The concept is different from shares or shares in a company because cryptocurrency is not recognized as money or an asset by any of the world’s major central banks.
The cryptocurrency is widely known as Bitcoin, and its biggest rival is Ethereum. The two main cryptocurrencies, which were originally created by developers of bitcoin, are the most popular way for people to trade their bitcoins.
Before you start trying to make money from virtual coins, you need to know a little more about them.
What are they?
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Blockchain is the technology that underpins the bitcoin and Ethereum blockchains. It means the transactions are verified by computer network participants.
What is a blockchain?
A blockchain is a public ledger of all the transactions made over a network of computers. It is stored on many different computers, or “nodes” and can be used to store other kinds of data. For example, a bank might use a blockchain to record how much money each of its customers has in their accounts.
That means a transaction made with a smartphone could be checked against the record of the transactions to date and the one to come in the future. If there were no transactions in a block at a particular time, then a transaction has to be added. That’s what is happening now in the cryptocurrency world.
The blocks of information are known as “blocks”. In the case of bitcoin, the blocks are added roughly every 10 minutes by network members.
How is the blockchain used to make money?
A popular way to create and send bitcoins is known as an “initial coin offering”. This involves creating and selling a digital currency that has no physical equivalent.
The idea is that people can pay for transactions using a certain currency, which is known as the “coin”. To make a transaction, the user sets a price for the coin and broadcasts it to the network. This “mining” process is a kind of competition.
The first person to find a sequence of combinations of random numbers known as a “hash” (a kind of digital signature) that matches the one entered by the second user, who in this case is the miner, wins the right to use the coins. The winner also gets a slice of the transaction fees the network generates as a result of that process.
How can you make money from a coin?
Here’s a summary of some of the most common “craze” coins:
Bitcoin: Created by the mysterious Satoshi Nakamoto, it was the first cryptocurrency and became hugely successful in 2013. It was worth less than US$1,000 at the time of writing and has fluctuated significantly in price. Bitcoins have been the most widely used form of cryptocurrency.
Ethereum: Created by a Russian scientist in 2015, it is similar to bitcoin in some ways but allows users to carry out more complicated financial transactions. Ethereum is less volatile than bitcoin and has seen a lot of interest from companies.
Cardano: Created by a Canadian company in 2015, this has been one of the fastest-growing cryptocurrencies. It has no future value. Instead, it is aimed at being a general-purpose computing platform. A “proof-of-stake” algorithm is used to approve transactions and rewards investors with new coins.
Litecoin: Created by a former Google engineer in 2011, it is currently one of the smallest and best-known cryptocurrencies. It was also a popular choice among users of the now-defunct Mt Gox bitcoin exchange. It is a peer-to-peer cryptocurrency without mining or block creation. The coins are obtained by checking whether the same number is in two sets of databases.
Augur: Part of the “worldcoin” family, this is an “expiry” coin. It is meant to offer a way for traders to get paid based on whether or not a particular event comes to pass. A “point” is needed to trigger the event. As it is unlikely that many people will want to watch a single live sporting event or an election campaign unfold, it could be an attractive form of an online prediction market.
Vertcoin: It is the fifth-largest cryptocurrency by market value, but has seen its value tumble recently. It was created by a hacker in 2014, who sold the cryptocurrency to another person a year later. The original was paid back in 2016. The currency uses several features from the bitcoin and ethereum blockchains but it doesn’t follow the rules of any of them. Its developers have said they deliberately made it different.
Do these coins exist only as an investment?
Yes. If you put your money in some kind of cryptocurrency at the outset, you could lose it if the currency falls in value. Cryptocurrencies fluctuate widely and have a higher risk profile than most other investments. One academic study found that “over a five-year horizon, bitcoin was less likely to appreciate (than other cryptocurrencies) than to decline in value by 70 percent”.
What are some good investments?
Many people would argue that bitcoin is an outstanding long-term investment. The cryptocurrency is backed by technology – not the government or the company issuing it – and is one of the most widely accepted forms of payment.
Nasdaq, one of the largest stock markets in the world, has announced that it is to launch a “crypto ETF”, meaning that investors will be able to trade in the cryptocurrency without buying it.
But a quick glance at some cryptocurrencies suggests that many have very little in the way of profits. The 10 biggest – of which bitcoin is the largest – have a combined market capitalization of about $70bn (€64bn).
Are some of these coins based on other forms of currency?
Yes. Ethereum, for example, is based on the ethereum blockchain, while some of the Litecoin and Cardano coins are based on the ethereum blockchain.
A crypto lib is a decentralized computing environment that works without a central party controlling it. Some cryptocurrencies use the same technology, known as “the blockchain”, to secure and process transactions, while others rely on other technologies.
Mr. McCaffrey says that investing in “crypto libs” (blockchains) was currently more attractive to investors than investing in traditional assets.
In many cases, there is a large barrier to entry into the cryptocurrency field, particularly when it comes to initial coin offerings, which are a way of funding a new business by selling cryptocurrency. The recent dabbling by venture capital firms in the field does not bode well for existing ventures, which have faced a large increase in the price of their currencies in recent months.
“The hurdle in entry to the space is very high, and that has a large skew towards new money entering the space,” Mr. McCaffrey says.
Could someone build a cryptocurrency with the sole purpose of creating money to pay off investors?
“It’s possible, but it’s unlikely,” Mr. McCaffrey says. “That isn’t to say it’s not possible because it’s not. But that’s more of a misconception. They are coming out with different uses for it, for example, Augur’s prediction market for events. Some of them might be thought of as a speculative bubble, but that doesn’t mean they are not worth investing in. It’s about being in the right place at the right time. These things are moving very fast.”
How can people make money from investing in cryptocurrencies?
It is more difficult than investing in traditional assets such as shares or property. For example, just like with shares, bitcoin is not always a sure thing. The prices of some of its more volatile cryptocurrencies, such as ethereum, have soared recently, only to fall back sharply.
One of the best-known ways to make money from investing in cryptocurrencies is to earn interest on your holdings. In a traditional currency, the buying power of your savings rises as inflation rises. This is because banks lend more to the public in order to balance their books. When inflation goes up, the value of the currency in your pocket goes down – and when the currency starts to lose value, interest rates rise in order to keep people motivated to buy the currency.
In the bitcoin market, this process takes the form of the so-called “rent” being paid to those who own the cryptocurrency.
“The central bank prints new money, so everyone else has to pay them money in order to have access to the money supply,” Mr. McCaffrey says. “That’s why you get inflation and also why interest rates go up as a result.”
In another sense, bitcoin is similar to money. One of the things that set it apart from traditional currencies is that it is not backed by a central bank. As such, the value of bitcoin can go down as well as up. If demand for the currency drops, then it has the potential to lose a lot of value very quickly.
What would happen if the supply of bitcoin was increased?
Bitcoins are created through the use of complex algorithms that are set up by developers of the ethereum blockchain – a digital ledger that records transactions.
It is estimated that there are currently about 16.7 million bitcoins in existence. The owners of these bitcoins can create more in order to “mine” them, but at a much slower rate than in traditional currency markets. To mine a bitcoin, a user has to solve a complex mathematical problem, which takes a certain amount of computing power to complete.
Every 10 minutes, anyone who has created a bitcoin through a mining process has the right to share in the earnings that have been made. This process is set up to reward new miners with the currency. If there is a shortage of bitcoin, the holders of the currency will receive fewer shares in its future value.
In fact, the number of bitcoin mining shares could be capped at 21 million – this means that the currency’s price could rise or fall depending on how many are created.
In what way are cryptocurrency and bitcoin different from online gambling?
There are some similarities between online gambling and cryptocurrencies. For example, when a gambler places a bet with a betting exchange, they are essentially putting money on the side in order to speculate on the outcome of an event – for example, whether a goalkeeper will make a good save or whether a football team will win. The exchange then charges a fee for placing the bet.
But the difference is that with bitcoin, the event is real – but the value of the bet is a reflection of the traders’ belief in the event’s success.
For example, if you believe that “the price of bitcoin will go up”, you can bet on it. If you are right, you can make money. But if you are wrong, there is little you can do to recoup the loss.