Financial guru Lacey Filipich gives us an overview of everything that has to do with Bitcoin and cryptocurrency. Should it be the new way for us to make easy money?
How would you feel if you paid A $ 630 million for a couple of pizzas?
Or lose a hard drive with the key for a cryptocurrency worth AUD 470 million?
With such astronomical figures, it’s no wonder Bitcoin is making the headlines.
Add in the world’s most controversial entrepreneur Elon Musk, who is buying the $ 1.5 billion worth of stuff, and you have some serious entertainment value.
But with every Conman and his dog flooding our inboxes with opportunities to “make tens of thousands of dollars a day from crypto,” it’s fair to be skeptical about this financial innovation.
Before you can break through the hype – and the FOMO – to decide whether or not crypto is right for you, it’s important to understand a few things, especially:
- What kind of blockchain is
- how cryptocurrencies use blockchains, and
- whether cryptocurrencies are considered assets.
Bitcoin and blockchain are often merged. They are not the same. Let’s start with the underlying technology …
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Before deciding whether or not crypto is right for you, it is important to understand a few things. Image: iStock
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What is a blockchain?
Blockchain is an encryption technology. It was developed in 1992 with online shopping in mind. The creators wanted to time stamp transactions in a way that would be impervious to fraud.
We traditionally manage transactions through a central ledger. This is usually done through banks that keep their own books. When we buy something, the merchant sends a message to the bank that we have made this transaction. The bank adds this information to the ledger and calculates our balance.
The same thing happens when we send money to other bank accounts. It goes through a clearing process, there are checks and balances, and we pay the bank for the privilege of making sure that all of our dollars are booked.
A blockchain means you don’t need a bank to check if a transaction has taken place.
Instead, each participant has a unique identifier that cannot be easily stolen or hacked (unlike credit cards, for example). When the transaction takes place, it is not monitored by a third party – it is recorded by all users of the system in a distributed ledger.
If you try to modify your copy of this distributed ledger, it will not match any of the other copies and a red flag will appear. This prevents fraud, which is why blockchains are affectionately known as trust machines.
For those interested in the technology, the blockchain is made up of two parts: the block and the chain.
Everyone block encodes information about a group of transactions. When the block has reached its transaction capacity, a new block is created and linked to the previous block. This link is the Chain little.
A blockchain can be used to record transactions wherever you have them – for example, to sign legal contracts. With this technology, you don’t need a third party to manage the process. You also don’t need to examine events to prove they happened. The blockchain naturally does this. This saves time and money related to these activities.
It can also be used for financial transactions, which leads us to …
What is a cryptocurrency?
A cryptocurrency is like any other currency except that it uses a blockchain to record its transactions, rather than a third party like a bank.
You have probably heard of the earliest cryptocurrencies: Bitcoin (BTC), Ethereum (ETH), and Ripple (XRP) for example. Given the low barrier to entry (meaning you don’t have to be a bank), there are thousands of others and new ones keep popping up.
Cryptocurrency as a concept offers some key advantages:
- It’s designed by nature to eliminate fraudulent transactions so you don’t need reviewers and the checks and balances we now rely on.
- You don’t need a third party to run it, so don’t pay the 1.5-2% premium we banks paid over the last century to take on the role of chief accountant.
- It’s 100% electronic so you no longer have to worry about banknotes and coins being issued as is now the case with fiat currencies. Without a hard currency, those who control the ledger can theoretically control inflation (a major incentive for countries).
- Since the handling of cash is now inconvenient (thanks, COVID-19), crypto can also be viewed as hygienic!
As for the downsides, there are a few
Since today’s cryptocurrencies do not require a unit like a bank to monitor them, they can exist outside of legal jurisdiction.
Whether you could avoid paying capital gains taxes or fund criminal activity, it could be seen as a benefit by those looking to stay off the radar, but the ethical challenges of tax avoidance and financing terrorism outweigh that personal interest. Gone are the days when crypto was used to evade the Australian Tax Office (ATO) folks. You have a reconciliation program that if you try, you will eventually get anywhere.
Being outside of legal oversight means that market manipulation is hardly a deterrent. Where insider trading on the exchange risks massive fines and jail sentences, there is no such penalty for the crypto trader. This means that every average joe is at risk of getting done if (not when) a great player does something dubious.
Then there is electricity. Creating new blocks takes enormous amounts of energy to power the computers it needs. Crypto is not exactly an environmentally friendly option, as Bitcoin alone uses more electricity than entire countries like Argentina.
(If you’re wondering where all of the energy is coming from without the bank having to pay for it, crypto miners get cryptocurrency when they mine – i.e. generate – a new block in the chain, so the miners have an incentive to buy the hardware own and supply the energy.)
After all, it’s intended as a replacement for fiat currencies, but it’s not yet popular in the everyday sense. Most of us already shy away from a merchant who will pass on a 1% credit card fee. In one example, a bar in Sydney passes on the corresponding BTC transaction fee of $ 10 for every purchase. For a $ 10 beer, that’s a 100% charge. Not attractive.
Then there is the ultimate question that seems to have divided the financial world …
Blockchain is an encryption technology. It was developed in 1992 with online shopping in mind. Image: iStock
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Is crypto an asset?
All currencies fall into the “money market assets” class, which is reserved for cash and cash equivalents. It’s liquid but doesn’t have much room for growth. Crypto probably belongs there, along with all fiat currencies like our Australian dollar.
If you stick to the Robert Kiyosaki definition of an asset – that it has to put money in your pocket – most cryptocurrencies will not qualify. You can only make money selling them as they don’t pay dividends or anything like that.
Where crypto creates confusion is recent rapid price growth.
When the first Bitcoin transaction was executed on May 22, 2010, Laszlo Hanyecz famously paid 10,000 BTC for two pizzas delivered – an event now known as Bitcoin Pizza Day.
As of this writing, one BTC is worth roughly AUD 63,000.
When two pizzas shipped are worth A $ 30, it means BTC has grown a whopping 2.1 billion percent in nearly 11 years.
Hard to get that kind of return anywhere else, isn’t it? No wonder so many people have crypto FOMO.
But: Between writing and publishing this article, nothing stands in the way of BTC doubling the price. Or cut in half. Or crash completely. Or go to a million dollars. It’s not a predictable currency right now as movements between AUD and USD are somewhat predictable regardless of what the crypto experts tell you.
Does that mean you should or shouldn’t buy some?
Personally, I wouldn’t invest any money to buy crypto. And for the record: I’ve bought and sold crypto in the past. I’m holding a tiny amount right now. I bought it with money I would otherwise have spent on supplies, not money I hope will fund my retirement. It’s a gamble if you will.
If I plan to keep playing – in the casino, the races, or the lottery – I would think about buying crypto instead. But I would hesitate to bet on such gains to continue. It would just be a nice bonus if they did.
If central banks switch to a version of the cryptocurrency that is monitored by the government – an e-dollar, for example – I’ll be thrilled.
Until then, it still seems a bit mischievous in the crypto scene. Be careful.
Lacey Filipich is the author of Money School: Get Financially Independent and Claim Your Life Back. She is a finance educator, chemical engineer and TEDx spokesperson.