Bitcoin: Understanding it bit by bit

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Bitcoin is the new buzz word in market & this article aims to educate our readers about cryptocurrencies and their basic ways of working. This post is written by our guest writer Suyash Sathe and we are thankful to him for taking time out of his busy schedule while working for a singapore based american investment bank. He is a value investor who made his first investment at an early age of 16. Over to him!

What’s the fuss about Bitcoins?

History of Bitcoin is a personification of what the online world itself is. Anonymous and rapidly evolving. In the midst of 2008 financial crisis, sprang a whitepaper from a certain Satoshi Nakamoto on a framework for a new digital transaction system called Bitcoin. No one knows if Nakamoto is an individual, a group or just a pseudo-identity (remember Yahoo messenger Chat!), but the framework quickly drew attention as a robust marriage of cryptography and decentralized networks which could eliminate the need for central regulators.

Since then, we have all heard terms like Blockchains and Cryptocurrencies, and how they’re going to change the world. A number of cryptocurrencies, like Ethereum, Ripple and Litecoin, have emerged since the invent of Bitcoin. Simply put, cryptocurrencies are digital currencies based on Blockchain technology which use cryptography for security and are aimed to enable transparent online transactions worldwide.

What is so great about Cryptocurrency like Bitcoin?

  1. Decentralized: All fiat currencies (US Dollar or Indian Rupee) are issued by Central Banks who get to modulate the level of liquidity in the market and a right to regulate each transaction passing through the financial institutions. Bitcoins on the other hand is de-centralized money i.e. not issued by any central body. It is generated (mined) by powerful computers and transacted on the internet without needing clearing houses, banks or payment gateways.
  2. Very Low Cost: Imagine not having to pay a cut on every transaction to Banks, Visa/MasterCard or other third party intermediaries! Sounds unrealistic? Then that’s exactly what Bitcoin offers. Cost of transmitting bits over the internet is virtually come to zero today. Text, voice calls and even high quality video is virtually free. Why should transferring money be expensive? Be it picture, audio, video or value, ultimately it’s just zeros & ones getting transmitted over the internet. Bitcoin addresses this concern to good effect by making transactions real time and very cheap.
  3. Secure: Apart from using advanced encryption algorithms to secure the transactions, Bitcoin uses public distributed ledger. Which means everyone can validate the transactions on a network. If an altercation in record is found which does not match with other ledger copies, that transactions is barred and the node(account) is frozen making it hard to counterfeit, tamper or double spend
  4. Mining: Mining is a process of validating transactions in the network. For example, with Bitcoin, thousands of transactions are thrust into the network per minute. Miners are programmers who solve complex mathematical problems to validate these transactions and are in-turn rewarded by the network. This motivates programmers to keep the network clean, up & running.

Should I invest in them?

Speed of Technology Adoption has drastically reduced over the last 50 years. TVs existed since 1920s, but it was only in 1980s that it was truly adopted by masses. That is a gradual adoption over 50 years. Compare that to smartphones; first iPhone was launched in 2007 and by 2012 almost everyone had a smartphone. That’s 5 years from initiation to adoption to maturity! So, if a new technology is truly innovative and game changing, adoption will be very fast.

Right now, cryptocurrencies are on the upward curve of adoption. Value appreciation of cryptocurrencies is linked to adoption (measured by market cap). Adoption right now means exchanging cryptocurrencies for fiat currencies (Rupee, Dollar, Yen) at market rate. As adoption rises, market cap goes up and so does the Rupee value. In Nov 2013, Bitcoin market cap was $2.4 billion. Today, it is $72 billion.

Bitcoins have gained negative publicity as they’ve been used for money laundering and drug trafficking. Sections of the society excluded from formal financial systems will naturally be early users, so we are not surprised. If anything, this is a successful proof of concept. However, what can buy you guns and drugs, will make people stop and think. There will be calls for regulation. And there will be a tussle between conventional financial institutions (including central banks) and crypto-revolutionists. Irrespective of who wins, the idea of decentralized and secure transaction systems is here to stay. Whether it is Bitcoins, Ethereum or something else, the way we view money, is about to change fundamentally.

Throughout history, the instruments of value have changed with time. From stones, to precious metal coins, to paper, to plastic, the instruments of transaction have come a long way. In the information age, it’s fitting that ‘bits’ are knocking on the door as an instrument of choice.

Our View

Although there is a wave of enthusiasm for Bitcoins, Etherium etc., it is still few years away from being mainstream. We recommend a cautious approach to cryptocurrency investing. These are very very high risk high return investments. Invest only small amounts (1% or 2% of your wealth) in multiple cryptocurrencies over time-frames of one year. You also need to keep an eye on new developments around this area. We will keep a close watch on all events in cryptocurrency space to keep readers up-to-date on opportunities and risks. A lot of curious clients are asking if we are going to launch a new service on cryptocurrency investing. Well, Bitcoin or any other crypto currencies are at very nascent stage for us to adapt & launch a new service out of it. So right now, we are not launching any new service but who knows about the future.

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