The Basics of Bitcoin and Cryptocurrency—and How to Invest
If you’re like us, chances are you hear the word “Bitcoin” and your eyes glaze over a little. But as with much of the finance world—which deliberately uses obfuscating language—you just have to chip away at a few of the core ideas and suddenly you find you’re not as out of the game as you thought.
Before we met Bill Barhydt, founder and CEO of the cryptocurrency-exchange app Abra, we also felt like we had very little reason to care about Bitcoin. But Abra—which is part user-friendly investing app, part Venmo for crypto—was initially created to allow people to use Bitcoin to easily and cheaply send money across borders. “Our main use was for remittances, or money that is sent home by workers earning a living in other countries,” Barhydt says. “Fees for these transactions can be as high as 15 percent…to move money around by the people who can least afford it.” And according to Barhydt, cryptocurrency is the technology that can solve that problem.
In the last year, Abra has expanded its investing services, too, in a way that fully leverages blockchain technology.
If we lost you at “blockchain”: Read on.
Question
What is Bitcoin?
Answer
Cryptocurrency is digital money, which means it can be stored on your computer or phone and sent person-to-person with no bank or intermediary. Bitcoin is the first cryptocurrency.
Rather than following the traditional process of a bank or credit card company confirming a customer’s identity, Bitcoin relies on a set of private and public keys that help protect people on both sides of the transaction. A public key is like an email address; you can give anyone the address and they can send Bitcoin to that address. The private key functions like your email password. It protects access to your Bitcoin and should be carefully guarded and protected.
Question
Where does Bitcoin come from and how is it created? Where can you get it?
Answer
Bitcoin is created via a process known as mining. Mining for Bitcoin is the digital equivalent of digging for gold. Miners use powerful computers to compete with each other to “win” Bitcoin by solving a math puzzle that gets harder and harder as more people try to win. The amount of Bitcoin that miners can win decreases over time.
This means that Bitcoin is a deflationary currency, like gold, which has created a hoarding situation that many economists predicted. This hoarding process creates a feedback loop: As Bitcoin becomes more valuable and more scarce, more people are motivated to hoard it, which increases the value, which leads to more hoarding and drives the price up more.
Miners also decide which transactions get accepted by the Bitcoin network. Users pay miners a small fee for accepting their transaction when they want to send money using the Bitcoin network. This is akin to paying a fee to your bank when you wire money. Miners generally take the transactions with the highest fees first since Bitcoin can process only about 25,000 transactions per hour. Soon, this will grow to millions of transactions per hour.
If you’re interested in owning Bitcoin as an investment or using it to send money but you’re not a miner, you can also buy some from other Bitcoin holders.
Lastly, lots of people maintain copies of the Bitcoin network, called nodes. Nodes ensure that everything runs correctly and that miners do their jobs according to the rules of the system: They run a sophisticated type of ledger called a blockchain that maintains a copy of every single Bitcoin transaction ever executed.
Question
How does cryptocurrency have value? How can you trust that it will have value in the future (as opposed to fiat money)?
Answer
Ultimately, anything has value because people agree that it has value. Government-issued money, such as the US dollar, has value because we all agree that it does, mostly because our government accepts payments of tax debts only in its own money.
Generally an asset such as cryptocurrency or baseball cards or gold has value for a few potential reasons—although not all have to be true at once:1. People want to hold an asset to store value or as an investment.
2. People think the asset is generally scarce with a reasonable assurance that it will remain scarce or no one can artificially create lots more of it.
3. People hold an asset if it serves some useful function either as money, a commodity, or a tradable good.
Bitcoin, specifically, has value for a few different reasons:1. The mining process. The same economic incentives that drive people to dig up gold or drill for oil are at work: People are willing to dedicate time and resources to create new Bitcoins. There’s a market there, and the market is driving production.
2. Its network effect. Bitcoin is the first and most dominant cryptocurrency. There are many alternatives, but people continue to use it because it remains the most widely adopted and secure network.
3. Scarcity. There will only ever be 21 million Bitcoins produced. Comparatively, modern fiat currency is a product of monetary policy that is controlled by central banks. As we see all over the globe, it’s pretty easy for governments to get that monetary policy wrong and cause all kinds problems. People are attracted to Bitcoin’s value proposition because it offers an alternative to traditional assets and is based on computer code that is global, apolitical, censorship-resistant, and inherently scarce.
Question
What is a blockchain and how does it work?
Answer
The Bitcoin blockchain is a distributed database that ensures that all past, present, and future transactions are valid and “unhackable.” Think of it as a huge global checkbook, with no bank, that millions of people have a copy of. Every time you want to deposit or withdraw money to or from the checkbook you have to call at least 51 percent of the people with a copy of the checkbook and get them to agree that the transaction is valid—majority rules. Why would you want to have a copy of every transaction in every checkbook? Simple: It’s the only known and proven way to guarantee that the money in the checkbook doesn’t get spent twice. (Of course, Bitcoin does this in a more efficient manner than the global checkbook analogy, but the idea is still the same.)
More importantly, the Bitcoin blockchain is a new way of organizing data. It is a structure that builds on itself. Each block contains information that has been verified and can’t be erased or rewritten. Once a block is completed it is linked to the next block, forming a chain of linkable information. Through solving the problem of trust on the internet, blockchain enables new kinds of economic activity based on the coins created to incentivize its management.
Question
What are other cryptocurrencies worth knowing about?
Answer
There are thousands of cryptocurrencies, and more are being developed and launched every day. Some cryptocurrencies are versions of the Bitcoin blockchain that are trying to solve for other issues. Litecoin, for example, is designed to enable faster and cheaper transactions, while a coin like Dash is designed with additional privacy in mind. Then there are other cryptocurrencies that are building completely new infrastructures. Ethereum is the second most popular cryptocurrency in terms of network value. There are a lot of ways to measure value, but cryptocurrency systems are valuable in part because they are open and distributed networks. And Ethereum is designed as a platform to run decentralized applications and smart contracts, and it is used to create new tokens that are distributed via initial coin offerings (ICOs) or token sales.
We’re still in the early days of cryptocurrencies, so it will be interesting to watch as this whole new sector unfolds.
Question
What’s the bigger picture with cryptocurrencies?
Answer
Today, the Bitcoin network is worth over $100 billion. We believe that eventually Bitcoin will be used to solve big global problems. I can think of three tangible examples.
The first is payments and money transfer for remittances. Over $500 billion is remitted globally by migrant workers to their families in other countries. Fees for these transactions can be as high as 15 percent and average around 10 percent. That means that $50 billion is wasted on needless fees to move money around by the people who can least afford it. Bitcoin can eventually eliminate these fees.
The second example is enabling new types of investing. Bitcoin can enable smart contracts that can be used simulate very simple derivatives, which can give investors exposure to US stocks in foreign countries. Or it can give US investors exposure to foreign stocks without having to find a broker to actually sell the stock.
Lastly, we believe Bitcoin technology will be used to enable people in developing markets to lease home electronics such as washing machines, refrigerators, televisions, etc. The buyer will simply forward a small amount of Bitcoin every week to the wallet of the seller and this will enable the appliance to function. This is not easily possible with traditional government money, and it is a powerful possibility.
Question
How should a newcomer approach investing in cryptocurrency?
Answer
The first investment that a newcomer to the crypto space should make is time. It’s important to understand some of the basics about how these different cryptocurrencies work. The information landscape in crypto is getting a little easier to navigate, and people are putting a lot of time and energy into trying to make cryptocurrency more accessible. Buy $10 worth of Bitcoin and get comfortable with the process.
But it’s important to look at what kinds of problems you’re trying to solve and decide whether or not the tech is best suited for those problems.
Question
How are the rules of conventional investing and the rules of investing in cryptocurrency similar? How are they different?
Answer
The fundamentals are the same. The goal is to try to find something that will grow in value. With traditional markets, investors need to spend time figuring out how things are moving and be ready to take advantage of opportunities. On a daily basis, crypto markets can be more volatile than traditional markets, but the trend, over time, is that they are increasing in value.
Cryptocurrencies are more like commodities than equity or bonds. Commodities, like gold or oil, do not derive value from any form of cash flow but rather from some intrinsic value. Bitcoin is generally viewed the same way but will also (likely) eventually be viewed as a better form of money. This promise of Bitcoin and other cryptocurrencies to solve huge problems—as a better form of money—is driving significant speculative value in these cryptocurrencies as investments.
Question
Are there common mistakes or misconceptions you see in this investment space?
Answer
There is a massive misconception that crypto is shady. Some of that reputation is based on the fact that it’s a new technology and not widely understood yet. But it’s also because the early days of Bitcoin were filled with all kinds of dramatic activity, like heists, drug rings, and other criminal activity. But now we are moving from a phase where cryptocurrencies were a very niche, technical topic to a phase of more mainstream adoption and use. Big institutional investors and name-brand financial companies are getting involved, which will not only bring more users but also kind of help take a little of the edge off crypto’s Wild West image. Recently, several of the largest university endowments in the US announced that they had invested in cryptocurrencies, too.
The irony of all of this is that it is all unfolding in exactly the same way that the internet itself evolved in the mid and late 1990s, when many people believed that it was all about gambling and pornography. Today we know that’s not true.
Question
How does the Abra app work?
Answer
Abra is an app that allows users to invest in thirty different cryptocurrencies, including Bitcoin, Ether, and fifty world currencies such as US dollars, euros, Chinese yuan, etc. We are a cryptocurrency wallet that lives on the Bitcoin blockchain, which means that it is really secure. Abra users control their private key to the wallet, meaning Abra cannot access or confiscate users’ funds, ever. This is a different setup than most crypto exchanges, but we think it’s in the best interest of all involved. In the background, we use a novel synthetic currency technology to peg values to whatever asset our investors want to hold. This allows people to move between multiple assets quickly and cheaply, opening up a world of investment opportunities.
Question
Can you explain the international function of Abra? How is it possible?
Answer
We started Abra in 2015 as an app that would allow people to use Bitcoin to easily and cheaply send money across borders. Remittances, or money that is sent home by workers earning a living in other countries, are a huge part of the global economy. Using traditional systems, sending that money is still complicated, and it takes a lot of time and resources to move it across borders.
Abra is available around the world; we have users in more than seventy-five countries. Cryptocurrencies don’t need to recognize governments or geographic borders. They exist as computer code, and so they are inherently global. While Bitcoin and cryptocurrencies are interesting and novel in the context of developed economies, they are way more critical and important in developing economies where access to banking and financial services is challenging or where monetary or governmental policies make it hard for people to save and invest using traditional markets.
Question
Do you see a gender imbalance in the cryptocurrency space? Why do you think that is?
Answer
There is definitely a gender imbalance in the cryptocurrency space, as there is in the rest of tech. The original versions of both the iOS and Android apps at Abra were developed by women and our original user experience team comprised only women (although they have an awesome guy on the team now!). Maybe crypto will become more accessible than previous types of patriarchal tech movements. Time will tell. Funding models and geographical distributions are already different, which I think will help. The crypto space is not Silicon Valley–centric, which gives me great hope for gender, racial, and socioeconomic diversity within the space. And data shows that in India, women are investing twice as much as men in crypto—whether that is an anomaly or a trend is not yet clear.
