A Beginner’s Guide to Bitcoin (and Other Cryptocurrencies)

Personal Finance · 21 Dec 2017

It was not long ago that Bitcoin seemed at the edge of a precipice. Slow transactions and frequent hacking scandals undermined confidence in the largest digital currency.

It was not long ago that Bitcoin seemed at the edge of a precipice. Slow transactions and frequent hacking scandals undermined confidence in the largest digital currency. But as Bitcoin nears its ninth year trading, it continues to set price records, hitting an all-time high of just over NZD $25,000 last week.

What are cryptocurrencies?

A cryptocurrency is a digital currency that uses cryptography (mathematical codes) for security, making them difficult to counterfeit. A key feature of the main cryptocurrencies is that they’re not issued by any central bank or government - the New Zealand dollar, on the other hand, is issued and regulated by the Reserve Bank.

When cryptocurrency is transferred, users create another entry in the currency’s ledger (referred to as the ‘blockchain’) - a peer-to-peer network makes sure that you haven’t already transferred the cryptocurrency to someone else. For checking these transactions, participants in the system known as ‘miners’ are rewarded with transaction fees and newly created cryptocurrency.

What’s the fuss about Bitcoin?

Bitcoin was the first cryptocurrency off the block - it began trading in 2009, long before other competitors were developed. Bitcoin is also based on older technology, something that proponents of newer cryptocurrencies have criticised. Despite this, Bitcoin remains the largest cryptocurrency by far, with a ‘market capitalisation’ of just over 400 billion New Zealand dollars.

How Can You Use Bitcoin?

Bitcoin can be used to make payments without going through traditional financial systems. When you shop online, you send money to the merchant through your bank, their bank and a credit card operator. In contrast, users who pay for goods using Bitcoin directly transfer money to the recipient - avoiding the middleman and reducing fees. If you’ve got family abroad or if you’re planning a holiday, Bitcoin offers another way to exchange your New Zealand dollars for the local currency. In reality, most Bitcoin trades at present are for investment purposes. People buy Bitcoin in the hopes that it will continue to rapidly increase in value.

NZD to BTC: How to Get Started

A number of NZ dealers trade in Bitcoin. To get started, you'll need a 'wallet’ to safely store your Bitcoin. You'll also need to sign up to an exchange. Some exchanges allow you to buy Bitcoin using a credit card, but this will incur extra fees. If you're a new investor buying a small amount of Bitcoin, it may be easiest to keep your Bitcoin in your account with the exchange rather than transferring it to a wallet.

Are there other cryptocurrencies?

Over a thousand alternative cryptocurrencies have been developed since 2009, although most of these have little chance of becoming a serious alternative to Bitcoin. Some, like Litecoin, are essentially smaller versions of Bitcoin. Others have more innovative uses.

Ethereum, now the second largest cryptocurrency, offers a decentralised platform to run smart contracts. With Bitcoin, Jane can send money to Tamati, whereas using Ethereum, Jane can send money to Tamati, which Tamati will only receive if he performs a specific task. Dash, short for digital cash, makes it easier to send money quickly. Traditional wire transfers can take days to clear, whereas Bitcoin transactions can take anywhere from minutes to hours to process. Payments using dash are confirmed in less than a second, allowing for instantaneous transfers.

Like Bitcoin, many alternative cryptocurrencies have experienced extreme growth. If you’d bought $2,500 of Ethereum in January 2016, you’d have enough for a house in Auckland today. A large number of cryptocurrency operators have set up shop in response to these extraordinary gains - some of these operators are unscrupulous, taking advantage of new investors in an unregulated industry.

It may also be worth looking at services which allow you to invest across a range of different cryptocurrencies. This may spread the risk of any single cryptocurrency failing dramatically in value.

Should You Invest?

Any major investor will confidently tell you that past gains do not guarantee future performance. Stocks that performed well might tank, and houses that have increased in value might go down in value. Compared to these types of investment, cryptocurrency is much more volatile and a good deal riskier. In April 2013, the price of Bitcoin dropped by 71% in the space of a few hours. Earlier this year, Bitcoin dropped by almost 40% after investors were spooked by rumours that the Chinese Government would ban cryptocurrency altogether.

Bitcoin has been performing strongly lately, so many would-be investors are worried about missing out on their share of the gains. FOMO is not a good way to make investment decisions. Because Bitcoin is so risky, you should only invest as much as you can comfortably afford to lose.

If cryptocurrency values drop suddenly, you could be left with a big shortfall to meet. But if you’ve got a little bit of spare cash, why not have a go? It might just be the next big thing.


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