,” Barhydt says. “Fees for these transactions can be as high as 15 percent…to move money around by the people who can least afford it.” And according to Barhydt, cryptocurrency is the technology that can solve that problem.

In the last year, Abra has expanded its investing services, too, in a way that fully leverages blockchain technology.

If we lost you at “blockchain”: Read on.

A Q&A with Bill Barhydt

Q What is Bitcoin? A

Cryptocurrency is digital money, which means it can be stored on your computer or phone and sent person-to-person with no bank or intermediary. Bitcoin is the first cryptocurrency.

Rather than following the traditional process of a bank or credit card company confirming a customer’s identity, Bitcoin relies on a set of private and public keys that help protect people on both sides of the transaction. A public key is like an email address; you can give anyone the address and they can send Bitcoin to that address. The private key functions like your email password. It protects access to your Bitcoin and should be carefully guarded and protected.

Q Where does Bitcoin come from and how is it created? Where can you get it? A

Bitcoin is created via a process known as mining. Mining for Bitcoin is the digital equivalent of digging for gold. Miners use powerful computers to compete with each other to “win” Bitcoin by solving a math puzzle that gets harder and harder as more people try to win. The amount of Bitcoin that miners can win decreases over time.

This means that Bitcoin is a deflationary currency, like gold, which has created a hoarding situation that many economists predicted. This hoarding process creates a feedback loop: As Bitcoin becomes more valuable and more scarce, more people are motivated to hoard it, which increases the value, which leads to more hoarding and drives the price up more.

Miners also decide which transactions get accepted by the Bitcoin network. Users pay miners a small fee for accepting their transaction when they want to send money using the Bitcoin network. This is akin to paying a fee to your bank when you wire money. Miners generally take the transactions with the highest fees first since Bitcoin can process only about 25,000 transactions per hour. Soon, this will grow to millions of transactions per hour.

If you’re interested in owning Bitcoin as an investment or using it to send money but you’re not a miner, you can also buy some from other Bitcoin holders. You guys can try Bitcoin Trader to buy bitcoin & trade it easily.

Lastly, lots of people maintain copies of the Bitcoin network, called nodes. Nodes ensure that everything runs correctly and that miners do their jobs according to the rules of the system: They run a sophisticated type of ledger called a blockchain that maintains a copy of every single Bitcoin transaction ever executed.

Q How does cryptocurrency have value? How can you trust that it will have value in the future (as opposed to fiat money)? A

Ultimately, anything has value because people agree that it has value. Government-issued money, such as the US dollar, has value because we all agree that it does, mostly because our government accepts payments of tax debts only in its own money.

Generally an asset such as cryptocurrency or baseball cards or gold has value for a few potential reasons—although not all have to be true at once: 1. People want to hold an asset to store value or as an investment.

2. People think the asset is generally scarce with a reasonable assurance that it will remain scarce or no one can artificially create lots more of it.

3. People hold an asset if it serves some useful function either as money, a commodity, or a tradable good.

Bitcoin, specifically, has value for a few different reasons: 1. The mining process. The same economic incentives that drive people to dig up gold or drill for oil are at work: People are willing to dedicate time and resources to create new Bitcoins. There’s a market there, and the market is driving production.

2. Its network effect. Bitcoin is the first and most dominant cryptocurrency. There are many alternatives, but people continue to use it because it remains the most widely adopted and secure network.

3. Scarcity. There will only ever be 21 million Bitcoins produced. Comparatively, modern fiat currency is a product of monetary policy that is controlled by central banks. As we see all over the globe, it’s pretty easy for governments to get that monetary policy wrong and cause all kinds problems. People are attracted to Bitcoin’s value proposition because it offers an alternative to traditional assets and is based on computer code that is global, apolitical, censorship-resistant, and inherently scarce.

Q What is a blockchain and how does it work? A

The Bitcoin blockchain is a distributed database that ensures that all past, present, and future transactions are valid and “unhackable.” Think of it as a huge global checkbook, with no bank, that millions of people have a copy of. Every time you want to deposit or withdraw money to or from the checkbook you have to call at least 51 percent of the people with a copy of the checkbook and get them to agree that the transaction is valid—majority rules. Why would you want to have a copy of every transaction in every checkbook? Simple: It’s the only known and proven way to guarantee that the money in the checkbook doesn’t get spent twice. (Of course, Bitcoin does this in a more efficient manner than the global checkbook analogy, but the idea is still the same.)

More importantly, the Bitcoin blockchain is a new way of organizing data. It is a structure that builds on itself. Each block contains information that has been verified and can’t be erased or rewritten. Once a block is completed it is linked to the next block, forming a chain of linkable information. Through solving the problem of trust on the internet, blockchain enables new kinds of economic activity based on the coins created to incentivize its management.

Q What are other cryptocurrencies worth knowing about? A

There are thousands of cryptocurrencies, and more are being developed and launched every day. Some cryptocurrencies are versions of the Bitcoin blockchain that are trying to solve for other issues. Litecoin, for example, is designed to enable faster and cheaper transactions, while a coin like Dash is designed with additional privacy in mind. Then there are other cryptocurrencies that are building completely new infrastructures. Ethereum is the second most popular cryptocurrency in terms of network value. There are a lot of ways to measure value, but cryptocurrency systems are valuable in part because they are open and distributed networks. And Ethereum is designed as a platform to run decentralized applications and smart contracts, and it is used to create new tokens that are distributed via initial coin offerings (ICOs) or token sales.

We’re still in the early days of cryptocurrencies, so it will be interesting to watch as this whole new sector unfolds.

Q What’s the bigger picture with cryptocurrencies? A

Today, the Bitcoin network is worth over $100 billion. We believe that eventually Bitcoin will be used to solve big global problems. I can think of three tangible examples.

The first is payments and money transfer for remittances. Over $500 billion is remitted globally by migrant workers to their families in other countries. Fees for these transactions can be as high as 15 percent and average around 10 percent. That means that $50 billion is wasted on needless fees to move money around by the people who can least afford it. Bitcoin can eventually eliminate these fees.

The second example is enabling new types of investing. Bitcoin can enable smart contracts that can be used simulate very simple derivatives, which can give investors exposure to US stocks in foreign countries. Or it can give US investors exposure to foreign stocks without having to find a broker to actually sell the stock.

Lastly, we believe Bitcoin technology will be used to enable people in developing markets to lease home electronics such as washing machines, refrigerators, televisions, etc. The buyer will simply forward a small amount of Bitcoin every week to the wallet of the seller and this will enable the appliance to function. This is not easily possible with traditional government money, and it is a powerful possibility.

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