This is written as a layman guide to understanding blockchain technology and is written as a support to that technology. It is technical advice, not investment advice. Those who want investment advice should consult someone who has degrees for that type of thing.
What is blockchain?
This is the first question you should be asking yourself before you jump in. It’s important to know why and how cryptocurrency gets its trading power. It all rests on the innovation of blockchain technology.
A blockchain is a public financial ledger of digital transactions. That is all.
It’s comparable to a bank statement for everyone on the network. Deposits come in and withdrawals go out. After the dust settles the balance is the sum of all transactions.
So What makes it innovative?
Well in one crucial way a blockchain is not like a bank statement at all - it’s decentralized. There is no one person or company responsible for making sure everything tallies up. That responsibility falls on the whole network equally. It’s what’s called a trustless system and it’s maintained by competition. It works like this:
- I want to buy something using bitcoin.
- I find a sales website that takes bitcoin.
- The website responds by showing me their wallet address. This is like their crypto bank account.
- Using my own wallet I can send any amount of bitcoin to that address. The website will tell me exactly how much to send as a decibel. Included with my purchase price will be a transaction fee.
- The moment I click send a million miners all across the globe will be competing to verify my transaction.
- They will run tests to make sure that I have the funds I sent and that I didn’t double-spend those funds elsewhere.
- The hard part comes in verifying their proof-of-work protocol. Which is a complex computer problem that gets more difficult every time.
- Whoever solves the problem first gets paid not only the transaction fees of every transfer in their block but also a predetermined reward released by the network.
- The whole network moves on to the next block, more transactions, and a harder proof of work protocol.
Is that really all it’s good for?
Cryptocurrency is trying to answer the dilemmas inherent to fiat based capitalism (fiat = state-sponsored, debt based money). Currently, our world economy is run by financial service middlemen. These companies charge fees in order to facilitate the transfer of money. In many ways, they make the market more efficient than it would otherwise be. However, blockchain aims to replace them with decentralized, trustless systems.
So what's wrong with fiat?
I think the best way to explain how expensive financial services are is to use a simplfied example:
If you owned a pizza shop and you want to do more sales you might decided to take credit cards. In order to do so you agree to pay 3% charge to the processing company. So you increase the price of a slice by 3% to accommodate this charge. But costs don't end there because the credit card company is known to always side with the customer in transaction disputes. It may not happen often, but when it does, you lose money. So you factor this and increase the price of pizza another 2%. Also, the funds that are transferred from your customers are in USD, which inflates in value by 1-3% annually. So every year you have to increase the price of pizza or you will be losing money. Unless the cost of your ingredients magically goes down, you will always have to consider increasing prices to earn a profit.
But then comes the alternative- a currency that transfers funds immediately, has low fees, is irreversible, and is designed to be deflationary. Meaning, all other things equal, funds you receive today will be worth more in the future. If it worked you would be able to lower your prices, and perhaps sell more, because there are no financial middlemen.
So then how is the price of bitcoin determined?
Bitcoin, and all cryptocurrencies are commodities. They are measures of value. They are designed and can be used as currency, but at their core they are more like assets. That means their inherent worth is measured solely by how much people are willing to pay for them.
Why is the price always changing?
That has to do with adoption rates, speculation, and the inherent deflationary technology of cryptocurrency.
There’s a famous example of the early days of Bitcoin when someone paid 10,000 BTC for 2 pizzas. The joke is that by today’s standard that would be many millions of USD. Of course, hindsights 20/20 but there’s another way to look at it. In 2010 there were a minuscule fraction of miners on the network as compared to today, and the notion of traders (i.e. a marketplace) was nearly nonexistent.
As adoption grows, so does value. As long as more people agree there is value in a commodity, the value grows. But people gauge that value based on a multitude of factors. Many people buy and sell commodities based on market trends and this puts their value into volatile swings. It’s an unavoidable feature of innovation hitting the marketplace.
So how can I make money in blockchain?
Buy and hold. Like any investment, cryptocurrencies reek havoc on the skittish investors. The only way to win is to play the long game. Don’t expect exponential returns to happen over night and don’t invest more than you can comfortably hold through volatile swings.
Do your research, but read critically
It’s very important to take everything you read or see in the news with a grain of salt. History has shown these institutions are reactionary and fueled by fear. Because investment is risk based, decisions based on fear rarely turn profit. Be specifically cautious of investment advice that speculated on specific price points. People who speculate this way are right as often as they are wrong because markets are not rational or predictable.
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