Virtual Money: A Beginner's Guide To Bitcoin & Cryptocurrency

Wealth

November 1, 2017 | BY Nick Ferguson

What exactly is cryptocurrency and how does it work? Find out in our guide below

The value of a single bitcoin has risen by around 400 percent this year, though exactly how much depends very much on which day you check. With such spectacular gains, high-net-worth individuals, institutional investors and investment banks are starting to take notice.

Mainstream interest in digital currencies isn’t entirely new. As the world becomes increasingly uncertain, many people are seeing bitcoin as a safe haven. Yes, it could be a bubble, but the growth of institutional flows is giving the market a more stable foundation.

“Bitcoin is the world’s biggest experiment,” says Dave Chapman, managing director of Octagon Strategy, a Hong Kong-based company that specialises in commodity and digital asset trading for high-net-worth investors and institutions. “But it’s less of an experiment than it was three years ago.”  

Illustration by Paddy Donnelly

What are cryptocurrencies?

Cryptocurrencies are digital currencies that use cryptography to secure transactions and the minting of new units of the currency. Bitcoin was the first to be created, when an anonymous individual known as Satoshi Nakamoto published the underlying technology in 2009. Many other cryptocurrencies have been introduced since then, but the general principle behind most of them is the creation of a decentralised digital currency that allows strangers to conduct anonymous transactions on the internet.

At the heart of these currencies is a secure database (such as the so-called blockchain that bitcoin uses, for example) that records and timestamps all transactions. This allows all parties to verify and validate a transaction—and by itself is a technology that has many potential applications in traditional financial services, such as money transfer or insurance or shipping, or basically anything that relies on accurate record-keeping between multiple parties. If you’ve ever been annoyed by the fact that it can still take days to transfer money internationally, blockchain might soon come to your rescue.

See also: 8 Wealth Management Insights For Entrepreneurs

Illustration by Paddy Donnelly

Mining for Bitcoin

The process for creating new bitcoins and other cryptocurrencies is one of the key attractions, especially among libertarians. Because traditional currencies are no longer backed by hard assets such as gold or silver, government-controlled central banks have absolute power over the quantity of currency in existence. They can create new supply by printing more money or reduce supply through taxation—whereas Bitcoin is immune to meddling governments.

Like a kind of digital gold, the supply of bitcoins is finite and new ones are created through a process known as “mining”. Anyone with a computer can mine blocks of bitcoin, but in practice, most are extracted by organised groups using hundreds of dedicated machines that earn the blocks by cracking a computer code. 

There is a limit of 21 million coins and 16.5 million have been mined so far. The value of each block, which is controlled by a mathematical protocol, halves every four years, meaning that 99 percent of all bitcoin will be mined by 2036—though it will take another century to mine the remaining 1 percent, assuming that the reward is still sufficient to pay for the cost of the electricity needed to mine them.

To put it simply, cryptocurrencies are money that exist outside of government control and the traditional banking system. They do not rely on the internet and can be stored offline on any external storage device—which means they can be lost just like paper money. It is estimated that 25 percent of all bitcoin in existence have been lost forever.

See also: Managing Your Legacy: How External Advisers Can Help

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