(A couple weeks after putting fiat into cryptos...I wrote this. It may be helpful to newbies, from another newbie. There are errors, but I want to share it.)
Blockchain
As digital records became more widespread, the only way to prevent fraud and double-payments was through third party verifications. Example: If I want to purchase a product or service from you with digital money, a debit card, how do you know that I have digital money in my account? You don’t. That is why verification through centralized third parties were necessary. The problem is this system has a single point of failure. Meaning, if the centralized third-party verification system has an error, the network will come to a stop. A realistic cyberattack scenario could leave bank servers without power for weeks. Without access to their digital dollars, the American financial system could collapse due to a lack of confidence hang over.
In 2009, the creator of Bitcoin implemented a proof-of-work (POW) protocol. Bitcoin POW is a cryptographic mathematical problem, or a puzzle, that requires specific computer processors to solve. These machines require electricity. But whoever solves the puzzle of transactions first gets an economic reward. The individuals and groups who process these mathematical equations are called miners. The miners and the equations are the decentralized verification.
The miners are mining blocks of transactions. Today the average block has 2000 transactions (blockchain.info). After a block has been mined it is connected to the previous block. Then the next block begins. Ergo…Blockchain!
Every transaction on the blockchain is timestamped. If there are insufficient funds, this innovation eliminates double spending by accepting the transaction which occurred first.
Benefits: This is a decentralized approach to verification of digital records/transactions. Decentralization means these recorded transactions are scattered across the globe. All it takes is one record of the blockchain to survive and the system can start again as if nothing ever happened. Decentralization also means that it is very, very difficult to alter these records once a block has been added to the chain. It is theoretically possible. But it would take the entire network to collude against itself. This type of action would be the end of a blockchain. Remember it is all about confidence.
Costs: The miners do not invest in expensive equipment and pay high electric bills because they have philanthropic intentions. They verify transactions and process blocks to receive the economic reward. If the reward becomes less than the cost of processing the blocks then no more miners. If prices continue upward no one will worry about this. However, this is a long-term concern. Even though this is a new technology, some are working to find something to do what blockchain does without blockchain parameters. This is the nature of technology. Nothing is perfect and innovators will always work to build something better.
Before I sum up Blockchain it is important to stress that Blockchain is not just for transaction verification. It can verify records. Imagine any kind of record. Blockchain can provide security (encryption) from tampering and transmit to the intended receiver at a fraction of the current time and cost.
Bitcoin was the first blockchain and it is the network on which secondary networks are built. Also, there are many, many networks being built on these secondary networks. Today what we call the Internet is just a series of networks built on top of other networks. It is my opinion that the next generation of the Web will be called Blockchain. This does not mean that the Bitcoin Blockchain will be it. This protocol is open sourced. Anyone can make an improvement to it and start their own blockchain. Bitcoin’s main edge to be the foundation of the next Web is the first mover advantage. An overwhelming majority of the best talent in this sector is working on the Bitcoin network. This is a good point to jump to cryptocurrencies.
Virtual Currency
Even though many nations are considering classifying Bitcoin and other digital currencies as legal currency, Japan is the only to do so. India announced they will soon. Currently the industry is in a grey area. It is not legal and it is not illegal. Illegalization is unlikely in developed nations. This is a promising technology that leaders don’t want to miss out on. For now, these currencies are just tokens in the eyes of the law. No different than a coin bought at an arcade to play a game. Regulators have limited oversight until legalization occurs. In my opinion, full adoption happens sooner than later. Currently, virtual currencies are classified as property by the IRS. The main difference in classifying virtual currencies as Currency would be an adjustment of how capital losses are treated. Now only $3000 in capital losses is allowed per year.
Bitcoin’s price on July 30, 2016 was $648 (USD). One year later it is $2726. Why the dramatic increase? I believe there are two prominent reasons. Capital flight and a decrease in supply.
First, Asian capital flows out of the US dollar into Bitcoin. The reasons for the Asian exodus is the uncertainty created by the Trump administration on US role in global trade. The other reason for capital flight out of US dollars is the uncertainty of the Federal Reserve’s unwinding of their Balance Sheet in the Fall.
Uncertainty over the US and the dollar has increased demand for value preservation. At the same time, the supply of Bitcoin on the open market has diminished. It has diminished due to uncertainty over the UASF and the MASF (User and Miner Activated Soft Fork).
Every now and then Bitcoin requires a software update. Bitcoin needs to be able to scale and with the current code that is not going to happen. This isn’t an easy problem to solve because the miners want one solution and the core developers (coders) want something different.
It comes down to both wanting SegWit (Segregated Witness) but the miners want to take this opportunity to increase the block size to 2MB. On August 1, 2017 the UASF will take effect, but will the miners protest and not verify transactions? This uncertainty has led seasoned Bitcoin holders to pull their coins off the exchanges and store them on offline hardware wallets. The reason for this is because this planned soft fork could ultimately be a hard fork. A hard fork would create two separate blockchains and it is unknowable how equipped the exchanges are to deal with this event.
Update: A hard fork has been signaled and will take place August 1, 2017. Bitcoin will become Bitcoin and Bitcoin Cash. No one knows how this will play out in the coming days or even years. However, Bitcoin is likely to thrive in the future. It is the oldest, most tested blockchain. Bitcoin is also the most widely recognized name in the space. 20% of Americans have heard of Bitcoin, while less than 1% own any Blockchain currency or asset.
An increase in demand and a decrease in supply is the reason Bitcoin has surged in 2017.
The major digital currencies are Bitcoin (48 billion market cap), Ethereum (18 billion), Ripple (6 billion) and Litecoin (2 billion). These four digital currencies make up 80% of all blockchain technology market capitalization. (coinmarketcap.com)
Bitcoin will likely be used by governments and corporations to settle accounts in the future. It is a very secure network, but it is much more expensive and slower than the other networks. Institutions will use Bitcoin to transfer funds because in the current paradigm it takes a lot of effort to transfer large amounts of money. Think of Bitcoin as the digital version of gold.
Ethereum is a great example of network effects. The Ethereum Foundation is only three years old. The ‘smart contract’ innovation has attracted many developers who have created complimentary tools to interact with the network. Ethereum’s Virtual Machine takes ‘ether’ or gas to run a smart contract. These smart contracts are enabling trustless P2P commerce. The smart contract executes when the pre-written protocol is triggered. In the future Ethereum will primarily be B2B. myetherwallet.com etherscan.io https://registrar.ens.domains/ https://etherdelta.github.io/#PLU-ETH
Ripple is a centralized digital currency. Legacy financial institutions are the main proponents and users of this digital currency to settle accounts. I don’t have much else to say about Ripple.
Litecoin is a major innovator in the digital currency sector. Litecoin was the first to adopt SegWit, and will be announcing the Lightning Network and Litecoin smart contracts very soon. This digital currency will likely have the fastest transaction times and the lowest fees. Even now the transaction fee is 1% of 1% and takes less than a second to send across the globe. With the future Lightning Network, this currency will be able to scale sooner and gain market share. Think of Litecoin as the digital currency that you will use to buy consumer goods. Whereas Ethereum’s smart contracts are designed for B2B, Litecoin’s will likely be P2P. Think about eBay, currently when you buy something from a stranger you must trust that the product is legitimate. Smart contracts create trustless commerce.
These digital currencies are software. Glitches have happened in the past. Remember that humans are the ones writing the code and the only way to know if a network is reasonably secure is to test, test, and test.
Minor digital currencies are mostly speculative and not worth mentioning here.
Virtual Assets
This is the most exciting and probably the longest section.
Wallets
A digital wallet is how cryptocurrencies are stored. There are many companies that offer wallets. The types of a digital wallet are too often overlooked by beginners.
Software wallets store cryptocurrencies via a corporate server or a personal electronic device (personal computer, phone, or tablet). The use of software wallets is inherently unsafe. The private keys are being trusted to third parties for security. Hackers have an economic incentive to penetrate these systems and steal your private keys and then transfer the cryptocurrency to themselves.
The other type of wallet is an offline hardware wallet. There are a couple of types of hardware wallets available on the market today. None are perfect. But the best that has been made so far is the Trezor. What separates this wallet from the others is the requirement to manually confirm a transaction by hand. This prevents hackers from remotely stealing your cryptos.
First Actions
Signup for an account with Coinbase. There are many exchanges but this one is insured and is the easiest to use for beginners. After your identity has been verified, you will need a camera phone to take picture of ID, your checking account will be linked to Coinbase. While waiting for approval from Coinbase, order a Trezor. It’s available on Amazon, like everything else. When activating any wallet be sure to write down the keys (public and private) and PIN (for Trezor). Store these in a safety deposit box. If your Trezor is broken, lost, or stolen you can recover your wallet with the private keys and PIN. It should go without saying, but just to be sure…
Anyone with access to your private keys and PIN can steal your digital wallet. They are for your eyes only!
Be sure to research as much as possible about each blockchain technology before you buy. I am a proponent of incremental buying. There is no need to get carried away with blockchain-fever. Incremental buying does result in a higher fee ratio, but it takes emotional overreaction off the table.
Be sure to keep track of the currency or asset symbol, time and date, buy price, sell price of all transactions. You will have to pay taxes on your capital gains. If you are interested in how digital currency is treated by the IRS, please contact an accountant who is competent in this field (good luck). If I knew of any to recommend, I would. The question you should seek clarity on is how much capital loss can be claimed in each year. This is something that no one is worried about because no one has capital losses. However, from my reading of the tax code and guidance given, capital losses are limited to $3000 and anything more must be carried over to future years. Again, do your own due diligence.
Conclusion
How we store value has adapted over time. It is no coincidence that Blockchain came along the same time that central banks began engaging in Quantitative Easing. Only 20% of QE was printed money. The rest was created by typing numbers into a keyboard. All fiat money is digital. The differences are: blockchain technology does not have a government and its taxpayers backing it and nearly all blockchain currencies have a max supply. Bitcoin will never have more than 21 million coins. How can we trust this? Again, blockchain is a trust less system. If it’s in the code, it’s in the code.
post script: there are a lot of issues, technical and fundamental, that should be expanded on. Mining, Tax Laws, Swap Converting, Money Transmitter Licenses, Token Generating Events, Security of Private Keys, Indicators of a Scam, Peer to Peer Platforms, Decentralized Exchanges, Centralized Exchanges, Smart Contracts, SegWit, Lightning Networks, Distributed Applications, and FUD.
I'll be writing more detailed how-to guides for beginners.
If you have something you don't understand it doesn't hurt to ask!
All constructive criticism is welcome.
If you would like to donate Ethereum:
0x164F1f6BE41C75F527fb36528524f2e295D2FBAB
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