Bitcoin and Crypto FAQ - New Investors Edition
One-paragraph-or-less answers to the most common bitcoin & crypto questions (not investment advice).
- Bitcoin only has '21 million coins' - what does that mean? The designer of bitcoin (Satoshi Nakamoto) designed the bitcoin protocol so that there will only ever by 21 million units of bitcoin in existence - with complete transparency and predictability. This is in contrast to assets where supply is considered finite but exact total supply is estimated (eg. oil and gold); and in strong contrast with 'fiat currencies' (government-issued currency), where supply is theoretically infinite as central banks can print as much as they like. Currently, the bitcoin software allows one bitcoin to be subdivided down to 8 decimal places (ie. minimum sending amount on BTC network is 0.00000001 BTC, equivalent to way less than $0.01 at current price), with transaction fee ranging from ~$0.1-$1 per transaction depending on speed.
- How do people create bitcoin? The first bitcoin was 'created' through the process of mining. One can think of it like gold mining where people buy heavy machinery to mine gold, but instead of excavators, bitcoin miners (currently mostly in places with low electricity costs) use computers; and instead of a relatively complex gold extraction process, these computers are given a math problem and the first computer to solve the math problem is rewarded with a certain number of bitcoins. After the problem is solved the process restarts and the same computers compete to solve the next problem the quickest. There is a bitcoin reward approx. every 10 minutes. When bitcoin mining first started in 2009, each reward (called the 'block reward') was 50 bitcoins. As of April 2020, the reward is 12.5 bitcoins.
A typical bitcoin mining computer ('miner' or 'mining rig') - How come there is less and less reward for mining? The designer of bitcoin wanted to encourage bitcoin mining and adoption by encouraging early participants with a greater reward for the greater risk that they are taking (dedicating time to a new technology). Roughly once every four years, the block reward is halved, so there is some incentive to 'get in early' as whenever halving (or 'halvening') occurs, there is usually some expectation that price will increase, spurred by assumptions 1) bitcoin miners usually sell what they mine and 2) upon halving, there is less selling pressure on the market as miners have less to sell. Halving events also provide bitcoin enthusiasts and those in the media to have something to talk about once every 4 years.
- Why are there so many different coins? Indeed, there are currently more than 5000 (!) cryptocurrencies in existence. You can think about it like this: if any company purporting to be doing something "internet related" during the 1990's could get listed with even less regulatory oversight, how many companies would have been listed? This is basically what happened in the cryptocurrency space beginning around Q2 2017, when ICOs started really taking off (ICO's are initial coin offerings - like an IPO, but coins instead of shares are offered to public investors for the first time).
- What's the difference between bitcoin and other coins? Are they just bitcoin copies? Direct copies or very similar versions of bitcoin haven't lasted for the same reason a complete copy of facebook wouldn't get a lot of sign-ups, due to network effects and lack of support (in addition, there are costs to maintaining a network). Cryptocurrencies that had some significant parameters tweaked and marketed as such have had varying success (see eg. Bitcoin Cash, Litecoin, and Monero). There are yet other cryptos that are different enough to be considered an entirely categorically different to bitcoin (eg. Ethereum, BNB, USDC, etc). The use case and technologies of cryptos could vary significantly.
- So anyone can do ICOs? In 2017 - yes, but many ICO sellers got into trouble with regulators (though many also escaped unscathed). Beginning in 2018, ICO activities have been tempered as global regulators got involved. The rules required for launching a cryptocurrencymay be slowly converging with the rules for launching a stock.
- Why isn't there just one global exchange? Which one should I choose? Because there is a lot of money involved and many companies want a piece of the crypto-market. Your choice should reflect your needs, as different exchange specialize in different products, services and geographies. Some, like Coinbase and Gemini, offer reliable USD-to-crypto gateways and focus on pairs like BTC/USD. Others like Binance are known to focus more on altcoins. Some are heavily favored in certain geographies (eg. OKEx and Huobi in China). Yet others like CME, Bitmex and Deribit are derivative exchanges. Institutional investors should probably look for exchanges with regulatory approvals and have dedicated coverage teams. Some exchanges are regulated by local regulators, most aren't. As a minimum, before transferring money to an exchange, you should get an idea of an exchange's security history by googling '[exchange name]' + 'hack', as hacks are probably the biggest risk to a crypto exchange.
- Is bitcoin only for criminals and illicit activities? Since its creation Bitcoin has its share of negative press, involving drug trades, money laundering, terrorist financing. But let's pause for a moment and think about how many world-changing technology has had controversial beginnings. The GPS had war-origins. The internet was and is still used to share adult content. Modern smartphones can be used by both good and bad actors. As a new technology, bitcoin offers a non-sovereign, global and decentralized way to store and transfer value - something never done before. Its use cases will continue to grow. Why bitcoin has value, an important subject, will be discussed in more depth in a further article.
- What are the main risks involved with owning or investing in bitcoin? Main ones are technology (it is possible for the protocol to be hacked; disrupted by advances in quantum computing; development roadmap could be disrupted by community infighting); regulatory (governments can simply decide to ban it completely; or selectively ban certain bitcoins); price/volatility (prices tend to move a lot); exchange (could shutdown / get hacked); custody (if you self-custody bitcoin, you could lose your keys - which is like your password except you can't reset it through a service provider); competition (something 'better' simply comes along). Each has its mitigants, which will be discussed in a later article.
This article summarizes the typical questions asked about bitcoin for those new in the space. If you have any further questions or comments on this article, let me know!
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