Cryptocurrency: A Beginner’s Guide
In the early days of its launch in 2009, several bitcoins were used to buy a pizza. Since then, the cryptocurrency’s meteoric rise to US$20,000 in December 2017, subsequently dropping by about 70 percent to around US$6,000 in mid-2018, boggles the mind of many people — cryptocurrency investors, traders, or just the plain curious who missed the boat.
How it all began
Bear in mind that dissatisfaction with the current financial system gave rise to the development of digital currency. The development of this cryptocurrency is based on blockchain technology by Satoshi Nakamoto, a pseudonym apparently used by a developer or group of developers.
Notwithstanding the many opinions predicting the death of cryptocurrency, bitcoin’s performance has inspired many other digital currencies, especially in recent years. The success with crowdfunding brought on by the blockchain fever also attracted those out to scam the unsuspecting public and this has come to the attention of regulators.
Bitcoin has inspired the launching of many other digital currencies, There are currently more than 1,000 versions of digital coins or tokens. Not all of them are the same and their values vary greatly, as do their liquidity.
Coins, altcoins, and tokens
It would suffice at this point to say there are fine distinctions between coins, altcoins, and tokens. Altcoins or alternative coins generally describe other than the pioneering bitcoin, although altcoins like ethereum, litecoin, ripple, dogecoin, and dash are regarded as in the ‘main’ category of coins, meaning they are traded in more cryptocurrency exchanges.
Coins serve as a currency or store of value whereas tokens offer asset or utility uses, an example being a blockchain service for supply chain management to validate and track wine products from winery to the consumer.
A point to note is that tokens or coins with low-value offer upside opportunities but do not expect similar meteoric increases like bitcoin. Put simply, the lesser-known tokens may be easy to buy but may be difficult to sell.
Before getting into a cryptocurrency, start by studying the value proposition and technological considerations viz-a-viz the commercial strategies outlined in the white paper accompanying each initial coin offering or ICO.
For those familiar with stocks and shares, it is not unlike an initial public offering or IPO. However, IPOs are issued by companies with tangible assets and a business track record. It is all done within a regulated environment. On the other hand, an ICO is based purely on an idea proposed in a white paper by a business — yet to be in operation and without assets — that is looking for funds to start up.
Unregulated, so buyers beware
‘One cannot regulate what is unknown’ probably sums up the situation with digital currency. Regulators and regulations are still trying to catch up with cryptocurrencies which are continuously evolving. The golden rule in the crypto space is ‘caveat emptor, let the buyer beware.
Some countries are keeping an open mind adopting a hands-off policy for cryptocurrencies and blockchain applications while keeping an eye on outright scams. Yet there are regulators in other countries more concerned with the cons than pros of digital money. Regulators generally realize the need to strike a balance and some are looking at existing laws on securities to try to have a handle on the many flavors of cryptocurrencies globally.
Digital wallets: The first step
A wallet is essential to get started in cryptocurrency. Think e-banking but minus the protection of the law in the case of virtual currency, so security is the first and last thought in the crypto space.
Wallets are of the digital type. There are two types of wallets.
- Hot wallets that are linked to the Internet put users at risk of being hacked
- Cold wallets that are not connected to the Internet and are deemed safer.
Apart from the two main types of wallets, it should be noted that there are wallets just for one cryptocurrency and others for multi-cryptocurrency. There is also an option to have a multi-signature wallet, somewhat similar to having a joint account with a bank.
The choice of a wallet depends on the user’s preference whether the interest is purely in bitcoin or ethereum, as each coin has its own wallet, or you can use a third-party wallet that includes security features.
The cryptocurrency wallet has a public and private key with personal transaction records. The public key includes a reference to the cryptocurrency account or address, not unlike the name required for one to receive a cheque payment.
The public key is available for all to see but transactions are confirmed only upon verification and validation based on the consensus mechanism relevant to each cryptocurrency.
The private key can be considered to be the PIN that is commonly used in e-financial transactions. It follows that the user should never divulge the private key to anyone and make back-ups of this data which should be stored offline.
It makes sense to have minimal cryptocurrency in a hot wallet while the bigger amount should be in a cold wallet. Losing the private key is as good as losing your cryptocurrency! The usual precautions about online financial dealings apply, from having strong passwords to being alert to malware and phishing.
Different types of wallets are available to suit individual preferences.
- Hardware wallets made by third parties have to be purchased. These devices work somewhat like a USB device which is deemed safe and only connected when required to the Internet.
- Web-based wallets provided, for example, by crypto exchanges, are considered hot wallets which put users at risk.
- Software-based wallets for desktops or mobiles are mostly available for free and could be provided by coin issuers or third parties.
- Paper-based wallets can be printed bearing the relevant data about the cryptocurrency owned with public and private keys in QR code format. These should be kept in a safe place until required in the course of crypto transactions and copies should be made in case of accidents such as water damage or printed data fading through the passage of time.
Crypto exchanges and marketplaces
Crypto exchanges are trading platforms for those interested in virtual currencies. The other options include websites for direct trading between buyers and sellers as well as brokers where there is no ‘market’ price but it is based on a compromise between parties to the transaction.
Hence, there are many crypto exchanges located in various countries but with differing standards of security practices and infrastructure. They range from ones allowing for anonymous registration requiring just email to open an account and start trading. Yet there are others that require users to comply with international identity confirmation, known as Know-Your-Customer, and anti-money laundering (AML) measures.
The choice of crypto exchange depends on the user’s preference but anonymous ones may have limitations on the extent of trading allowed or could be subject to sudden new regulations in the country of domicile of the exchange. Minimal administrative procedures with anonymous registration let users start trading quickly while going through KYC and AML processes will take more time.
All crypto traders have to be duly processed and validated which can take from a few minutes to a few hours, depending on the coins or tokens being transacted and the volume of trade. Scalability is known to be an issue with cryptocurrencies and developers are working on ways to find a solution.
Cryptocurrency exchanges are in two categories.
- Fiat-cryptocurrency Such exchanges provide for fiat-cryptocurrency purchase via direct transfers from banks or credit and debit cards, or via ATMs in some countries.
- Cryptocurrency only.There crypto exchanges dealing in cryptocurrency only, meaning customers must already own a cryptocurrency — such as bitcoin or ethereum, — to be ‘exchanged’ for other coins or tokens, based on market rate.
Fees are charged to facilitate the purchase and sale of cryptocurrencies. Users should do the research to be satisfied with the infrastructure and security measures as well as to determine the fees they are comfortable with as different rates are charged by various exchanges.
Do not expect a common market price for the same cryptocurrency with different exchanges It may be worthwhile to spend time doing research on the best price for coins and tokens that are of interest to you.
Financial transactions online carry risks and users should factor in the caveats such as two-factor authentication or 2-FA, keeping updated on the latest security measures, and being aware of phishing scams. One golden rule on phishing is not to click on links provided, no matter how authentic a message or email is.