Ever since the explosion in mainstream media coverage a few years ago, Bitcoin has been one of the most mysterious yet commonly known novelties in financial markets. We look at what it is, and more importantly, its impact on your life.
In a nutshell, Bitcoin is a currency that is only based on the internet and held electronically. It is an example of the growing category of digital currency and cryptocurrency. Bitcoin can be traded against real-world currencies, hence we see widely traded pairs like BTC/USD and BTC/EUR.
Bitcoin is based on blockchain technology, which is the concept of a de-centralized open ledger system that is constantly re-updated and free from external influences, such as governments and corporations. When you own a Bitcoin, you own a portion of that ledger.
Just like how central banks issue currency, bitcoin also has its own form of issuance – namely “mining”. Miners simply use the processing power of computers to solve a complex mathematical puzzle within a “block” of data, and after solving, the block is added to the ledger, i.e. Increasing the “money supply”.
The miner is then rewarded with a predetermined number of bitcoins. The difficulty of solving the next puzzle goes up alongside the speed required, requiring greater processing power and the cycle goes on.
After a certain amount of mining, the mining reward is halved and this continues until the reward starts tending to zero – at that point the ledger will stop expanding, keeping the supply of Bitcoin finite. The Bitcoin protocol states that miners can only produce up to 21 million Bitcoins which can be divided up to the smallest unit (called a ‘satoshi’).
Why All The Hype?
Bitcoin was created after the 2008 crisis as a suggested solution to centralized currencies. By being free of a central influence, no one can game the system, thus ensuring fairness.
The main attraction, however, was that this created a payment system that did not require intermediaries like banks. Imagine a scenario where you can anonymously transfer a sizeable amount of money overseas, without paying wire transfer fees and with minimal bid/offer spreads.
Due to the purported benefits, concerns about quantitative easing and the stability of the global financial system led to huge speculation regarding Bitcoin, leading to an explosion in interest and price of Bitcoin. Although prices have come down since, many fund managers have Bitcoin in their investment portfolios.
There have also been big developments in the cryptocurrency space, leading to the rise of other currencies like Litecoin. Many merchants have adopted Bitcoin as a payment mode, and an entire economic ecosystem has arisen around digital currencies.
Should You Be Involved and How?
Although beyond the scope of this article, a long-term investment in Bitcoin would reflect the view that Bitcoin would rise further in prominence and take centre stage in the global financial system. Bitcoin is traded on decentralized exchanges, with most specializing in certain geographies. A simple Google search should yield a variety of ways to buy Bitcoins and the process of setting up a digital wallet (where you store your Bitcoin securely).
However, be mindful of the risks involved, as exemplified by the collapse of the Mt Gox exchange and the volatility of Bitcoin prices. As with other traditional forms of investment, due diligence is highly recommended before one invests.
Perhaps a better way to gain exposure would be through getting involved with blockchain technology, which has been much better received by authorities and financial institutions (which are developing it as a solution for the future). This is best shown through MAS’ stance on the matter. It is currently funding a blockchain recordkeeping project and Managing Director Menon has stated the plausibility of central banks issuing digital currencies in future.
Understand Bitcoins Before You Start Trading
As with all types of financial products, it’s always important to understand the product that you are investing or trading with before you get started. Leveraged trading brings with it an addition layer of risk and responsibility since you will be using borrowed money to make your trades. So make sure you are fully aware of how Bitcoin CFDs trading works before you get started. A demo account could be one way to gain experience first without taking actual risk.