With Bitcoin hitting the $10,000 milestone in November 2017, it’s important to consider whether it’s a “bubble” or not.
This tutorial will not only explore the technology behind the the “crypto” craze, but also all of the steps that have lead to this point. Ultimately, you need to appreciate that, despite all the hype, “Bitcoin”, “Ethereum” etc are NOT currencies, and as such should not be treated (or traded) like them.
As ever, please consider that we are NOT regulated financial advisers, and as such cannot recommend any sort of financial steps. We *can* however describe the current market and how it should work…
What Is BitCoin?
Bitcoin is what’s known as a “crypto” currency.
Crypto currencies are part of a new “decentralized” infrastructure built on top of the “blockchain” database network. This differs from today’s standard because it removes the need for a “central processor” – a system or service designed specifically to handle particular data, such as a bank or government.
Despite being released (open source) in 2009, “Bitcoin” has become popular recently due to massive rises in its “price”. The problem is that this price is based on nothing more than a rampant secondary market (very similar to eBay), whereby speculative traders have been buying/selling the “coins” in an attempt to scrape profits off the top. This excellent article on Vox explained it a bit more.
Unfortunately, this market has ignored several core principles of investing, namely that everything you do financially should “balance” with a core set of value for the commodity or asset you’re working with. In the case of many of the “crypto” currencies, this “value” is not only hazy but actually could be considered void (more explained in a second).
To fully understand what “crypto” currencies are (which most people don’t), you need to look at the underlying technology. As mentioned, “Bitcoin”, “Ethereum” etc are all based on a piece of software technology called “blockchain”.
Blockchain is a decentralized database which works by providing a central data infrastructure that can be stored on 100’s or 1000’s of servers around the world… rather than one server that is core to the provision and management of the various elements of data, such as “email” for example.
The point of blockchain was to give people the opportunity to use decentralized apps which would basically allow users to manage transactional data through a peer-to-peer type setup (rather than the client/server setup prevalent now).
It was hoped these apps would introduce a new “paradigm” into computing which many people had been speculating on for a long time — whereby you could purchase a meal, book an airline ticket or call your spouse without the need for a central “provider”.
Colloquially known as “Web 3.0”, the new paradigm was also known as the “Internet of Things” – a system which would ensure that individual elements of someone’s home or business could not only communicate with each other, but actually be semi-autonomous and programmable. You save these cryptocurrencies using various wallets.
For example, if your boiler turned off when you were at work, you’d receive a message on your phone alerting you to the problem, an attached data dump explaining what had gone wrong and and offer to forward the alert to your local heating engineer. The engineer could then go and fix the boiler without any input needed from you.
Whilst this can be done today, the real problem lies in the way in which the “data” is used and stored by the various services. Because each data service requires a central processor to “store” and “access” the data, it ends up that a lot of the data becomes “siloed”, leading to most of the devices today being unable to communicate with each other.
The promise of “blockchain” is to decouple this dependence on a core processing facility, allowing for MASS adoption & editing of the various pieces of data generated & used through the “Internet of Things”. In other words, it *could* be a platform onto which a new wave of technology is adopted.
This is partly why “Bitcoin” etc have been adopted, but ultimately is only a very small part of the (financial) picture.
It’s NOT A Currency…
Bitcoin and other “crypto” currencies were built on top of the “blockchain” infrastructure to provide a private set of data.
In a nutshell, they are encryption algorithms designed to scramble the data within a blockchain database. Each “coin” within the “crypto” world is basically just a decryption token, designed to descramble a particular piece of data within the “blockchain” database system. Click here to find out more about the best crypto exchanges.
The misconception about “Bitcoin” (especially) is that it will be a “currency” in its own right, and thus having a price of $10,000 or even $11,000 per coin will be nothing compared to its major competitor – the USD.
What most people don’t seem to appreciate is that the USD, GBP etc are backed up with real world assets. If you wanted to buy a product, the strength of their relative economies will be able to back them up. However, none of the “crypto” currencies provide this. They’re almost entirely built on hot air.
In investment circles, this is known as something called intrinsic value, whereby the underlying use – or trade – value of an “asset” is weighed against its price.
Whilst many “investors” consider “growth” a fundamental factor in intrinsic value (which often makes them look speculative), the reality is that each time you create a “trade” – you’re really trying to buy an asset for below the price the market would determine, in the hope that you’d be able to sell it at a profit later on.
Unfortunately, it seems that “Bitcoin” has fallen into this category – with millions of speculative traders (especially in the likes of Japan and S.Korea) buying with the sole intent of selling later on. The problem is that when this train of new money runs out… the whole scheme will collapse.
Prepare for A Correction
Ultimately, the bottom line with the whole “Bitcoin” saga is that it’s all too familiar.
1630, 1929, 2008… it’s all the same.
People get greedy, think they cannot lose and suddenly realize that in order for “everyone” to continue to make massive profits, something has to give.
In the case of all these previous examples, the market corrected itself and almost brought down the entire global economy with it – in the case of 1929, millions were left in bread lines.
Whilst this won’t happen with the “Bitcoin” phenomenon, the chances are that it will be seeing a major correction when either the promise of “blockchain” is not met, or people begin to realize it’s not worth anywhere near the $10,000 price that each “coin” is being bought for.
In other words, as soon as the market of “greater fools” runs dry, the price will likely slump down to a figure more fitting its underlying value.
When this happens, the price of the asset will either implode spectacularly or reach a level whereby most people will be considering selling at a “loss”.
You see, underlying technology aside, it’s the people who bought the “coins” (decryption tokens) when they were $200 that are winning from the recent run… all the truck drivers who have emptied their life savings into the whirlwind are paying for the profits these early adopters are making. It doesn’t matter to these guys how far the price goes – just as long as they’re able to sell their “coins” to someone willing to spend several thousand off the back of the hope of “easy profits”.