As I prepared to purchase my first Bitcoin—a poster child of modern technology—I sat ironically with a piece of paper and pen in hand, like Ralphie in A Christmas Story decoding the secret message from Little Orphan Annie. Rather than Ralphie’s crummy Ovaltine commercial, my message consisted of a sequence of unrelated words (called a recovery seed) that was the key to access my Bitcoin. Next on my to do list: hide this code in a secret place, and use Bitcoin to buy something from the Czech Republic.
The purchase of Bitcoin and Ethereum (another cryptocurrency) has been, without a doubt, the strangest financial transaction of my adult life.
A bit of coin
If you had asked me a few months ago about Bitcoin, I would have told you very little: it was electronic currency that was independent of country, and maybe on the borders of legality. I pretty much ignored it.
Bitcoin was invented in 2008 by a mysterious anonymous individual by the name of Satoshi Nakamoto. Its utility and meteoric rise was made possible by the underlying complex coding mechanism known as the blockchain.
But before we continue, a couple of key definitions are in order.
- Cryptocurrency: Currency? Got it. Crypto? This refers to the digital encryption that allows cryptocurrency to function as a medium of exchange. Bitcoin and Ethereum are types of cryptocurrency, but there are hundreds more collectively known as “Altcoins.”
- Blockchain: The blockchain is simply a digital ledger of electronic transactions. It is a database that keeps track of the purchase and exchange of cryptocurrency. As an analogy, the blockchain is like the internet, and Bitcoin is like email; the blockchain is the underlying technology which cryptocurrency uses to function.
Back on the blockchain gang
So the blockchain is a digital ledger/database. But how does it actually work and why is it called a blockchain?
Each digital Bitcoin transaction becomes part of a cryptographically-protected “block,” grouped with other transactions that have occurred in the past 10 minutes. Each new block is then sent to the digital ledger of the blockchain, and is added to the chain of existing blocks (blockchain, get it?). Thus, the blockchain contains all prior transactions in the entire history of the blockchain. More, the complete blockchain database is duplicated on thousands of computers around the world, which reconcile their databases with each other every 10 minutes to ensure consistency.
Sweet Mary Jane, what if someone hacks the blockchain? They could change its whole history!
Relax. To corrupt the blockchain, a hacker would need to simultaneously alter data on each of the thousands of encrypted computers all over the world. By distributing and duplicating the ledger, the blockchain makes this type of corruption virtually impossible.
Why is cryptocurrency useful?
Essentially all financial transactions between individuals are mediated by a third-party: a government, a bank, a credit card company, etc. Why?
In a word: trust.
Without verification of a transaction through some third-party, we would all have to trust each other to be honest. Until the hippies take over, this ain’t happening in the real world.
Think about it: without the government, how would a grocery story know your money is not counterfeit? Without credit card companies, who would verify that you are cleared to buy those sweet Reebok Pumps from Foot Locker (you know you had a pair)? Without banks, how do I ensure my retirement money isn’t being directed to an offshore account in Estonia?
The blockchain and cryptocurrency are revolutionary in that they eliminate the middleman. They facilitate direct exchange between individuals via technology and cryptography rather than a trusted third-party.
In the United States, most non-conspiracy-theorists trust our government and banks. We have governmental mechanisms in place to ensure transparency and weed out corruption. But this is not the case in many less savory corners of the world (hint: one of them rhymes with Prussia). Individuals who live in such places are poised to benefit the most from blockchain technology.
Purchasing Bitcoin or other cryptocurrency is not sound investment strategy. I hesitate to even call it an investment; a gamble would be more appropriate. Putting it all on black might yield a similar outcome to what I describe here.
I am a fully-insured, three-index-fund-portfolio type of guy. The money I invested in Bitcoin represents a fraction of a percent of my portfolio; if I lost it all, it might delay my retirement by a month. I would certainly not recommend a speculative investment such as Bitcoin until all of your financial ducks are in a row.
Why am I purchasing Bitcoin? First, I find the technology fascinating and potentially paradigm-shifting for the world economy. I’m also currency speculating, pure and simple. I don’t plan to use it as an exchange medium; rather, I plan to buy and hold it as a commodity.
A step-by-step guide to buying and storing cryptocurrency
GOAL: Purchase $5000 each of Bitcoin and Ethereum (a newer, up-and-coming cryptocurrency), and hold indefinitely.
- Open a Coinbase account: Bitcoin ain’t available (yet) at the currency exchange counter in the airport. How do you buy it? Coinbase is an online cryptocurrency exchange headquartered in San Francisco that allows you to exchange US dollars for Bitcoin or Ethereum. Just enter some personal information, do a two-step verification via text message, and you are on your way.
- Link your bank account (or credit card): I chose the former due to the lower associated currency conversion fees of 1.49% (versus 3.99% for credit cards). Following initiation of the transfer, it takes 5-7 business days for the funds to hit your Coinbase account.
- Buy cryptocurrency: Once deposited, your funds are available to purchase cryptocurrency!
- A note on volatility. The price of cryptocurrency can fluctuate wildly. The Bitcoin-USD exchange rate ranged from $1800 to $2400 just this week! Thus, I decided to dollar cost average by purchasing $125 each of Bitcoin and Ethereum once per day over a 40 day period (which can be set up to occur automatically in Coinbase).
Storing is a bit of a misnomer here. Cryptocurrency is not actually stored anywhere; rather, a record of your money and transactions is maintained on the blockchain, out in the open for all to see.
This record is linked to you via your public key—akin to your bank account number. Anyone who sends you Bitcoin needs to know your public key.
However, only you can access and spend that money with your private key. A private key is a long, random alphanumeric sequence, analogous to an ATM card and pin number to access your bank account. It is known only to you, and critical to protect from prying eyes. If someone has your private key, they have your money.
Your private key is stored in a digital wallet.
- Choose a “wallet”: Cryptocurrency wallets come in a few different forms.
- Online wallet. Bitcoin purchased on the Coinbase exchange will initially be held in a wallet of this type, in which your private keys are stored on the cloud. A private key is generally more vulnerable to hacking with online wallets.
- Mobile wallet. Slightly more secure than an online wallet, a mobile wallet is an app with your private key stored on your phone. I initially transferred Bitcoin from Coinbase to a mobile wallet called Jaxx. Mycelium is another mobile wallet recommended to me by a friend in cybersecurity.
- Hardware wallet. A hardware wallet is widely considered the most secure storage option; I currently use a Trezor wallet—fresh from the manufacturer in the Czech Republic—to store my Bitcoin and Ethereum. The private key of a hardware wallet is generated and stored offline on the small device, which you connect via USB to a computer in order to access your money and make transactions.
- Record your recovery seed. Muy muy importante!!! Before a mobile or hardware wallet is ready to use, you need to set it up with a recovery seed—the sequence of random words that I was writing down on paper at the beginning of this post. A recovery seed generates both your public and private keys, and in many ways is your wallet. Someone with your recovery seed will have access to all your money!
- Transfer money to your wallet of choice. The Jaxx mobile wallet and Trezor hardware wallet are accessed with self-selected pin numbers (different from a private key). To send cryptocurrency, you simply input the public key of the destination wallet, choose the amount you want to send, and click “send.” Initially I sent Bitcoin and Ethereum from the Coinbase exchange to my Jaxx wallet, and eventually sent it all to my Trezor wallet for more permanent, secure storage.
- Don’t lose your effin’ recovery seed! If your wallet is lost or stolen, do not despair! As long as you know the recovery seed, you can regenerate your public and private keys, and save your money. If you lose your recovery seed, however, you are up sh$t creek.
Dangers of Bitcoin
Apart from wild volatility, potential collapse in value, and vulnerability to hackers, cryptocurrency is perfectly safe.
Another concern unique to cryptocurrency is related to traceability. Recall that the entire history of currency transactions on the blockchain is public knowledge. What if the guy you bought that vintage Ultimate Warrior poster from turns out to be a convicted meth dealer? Would you want a permanent record that you sent $100 of Bitcoin to Walter White?
Was my purchase of cryptocurrency a solid investment? Probably not. Was it reckless? Perhaps a little. But I learned a great deal and discovered an entire economy previously unknown to me, and for that reason alone I deem it worthwhile.
Have any of you dabbled in the shady realm of cryptocurrency?