Part I
It seems these days you hear about Bitcoin everywhere you go. Well, I had hoped it would go away because I was not looking forward to having to explain it.
Cryptocurrencies and blockchain are all the rage and I have yet to find anyone who can explain it in terms I can understand. So I will take a stab at it, but I'm no expert, and I am passing along what I am learning. In order to understand cryptocurrency, you have to also understand Blockchain, as they are connected. My intention is to provide you with a working knowledge of what this is and how it works.
First off, you may want to check out this page by RBC Global Markets to get another helpful visual.
Key points:
1. There are hundreds of cryptocurrencies and bitcoin is just one of them, the most expensive, and the most popular.
2. It is a digital or electronic currency - contrary to its name it isn't a physical coin and it isn't mined from the earth as you would rationally conclude.
3. It is decentralized which means it isn't controlled by anyone or by any government - that's what all governments hate about it.
4. The value is constantly changing - it's highly volatile. One of the reasons for this is excessive trading by speculators. The value can change rapidly, especially from a comment by a celebrity like Elon Musk.
5. It is legitimate.
6. It's not going away and is going to become even more commonplace.
7. It's really spooky stuff for many of us.
8. It's incredibly complex to understand.
Can you make money from it?
There are two main ways to make money. The first is to buy, hold, or trade the coin itself and the second is to invest in the mining of the coins directly.
How are blockchain and cryptocurrency connected?
This is the difficult part. Imagine a long chain and each link represents a block. the blocks are connected and form the blockchain. Inside each block is a transaction and that transaction, once created, is set, verified, and protected. It can't be changed.
According to Nerdwallet,
"A blockchain is a public digital ledger of transactions that records information in a way that makes it difficult to hack or alter. The technology allows a secure way for individuals to deal directly with each other, without an intermediary like a government, bank, or other third parties. The growing list of records, called blocks, is linked together using cryptography. Each transaction is independently verified by peer-to-peer computer networks, time-stamped, and added to a growing chain of data. Once recorded, the data cannot be altered."
How is a "Bitcoin value" attributed to each block?
Basically, each block, which is 1 megabyte of data, is currently worth 6.25 bitcoin. Bitcoin is trading at $62,753 - so a block is worth $392,206.
Click here for a long article to help you understand all of this in greater detail.
Is it a good investment choice? How can you participate? Should you participate? We'll deal with those questions in part II because we believe it is important to understand this new digital currency - it isn't going away.
Hope this helps a little!
Learn more about our fee-only retirement income planning process for clients 55+.
Retirement Income, Investment & Tax Planning,
Willis J Langford BA, MA, CFP
Nancy R Langford CRS
Our mission is to help our clients get their total financial house in order and retire more confidently with purpose & peace of mind
Cryptocurrency: Part II
What is bitcoin mining? Is it a good investment choice? How can you participate? Should you participate?
The following are bits and pieces I have gathered from other websites. Click the links to get a more in-depth understanding.
This is probably the best explanation of crypto mining I have found yet. Check it out.
Bitcoin is the first decentralized digital currency that allows peer-to-peer transfers without any intermediaries such as banks, governments, agents or brokers, using the underlying technology of blockchain.
Bitcoin Advantages
1. Decentralization
2. Security of the transaction
3. Flexibility of payment
4. No currency fluctuations
Fiat money — money like the American (USD) or Canadian (CAD) dollar — is issued by the government, meaning there’s a central authority that controls its value, interest rates, and supply (how much is in circulation).
Compared to traditional fiat currencies, assets can be transferred faster on the bitcoin network. The system also has lower transaction fees, because it’s decentralized and there are no intermediaries, and it is cryptographically secure—the identities of the sender and the receiver are kept hidden, and it is impossible to counterfeit or hack the transactions. Plus, all the information is available on a public ledger, so anyone can view the transactions.
What Is Bitcoin Mining?
Bitcoin mining is the process of verifying bitcoin transactions and recording them in the public blockchain ledger. In the blockchain, the transactions are verified by bitcoin users, so basically the transactions have to be verified by the participants of the network. Those who have the required hardware and computing power are called miners.
We will talk more about them later, but the important concept to understand here is that there is nothing like a centralized body—a regulatory body, a governing body, a bank—to make bitcoin transactions go through. Any user with mining hardware and Internet access can be a participant and contribute to the mining community.
The process is solved based on a difficult mathematical puzzle called proof of work. The proof of work is needed to validate the transaction and for the miner to earn a reward. All the miners are competing amongst themselves to mine a particular transaction; the miner who first solves the puzzle gets the reward. Miners are the network participants who have the necessary hardware and computing power to validate the transactions.
Prevention of Hacking
What if someone tries to hack the data? Blockchain, as the name implies, is a chain of blocks—let’s call the blocks A, B and C. Each block has solved a puzzle and generated a hash value of its own, which is its identifier. Now suppose a person tries to tamper with block B and change the data. The data is aggregated in the block, so if the data of the block changes, then the hash value that is the digital signature of the block will also change. It will therefore corrupt the chain after it—the blocks ahead of block B will all get delinked because the previous hash value of block C will not remain valid.
For a hacker to make the entire blockchain valid for block B that has been changed, he or she would have to change the hash value of all the blocks ahead of block B. This would require a huge amount of computing power and is next to impossible. With this method, blockchain is non-hackable and prevents data modification.
Information was gathered from this site.
How can you invest in this?
There are sites where a person can buy cryptocurrencies but it is considered high risk and how do you know which one is trustworthy. Eventually, most investment funds will likely have a portion invested in this asset class so at that point the fund managers will have done the necessary due diligence and we'll trust them to do the investing on our behalf as we're doing now with all other assets classes.
One of our clients sent along this link which she found helpful in learning more on this topic: "How To Invest In Cryptocurrencies: The Ultimate Beginners Guide"
The better question is...
Should you invest in this?
Here are some pointers and rules of thumb we follow:
1. Invest in things you understand. If something interests you then learn everything you can about it so you can make informed decisions. If you start then start with a small investment.
2. Answer the question, "Why am I investing in this?". We all have a tendency to want to make fast and easy money. We hear the stories of those who have made a bunch of money, however, we do not hear as many stories of all of the people who have lost their life savings. People don't brag about that.
3. My advice is that it is still too early and too volatile to invest in cryptocurrencies. There are two influences that move the markets. One is the fundamentals and the other is sentiment. Fundamentals are things like actual measurable usefulness, profitability, revenues, earnings per share, year over year growth rates, etc.
Sentiment, on the other hand, is the whimsical stuff. One tweet from Elon Musk and the currency can go up or down by 20%. All commodities are subject to sentimental trading, and cryptos are no different.
Cryptocurrencies tend to move mainly on sentiments, such as an event or a comment from a celebrity. Well, I won't play that game. It's too emotional and draining; not to mention risky.
4. A buy-and-hold strategy is the best strategy - in most cases. Purchasing cryptocurrency, you may find it difficult to control your own emotions as the value can swing wildly from one day to the next.
5. Trying to time the markets is very difficult. The price goes down and you think, "Should I buy more?" the price goes up and you think, "Should I sell? Maybe it will go higher." The price drops and you think, "I just missed my opportunity." There's a lot of self-inflicted anguish with this. One of the reasons we like investing in funds or pooled investments is because it takes the emotion out of it and we do not have to be constantly making investment decisions.
6. Investing in cryptocurrency is still a big speculative investment. You have to be prepared to lose all of your money; so it has to be money you can afford to lose.
7. At the end of the day the purpose of investing is to put your money to work on your behalf so that it can earn a return and fund your lifestyle. When we build plans to forecast income and cash flow needs in the future we are using assumptions, like rates of return and inflation, to come up with estimates and probable outcomes.
The reality is, you don't need to win the lottery to fund your lifestyle, you just need to save regularly and earn a reasonable and consistent rate of return each year in the 5-6% range. The most important thing about investing is being able to get more consistent returns. You don't need to hit a home run every time you get up to bat - you just need to get on base.
"He who gathers little by little makes it grow."
At this point we do not offer a platform for investing in digital currency, nor can we recommend one. I do think it will be something that is more mainstream and commonplace in the coming months and years. It's here. It's not going away. So we have to learn more about it and how to use it.
Let us know if you have any questions or comments.
Willis and Nancy Langford
Fee Only Retirement Planners
