How’s this for a hero’s journey: In July 2010, one bitcoin cost just 5 cents. In December 2017, that figure had risen to nearly $20,000. And just three months ago, the price fell to around $6,000 — meaning the global cryptocurrency market has lost more than $600 billion from its peak.
Despite the recent downturn and fluctuations in the market, the top 100 cryptocurrencies boast a current market cap of $219 billion, and the majority of Americans — 69 percent — expect the price of cryptocurrencies to rise in the next five years, according to a survey by the Global Blockchain Business Council. That same study showed that 21 percent of people are considering adding bitcoin to their portfolios, but 38 percent of Americans see bitcoin as a bubble that’s ready to pop — so what gives? If you’re considering putting money into bitcoin (or just want to talk intelligently about it at a cocktail party) here’s what you need to know.
WHAT IS BITCOIN?
Bitcoin is one type of digital currency, or “cryptocurrency,” that was dreamed up by an anonymous inventor (known as Satoshi Nakamoto) in the wake of the 2008 financial crisis. Think about digital currencies like viewing your checking account balance online — you see the number on your screen, but you don’t have the bills in your hands. In the case of bitcoin and other digital currencies, however, there is no standardized physical representation (like a dollar bill) — the assets exist only in digital form. There's also no regulation. The payment network that allows the digital tokens to move between individuals isn’t managed by any one entity (like the government) or company (like Visa, Wells Fargo or Venmo). Instead, it’s decentralized, made possible by a system of computers around the world, and transactions are private; in fact, many users value the degree of anonymity that digital currencies offer.
While purchase options with bitcoin have historically been limited, today you can use it at hundreds of online retailers including Overstock, Expedia, Newegg and Etsy, and it’s become increasingly popular to purchase gift card using bitcoin, on sites like Gyft and eGifter, where you can purchase gift cards to virtually any retailer, thus making bitcoin infinitely more spendable.
HOW DOES BITCOIN WORK?
The technology that makes bitcoin and other digital currencies work is called blockchain, which Mercina Tillemann, chief operating officer at the Global Blockchain Business Council, says is kind of like a set of railroad tracks. "In order to get something from me to anywhere else, I need that framework — [those tracks] — to exist.” Bitcoin is like a train car that travels on top of the tracks. When you send bitcoin to someone, the transaction is verified by computers all over the world. The computer or data center that verifies the transaction first (it involves solving a complex mathematical equation) is rewarded in the form of a bitcoin payment, says Kyle Forkey, general partner at Amentum, a cryptocurrency investment firm. (People and groups who race to do this can turn a significant profit.)
Until recently, it was difficult to move something digitally without the risk of it being copied or altered in the process. For example, think about when you send someone an email — you retain the original, and they receive a copy. If the same thing happened when you sent money, it’d be a real problem, says Tilleman. That’s why we currently rely on intermediaries — banks, credit unions, companies like PayPal — to make sure that doubling-up issue never occurs. These middlemen charge fees for ensuring that when you send someone money, you’re parting ways with it completely, and the other person is legitimately receiving it. With bitcoin, there's also always an intermediary — it's whoever is managing the transaction, whether it’s an exchange or other platform. But because there are no restrictions on who can participate (and no account minimums), they're not the traditional financial services players.
SHOULD YOU INVEST IN BITCOIN?
Before diving into bitcoin or other digital currencies, you need to understand the risks. One: volatility. It's normal in the world of cryptocurrencies for prices to go up and down 30 percent in a single day, says Bobby Ong, co-founder of CoinGecko, a cryptocurrency valuation and ranking website. Two: The fuzzy future. “I do fundamentally believe that blockchain technology will ultimately change the way money moves from one place to another,” says David Bach, author of "Smart Couples Finish Rich.” But he also thinks that “90 percent of the cryptocurrencies out there will be worthless within less than five years.”
That means only investing as much as you’re comfortable losing, which Bach says should be no more than 1 to 2 percent of your overall portfolio. If you decide to go forward, dollar-cost averaging could be a good way to do it, since each prices vary widely from day to day. (How? Take the amount of money you decided to put in, then divide it by 12. On the first of every month for a year, buy that amount of your chosen currency.) Two top digital currencies are currently bitcoin and Ethereum, so Ong says he’d likely look at those first, putting 70 to 80 percent of his portfolio in those two coins, then invest the remaining 20 to 30 percent in smaller cryptocurrencies. Diversity in this sector is as important as it is in the markets overall. Several other cryptocurrencies have made it into the American consciousness over the last few years, including Litecoin, Ripple, and Dodgecoin.
HOW DO YOU INVEST IN CRYPTOCURRENCIES?
If you’re looking for an easy way to buy bitcoin or another digital currency, there are user-friendly exchange services that allow you to use money in your bank account to make the purchase. “Coinbase is kind of the gold standard, but there are a lot of other really great exchanges that offer a wider range of currencies,” says Tilleman. You create an account, input the account information you’d like to use, then make your purchase. Know that if you do use an exchange, just like transferring to any currency, you will be charged a transaction fee — for example, Coinbase’s averages 1.5% for bitcoin, says Dan Romero, vice president and general manager of Coinbase.
Finally, let's talk about security risk here — and the extra steps you need to take to keep your assets safe. When you buy stocks, a registry is kept of all the shareholders. But since bitcoin isn’t controlled by any one entity, if your coins are stolen by a hacker, they’re likely gone forever. “Whoever has it owns it,” says Ong.
Once you buy units of a digital currency, they’re kept in your digital wallet, which can be easily stored on the exchange you purchased it on. The site gives you a unique key (a string of letters and numbers) to use for access. But keeping your bitcoin in the exchange-provided digital wallet might not be the most secure option — for example, in January of this year, hackers stole upwards of $500 million in digital currency when they broke into an exchange called Coincheck. You can read the fine print on any exchange’s security policy to see if they offer insurance, but that’s rare — most insurance companies shy away from insuring digital currencies since it’s almost impossible to retrieve stolen coins. Instead, look into using a “hardware wallet” like Ledger or Trezor, says Ong. These cost around $100 and are protected with a PIN and a backup called a "seed" in case you forget your PIN. Suffice it to say you'll have to keep this device as safe as possible. Ironically, the best place to do that might be an old-fashioned safety deposit box at an old-fashioned institution called a bank.
With Hayden Field & Kathryn Tuggle