We get it, digital currencies can be an intimidating topic. There’s a lot to learn and it’s constantly changing. This guide is designed to give you an epic starting point for your journey down the crypto rabbit hole.
Why do we need digital currencies?
- Today’s money isn’t backed by anything tangible and can easily be created/destroyed/manipulated by central authorities – giving them power over us.
- Banks have proven that they can’t be trusted, and technology has made them irrelevant. With the right tools, we are more than capable of being in control of our hard earned money.
Where did digital currencies come from?
- While bitcoin was not the first attempt at digital money (hashcash, bitgold and digicash to name a few), it was the first to solve two of it’s biggest challenges: How do we ensure the digital money can not be duplicated like files can? and how we ensure the history of transactions is not controlled or tampered with?
- Satoshi Nakamato released his solution to the world as the bitcoin white paper on October 31st 2008, and launched the first publicly available version of the bitcoin software in January 2009.
- In December of 2010 as the bitcoin value grew and the community flourished, Satoshi mysteriously disappeared without warning.
What are digital currencies?
- While there is some nuance to it, when people talk about crypto currencies, digital assets, tokens, etc. they are essentially talking about the same thing. We’re going to them all as digital currencies.
- The definition of a currency has been debated between philosophers and economists for years, however it’s generally agreed that currencies contain the following properties:
- Portability – it should be portable
- Fungibility – it should be mutually interchangable
- Divisibility – it should be easily divisible into smaller portions
- Transferability – it should be easily transferable between parties
- Durability – it should not change, corrode or fade away
- Digital currencies like bitcoin combine the properties of general currencies with the best properties of gold, cash and debit cards.
- Like gold, bitcoin is a fungible finite resource which comes into existence through a mining process. There are only 21 million bitcoins available to be mined. Unlike gold, bitcoins themselves are not tangible. Bitcoins are simply numbers that exist on the Blockchain, a decentralized “spreadsheet in the cloud” which keeps track of every bitcoin which ever existed since the first bitcoins were mined.
- Like cash, bitcoin is easily divisible and transactions can occur without exchanging any personal information. Although each bitcoin currently costs thousands of US dollars a bitcoin is divisible by up to 100 Millionth (0.00000001), also known as 1 Satoshi, named after bitcoin’s creator. Unlike cash, bitcoin can be transacted over the internet, can be stored (and even owned) by computers and is not created/managed/distributed by the government.
- Like debit cards, bitcoin transactions can occur instantly between two parties on opposite ends of the world. Unlike debit cards, the network which facilitates bitcoin transactions is distributed, meaning thousands of independent parties verify the transaction instead of a single central authority like Visa.
How do you use digital currencies like bitcoin?
- To begin using bitcoin you need a wallet. A wallet is software which protects your private key, allows you to send and receive bitcoin and track your transactions.
- For small everyday expenses, a bitcoin mobile app wallet like Mycelium or CoPay will do the trick. When selecting a wallet, always ensure the software is open sourced and reviewed/vetted by the community.
- When you first setup your wallet, it will ask you to write down 12 or 24 random words otherwise known as a mnemonic phrase or seed. Your wallet uses this seed to generate your private key, which is the secret password used to determine which bitcoins on the blockchain are yours.
- Protecting your private key is your responsibility. If anyone knows your seed, or can hack your wallet, they can get your private key and steal your bitcoin! Always write your seed down on paper (don’t store them on a computer!) and keep it somewhere safe.
- A hardware wallet is a stick drive sized computer which can be used to generate and protect your private key without ever connecting to the internet. Hardware wallets are one of the most secure ways to store digital currencies and are highly recommended for storing large amounts. Some popular hardware wallets include Trezors, Ledgers or KeepKeys. Our favorite here at BitLift is the Trezor.
- If your wallet doesn’t provide your seed or private key (for example, Coinbase and most exchanges) then that means the company providing the wallet controls your digital currency, not you! You should move your digital currency ASAP to a wallet where you control the private key.
- Once your wallet is setup, you will likely see an option to create multiple “accounts”. Accounts can be used to organize your coins if necessary. For example, you may want spending, savings and/or business accounts.
For each account you will see a random string of 34 upper/lower case letters and numbers typically accompanied by a QR code. This is your receiving address and it acts like an email address for this account in your wallet. Any bitcoin sent to this address will show up in your wallet. You can send bitcoin to this address as many times as you want, however you’ll notice that the address in your wallet changes every time you use it. That’s because for privacy reasons it’s not recommended to continually transact using the same address since every address can be looked up publicly on the blockchain.
- When you receive your first bitcoin you’ll notice that it arrives with a status of “Unconfirmed”. That means your wallet has detected the transaction but it has not been confirmed by the bitcoin network. It’s recommended that you wait for 6 confirmations which can take anywhere from 20 minutes to a few hours to ensure the bitcoins were sent properly.
- When sending bitcoins, you’ll notice you need to attach a small fee. This is usually handled automatically by the wallet. This fee is awarded to the computers on the bitcoin network for helping facilitate your transaction. The higher the fee, the faster your transaction will be processed. Only a certain amount of transactions can be processed every 10 minutes, so when there’s high demand on the network, fees can become very expensive (as we’ve seen in recent years).
- Get comfortable sending and receiving small amounts of bitcoin. It’s also wise to practice setting up your wallet, writing down your seed, deleting your wallet, and then restoring it from your seed to ensure you’ve written it down correctly.
- Pro Tip #1 – When setting up your wallet it may ask if you’d like to add a “passphrase”. Passphrases act as a 13th or 25th word in your seed and can be used to create an infinite number of wallets each with a unique private key. You can keep a small amount of digital currency in your wallet with no passphrase, and the rest in a wallet with a passphrase. That way if anyone ever found your seed or forced you to give it up, they would only find a small amount and your passphrase protected wallet would remain safe.
- Pro Tip #2 – It’s a good idea to keep a backup of your seed somewhere remote from your hardware wallet incase of fire/flooding/etc. If you’re worried about protecting the piece of paper with your mnemonic phrase on it, you may consider getting a Cryptosteel.
- Pro Tip #3 – An added benefit to keeping your coins in a wallet where you control the private keys is that occasionally a coin you’re holding may “fork” giving you access to the new coins created on the new blockchain. This happened recently with Bitcoin Cash and Bitcoin Gold.
- Pro Tip #4 – Fees on the bitcoin network have gotten extremely high (sometimes hundreds of dollars!). Most wallets will calculate the fee for you based on the current load on the network. If you don’t need your transaction confirmed quickly, you can lower the fee. Earn.com has a great tool for seeing how much fee needs to be included with your transaction.
What about all the other digital currencies?
- Bitcoin was the first digital currency, but it’s certainly not the only one. Thousands of alternatives to Bitcoin (aka Altcoins) have sprung up, each with their own unique value proposition.
- Most digital currencies work very similarly from a user’s perspective (wallets, addresses, blockchains, etc.) as they are almost all based on bitcoin’s innovative blockchain technology. Some wallets support storing and using multiple altcoins, but in many cases you need to download and use a dedicated wallet for each altcoin.
- Ethereum was the first to popularize the idea of a “token” which is a new digital currency built on top of Ethereum’s blockchain. These tokens, which are ERC20 compatible, can be sent and received by any Ethereum address, however use caution because not every Ethereum wallet supports them. The most popular Ethereum wallet for managing ERC20 tokens is MyEtherWallet (aka MEW).
- As described, each altcoin proposes a unique usecase which we can organize into the following baskets:
- Currencies – Digital currencies focused exclusively on storing value and being used for monetary transactions (Bitcoin, Litecoin, Monero)
- Privacy Currencies – Currencies focused on improving privacy (Monero, ZCASH, Verge)
- Governance – Coins focused on improving governance (Decred, Tezos)
- Platforms – Digital currencies used for creating, managing and transacting other tokens and digital currencies on their blockchain (Ethereum, Ripple, Waves, Neo)
- Investment Funds – Digital currencies used to represent ownership in an investment fund and manage dividend distributions (Astro, BCAP, Iconomi’s Blockchain Index)
- Forks – Copies of another digital currency’s code/blockchain history typically created out of disagreement in the direction of the community (Bitcoin Cash, Bitcoin Gold, Ethereum Classic)
- Utility Tokens – There’s a popular belief that the future of the internet will be built on top of blockchain technology (aka Web3). Startups working towards this decentralized internet of the future release their own tokens to raise money for their startup and bring tokens used within their apps into existence (Blockstack, Status, Golem, Civic)
- An Initial Coin Offering (ICO) is the process by which new digital currencies are released to the public. Similarly to an IPO in the public stock market, these new coins are first offered to savvy investors before being available publicly on exchanges.
- Warning! Altcoins and ICOs are hotbeds for hackings and scammings so use extreme caution when participating and always do your own due diligence.
Investing in Digital Currencies
- This is not investment advice, just a few things we’ve learned along the way. Always do your own research before buying/selling/investing in digital currencies!
- Digital currencies are highly speculative and in some cases people have been wiped out entirely. Never invest more than you are willing to lose.
- You buy digital currencies on exchanges, but NEVER leave them on the exchange longer than necessary to avoid hackings, seizings and freezings of accounts. Withdraw the digital currencies to your personal wallet where you control your private keys.
- In the US, we like to use GDAX to buy bitcoin, litecoin and ethereum, and Gemini for bitcoin and ethereum.
- If you want to buy altcoins not offered at GDAX and Gemini, you first buy bitcoin, litecoin or ethereum, transfer it to your personal wallet, transfer that to an exchange which supports your altcoin and use the bitcoin, litecoin or ethereum to pay for the altcoin.
- There are many exchanges for investing in altcoins, our favorite is Bittrex. Make sure you have a high enough daily withdrawal limit before transferring digital currency to Bittrex or it will be difficult to get it out.
- If doing large deposits/withdrawals, always do a small test first.
- As with any investment, diversification is the only free lunch. We recommend building a diversified portfolio spread across the various digital currency markets outlined above:
- 40% Currency Coins
- 20% Funds
- 20% Platforms
- 10% Privacy Coins
- 10% Startups/utility tokens/hail marys/gambles with 100x+ upside opportunity spread across 5-10 different assets
- Pro Tip #1 – On GDAX, if you place a limit order on the books, one that will not strike instantly, you will be considered the “market maker” if someone decides to exchange with you and you will not pay a fee.
- Pro Tip #2 – TradingView.com is an excellent tool for charting and technical analysis. Set the chart to be viewed logarithmically and add 50 and 200 simple day moving averages. Draw basic lines connecting recent lows (support) and lines connecting recent highs (resistance) and place buy orders near the support line. If your order triggers someday then you know you got a great price, if not… do it again. This prevents emotional trades and attempting to perfectly time the market.
- Pro Tip #3 – Blockfolio for iPhone and Android is our favorite app for tracking our digital currency investments.
- Pro Tip #4 – When buying large amounts of any digital currency, don’t buy all at once. Dollar Cost Average into your position to eliminate price sensitivity (and paranoia). For example, if buying $10k of bitcoin, buy in 5 chunks of $2k over the course of a month or so. Buy $2k today, and then wait for dips to buy more. Or you can even simply buy $2k on the 1st of each month for 5 months.
- Pro Tip #5 – Always setup 2 Factor Authentication on every exchange you use to add an extra level of much needed security.