- The rise of popularity in cryptocurrency has caught the attention of even the most conservative investors.
- What is a cryptocurrency and how does the underlying technology known as the blockchain works?
- Does the digital coin and its relatives have any room in our portfolios?
Although most of our articles focus on value investing in businesses or other financial instruments such as bonds or exchange traded funds (ETFs), most readers would have heard of bitcoin – the digital coin that is dominating the cryptocurrency market. I first heard of it from an army camp mate back in 2012 when it was under $10 a pop and quickly dismissed it as a foolish idea that would not have a future.
Who would have thought that cryptocurrency would not only survive but prosper in the digital age.
Before we get caught up in the hype, let us take a dive into what a cryptocurrency is and its underlying technology.
- What is a cryptocurrency?
A cryptocurrency such as Bitcoin or Ethereum is a form of digital currency which is created and stored electronically. It is different from a fiat currency as it is not bounded by economic legislation or controlled by a central bank. On the contrary, it is a decentralised currency that is produced by people and businesses through the use of computer software to solve mathematical problems.
The first cryptocurrency was released back in 2009 by Satoshi Nakamoto, the illusive founder of Bitcoin. As it gains popularity, more merchants are starting to accept cryptocurrencies as a medium of exchange for goods and services provided. In that sense, it is similar to conventional currencies like the dollar, euros or yen, which are also traded digitally.
The key difference in digital currency is that it operates on a decentralised system known as a blockchain.
- What in the world is a blockchain?
A blockchain is a distributed database which is also known as a distributed ledger. To make things simpler and relatable, let us call the distributed ledger a shared record book instead. To be clear, this book is not stored in a centralised system with only a single copy but it has thousands of copies stored in computers all around the world – hence the term decentralised.
The most common record found on this book is the transfer of money from one individual to another at this moment. For example, if James would like to send money to Susan, a new entry is sent to everyone who has a copy of the record book. Those computers confirm that the transaction is authorised, and ultimately they agree (or disagree) that the details about the transaction is legitimate before giving their final approval.
Additionally, the entries recorded in the book are irreversible. Every line entry made will exist for as long as the internet exists. If Susan wanted to refund James’ money, this would be a new line item sending the money back – one cannot simply cross out of the original transaction. A verification process will be executed by the many computers (all the people who has a copy of the record book) before any changes are made.
- Where are these coins stored?
Imagine now that there are 100 coins. Each of these coins were given to James, Susan and other participants in the network. In order to receive these coins, James and Susan are required to provide a wallet address, similar to a bank account number, in order to store their coins. The coins held in their wallets are represented by a string of codes which are unique and bear the owner’s unique signature. This is how millions of people can have a copy of the shared record book but yet without being able to add new entries relating to any of the other coins that are documented in this shared record book.
- Does it belong in your portfolio?
Now, for the $4000 question! Should we purchase Bitcoins or other cryptocurrency with the hopes that we may profit from its extreme volatility?
At today’s price, I would not purchase any Bitcoins or even other digital currencies. That is not because that it will never work out. It is because I have never been an expert in predicting future price movements and thus, have never bet on them. Since I would not be able to anticipate the price movements of cryptocurrencies (or any other financial instrument for that matter) in the short-run, I should at least do the next logical thing when it comes to investing in cryptocurrencies – Do not invest.
The underlying technology which powers cryptocurrencies have attracted attention from public and private institutions alike. Companies such as IBM, Wal-Mart and JP Morgan have started to test its function by implementing them into their day-to-day operations, on a smaller scale first. Whether or not cryptocurrencies will be widely accepted as a medium of exchange is an entire different story altogether.
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.