Chapter 2: What is Bitcoin
Transcription
Chapter 2: What is Bitcoin
TABLE OF CONTENTS CHAPTER 1: INTRODUCTION: BITCOIN AND CRYPTOCURRENCIES 2 OVERVIEW OF CRYPTOCURRENCIES 1.1 HISTORY 1.2 EVOLUTION OF CRYPTOCURRENCIES 1.3 THE BITCOIN REVOLUTION 2 2 2 3 CHAPTER 2: WHAT IS BITCOIN 4 BITCOIN: THE PHENOMENON EXPLAINED 2.1 WHAT IS BITCOIN 2.2 CHARACTERISTICS OF BITCOIN 2.3 HOW DOES BITCOIN WORK: BEHIND THE SCENES 4 4 4 5 CHAPTER 3: WHY USE BITCOIN 6 ADVANTAGES OF USING BITCOIN 3.1 FASTER 3.2 CHEAPER 3.3 ANONYMOUS 3.4 NON-REPUDIABLE 3.5 SELF-REGULATORY 3.6 DEFLATIONARY 3.7 TRANSPORTABLE 6 6 6 6 6 6 6 6 CHAPTER 4: HOW TO SEND AND RECEIVE BITCOINS 7 4.1 SENDING AND RECEIVING BITCOINS 4.1.1 SETTING UP YOUR BITCOIN (BTC) WALLET 4.1.2 SENDING AND RECEIVING BITCOINS 4.2 HOW TO GET BITCOINS 4.2.1 BUYING BITCOINS 4.2.2 MINING BITCOINS 4.2.3 ACCEPTING BITCOINS FOR SERVICES/PRODUCTS 4.3 SECURING YOUR WALLET 4.3.1 MAINTAINING BALANCE 4.3.2 ENCRYPTING YOUR BTC WALLET 4.3.3 BACKING UP 4.3.4 SETTING UP COLD STORAGE 4.3.5 CREATING A PAPER WALLET 7 7 7 8 8 8 9 10 10 12 12 12 13 CHAPTER 5: HOW TO MINE BITCOINS 12 5.1 DYNAMICS OF BITCOIN MINING 5.1.1 THE BLOCK-CHAIN CONCEPT 5.1.2 THE DIFFICULTY METRIC 5.1.3 POOLS 5.2 THE MINING ECOSYSTEM 5.2.1 HOW TO MINE BITCOINS USING YOUR SYSTEM 5.2.2 ADVANCED MINING TECHNIQUES 5.2.3 PROFITABILITY OF BITCOIN MINING 12 12 13 13 14 14 15 16 CHAPTER 6: HOW TO TRADE BITCOINS 17 6.1 6.1.1 6.1.2 6.1.3 6.2 6.2.1 6.2.2 6.3 6.3.1 6.3.2 6.3.3 6.3.4 6.3.5 6.4 6.4.1 6.4.2 6.4.2 17 WHY INVEST IN BITCOIN CURRENT MARKET: TRENDS AND ANALYSIS HIGH PROFITABILITY LONG TERM V/S SHORT TERM GAIN GETTING STARTED FOREX TRADING V/S BITCOIN TRADING SETTING UP A TRADING ACCOUNT MARKET STAKE-HOLDERS BITCOIN EXCHANGES TRADERS MINERS HEDGE FUND INVESTORS COIN DEVELOPERS TRADING STRATEGIES TRADING BITCOIN WITH ARBITRAGE MARGIN TRADING AUTOMATED TRADING 17 17 18 19 18 19 20 21 21 22 22 22 23 23 24 24 CHAPTER 7: OTHER CRYPTOCURRENCIES: ALTCOIN 25 7.1 WHAT ARE ALTCOINS 7.2 TYPES OF ALTCOINS 7.2.1 LITECOIN 7.2.2 RIPPLE 7.2.3 BITSHARES 7.2.4 DARKCOIN 7.3 INVESTING IN CRYPTOCURRENCIES 7.3.1 RISK AND VOLATILITY 7.3.2 METRICS 7.3.3 RETURN ON INVESTMENT 25 25 25 25 26 26 27 27 28 28 CHAPTER: THE FUTURE OF BITCOIN 29 8.1 ESTIMATED GROWTH 8.2 CHALLENGES 8.3 BITCOIN- THE CURRENCY OF THE FUTURE 29 29 30 Chapter 1: Introduction: Bitcoin and Cryptocurrencies Overview of cryptocurrencies The word ―crypto‖ in the English language—deriving its root from the Greek—means something that‘s ―hidden‖ or ―private‖. The word ―cryptic‖, often associated with messages, refers to any information that‘s made obscure or undecipherable through techniques like ―encryption‖. Cryptocurrency, thus, implies a form of currency that‘s hidden and private, and thereby secure. Cryptographic techniques like encryption and hashing are used to secure, regulate and verify the transactions and to maintain the generation of new currency units. The defining feature of cryptocurrency, however, is not its obscurity, but the fact that it‘s completely decentralized and is not regulated by any central authority. Since there‘s no central authority involved, all transactions get spread across the network and occur autonomously and anonymously. It‘s the anonymity and autonomy of the cryptocurrency in the recent times that has popularized it to an extent that it‘s now a billion-dollar market ($5.6 billion). Words like ―digital currency‖ or ―alternative currency‖ are often used interchangeably with the word cryptocurrency to make the term more comprehensible and user-friendly. But, the concept behind it still remains the same. We would be explaining the idea a lot more comprehensively in the upcoming sections of the book, but for now just think of cryptocurrency as a ‗digital-only‘ form of currency. 1.1 History The first decentralized currency-- Bitcoin-- was created in 2009 by a pseudonymous developer Satoshi Nakamoto. It used a cryptographic function (SHA-256) to establish a proof-of-work scheme** that ensured the security and integrity of the currency minting mechanism. 1.2 Evolution of Cryptocurrencies In 2011, Litecoin was released that improvised on the proof-of-work idea by using a different cryptographic function. In 2012, Peercoin proposed a hybrid proof-of-work scheme. Since then, many Cryptocurrencies like Namecoin, Peercoin, Dogecoin, etc. have emerged, but the central idea behind the cryptocurrency (the proof-of-work scheme) has still remained intact. **Proof-of-work scheme: Proof-of-work scheme is a cryptographic technique that uses advanced hashing functions (SHA-1, SHA-256) to validate and authenticate blocks of transactions in Bitcoin network. For more technical details, click here. 1.3 The Bitcoin Revolution Conceptualized in 2008 as an open-source online payment system, Bitcoin has grown on to become the most widely accepted digital currency. The fact that Bitcoin is now accepted by the likes of Amazon, CVS, Microsoft, Wordpress, Dell and PayPal substantiates the ubiquity of the popular digital currency. What started out as an underground currency for anonymous activities has now become the world‘s largest cryptocurrency in terms of total market value ($3.8 billion). The demand for the currency spiked in 2013, and the price sky-rocketed from $13 to a high of over $1000—an astounding 7000% increase in valuation. Shortly after, China cracked down on its usage, forbidding banks from dealing with the currency, and the prices plunged. However, it has continued getting attention from host of merchants and venture capitalists, which has kept the price snowballing. The three profound reasons for the Bitcoin revolution are: a) Bitcoin‘s cryptographic features make it immune to counterfeiting or any other type of frauds. Transactions are completely anonymous and are processed without the intervention of any regulatory authorities. b) The Bitcoin infrastructure is backed up a very strong and powerful computing network. The valuation of Bitcoin is maintained across the network through a process called ‗mining‘. Miners support the Bitcoin network with the required computational power and they, in turn, are rewarded with brand-new coins. It‘s estimated that the combined computational power of the Bitcoin network far exceeds the strength of the top 500 most powerful supercomputers. c) Lastly, the most important reason behind the Bitcoin revolution is its acceptance. There are many other Cryptocurrencies (also known as Altcoins) that provide the same features, but Bitcoin, by far, is the most accepted digital currency on the Internet. By creating a whole new infrastructure, Bitcoin has transformed the landscape of online payments and has paved way for a whole set of exciting processes. It allows you to break the chains of conventionalism and transact securely, anonymously and inexpensively. The revolution has helped unlock a whole new world of possibilities, and would continue its journey of incremental acceptance. With more and more players hopping on board, the revolution would continue to transcend and unfold—changing the way we access, store, and spend money in the digital arena. . Chapter 2: What is Bitcoin Bitcoin: The Phenomenon Explained 2.1 What is Bitcoin Bitcoin is the most popular digital currency network to an online-only alternative form of money. It‘s the first decentralized, peer-to-peer payment network, meaning that—unlike traditional currency— bitcoins are not created, monitored or regulated by a central body. Just to make the analogy simpler, Bitcoin refers to the payment network, whereas ―bitcoin‖ symbolizes the currency of the network. It‘s currently the leading digital currency. Of course, there are other cryptocurrencies, too. But, just as USD overpowers every other fiat currency in acceptance and volume, bitcoin overpowers every other cryptocurrency in the digital world, and that‘s one of the reasons why it‘s so highly valued. 2.2 Characteristics of Bitcoin Open-source: The Bitcoin protocol and software are open-source and can be reviewed/modified by any developer around the world to create modified versions of the cryptocurrency. Detailed History: The Bitcoin network makes it very difficult to counterfeit transactions by maintaining a detailed history and verifying every transaction till the very last transaction in the network. Easy to setup: Getting started with sending/receiving Bitcoins is pretty straight-forward. All you need is a Bitcoin wallet and you‘re good to go. Transparency: All transactions in the Bitcoin network are transparent in the ledger i.e. anyone can view it. However, since there‘s no way to decipher the sender and receiver address, the information might not be sufficient to reveal the identity. But, case in point, every transaction is recorded in the Bitcoin network for everyone to view and verify. Finite-number: Like gold, there‘s a finite number of bitcoins in the network, with a threshold of 21 million bitcoins, expected to be mined by 2140. 2.3 How Does Bitcoin Work: Behind the Scenes Although you can get started with using bitcoins right-away, the enigmatic clockwork behind the world‘s largest digital currency network is, indeed, fascinating. Without going into gory technical details, let‘s understand the fundamentals of the Bitcoin network and how things work behind the scenes: Firstly, there are no bitcoins in the Bitcoin network, just records of transactions. It might sound amusing, but there are no bitcoins held in your Bitcoin wallet. Instead, there are only records of transactions between different addresses, which is also known as the public ledger or the block chain. The ledger holds the information of every transaction that ever took place, right from the very first transaction. So, whenever you want to find out how many bitcoins you hold, the network has to reconstruct the balance by looking at the block chain. But, then, what information does a transaction hold? A Bitcoin transaction holds three pieces of information: The recipient’s address, the amount to be sent, and the bitcoin address of the sender of the previous successfully received transaction. The concept might be a little tricky to understand, so for the sake of simplicity, let‘s understand it with a real-life example. Let‘s say Sam wants to send two dollars to Bob through wire transfer. Quite obviously, before proceeding, the bank would have to ensure that Sam holds at least two dollars in his account. But, what if account balances were not maintained. How does the bank ensure that Sam has at least two dollars? Well, then, the bank would then have to iterate and verify every previous transaction Sam has ever made, and ensure that Sam holds at least the amount that he intends to send. Well, that‘s exactly how the Bitcoin network works. The Bitcoin network takes the bitcoin address of every previous transaction as input to validate the fact that the amount intended to be sent is unspent. The validation process takes a few minutes of time and is done by the network through a process known as ‗mining‘. Once the transaction is verified, the public ledger is updated with the transaction details and updated across the whole network. But, if the public ledger is transparent, how does the Bitcoin network ensure the anonymity of transactions? Well, unlike your bank account number, your bitcoin address isn‘t unique. In fact, they are just randomly generated sequence of numbers and characters. The bitcoin address is signed using the sender‘s private key, and decrypted at the recipient end to ensure the integrity and authenticity of every transaction.Since the private key of the sender is kept secret and the receiver‘s bitcoin address is randomly generated, there‘s no way to link any transaction back to anyone. In case you‘re interested in the technicalities of the cryptographic techniques used in the Bitcoin network, you can read the original paper or browse the developer guide. Chapter 3: Why Use Bitcoin As a relatively new form of currency, Bitcoin is still struggling to get mainstream, primarily because a relatively large portion of the crowd still struggles to fully understand it. In case you‘re wondering the same, here are seven strong reasons why it‘s worth taking the time to understand the digital currency and get involved in it. Advantages of using Bitcoin 3.1 Faster Unlike wire transfers that take a longer processing time, Bitcoin transactions are processed much faster. Transactions can also be made almost instantaneous if the merchant trusts you and takes the responsibility of accepting a transaction that‘s yet to be confirmed by the block chain. In usual cases, where the transactions needs to be verified, it takes around 10 minutes. That‘s still way faster than any other inter-bank transfer. 3.2 Cheaper Bitcoin transaction fees are minimal, or in some cases free. Compare that to the transaction charges levied by the payment gateways of credit and debit card transactions. 3.3 Anonymous Since you don‘t reveal your name or your social security number on the Bitcoin network, all the bitcoin transactions are completely anonymous. They cannot be traced back to you. Moreover, there‘s no risk of your sensitive information (credit card details, banking passwords, etc.) getting stolen. 3.4 Non-repudiable Once the bitcoins are sent, they‘re gone. There‘s no way to undo a Bitcoin transaction without the consent of the recipient. Compare this to the existing payment framework, where people make a payment and then ask the bank to make a chargeback, effectively reversing the transaction. 3.5 Self-regulatory Unlike fiat currencies that are regulated by the government, Bitcoin is free from any external intervention. No central authority can swoop on your money and take the control away from you. 3.6 Deflationary There are only a limited number of bitcoins in the network and the algorithm would continue to deflate the number with time. This would ensure that bitcoin never loses its value with time, as it happens with fiat currencies where the government keeps minting more money to pay off national debts, and the dollar keeps losing its value. 3.7 Transportable Since bitcoins are linked to your bitcoin address and not stored in a central repository, you can move your digital currency anywhere, anytime. How do you do that? That‘s explained methodically in the next section. Chapter 4: How to Send and Receive Bitcoins Now that you‘ve understood all the advantages of the future digital currency, the next step would be to understand how bitcoins can be sent, received and stored in your bitcoin wallet. Let‘s get started. 4.1 Sending and Receiving bitcoins 4.1.1 Setting up your Bitcoin (BTC) wallet Setting up your Bitcoin wallet is the first step to start sending and receiving bitcoins. But, before trying to setup a bitcoin wallet, let‘s understand why you need a bitcoin wallet. Well, unlike a physical wallet, a Bitcoin wallet does not store bitcoins; instead, it stores private keys that you need to spend your funds, and to generate a bitcoin address that you would need to start receiving bitcoins. Therefore, a bitcoin wallet simplifies bitcoin transactions by storing all the sensitive information. There are three types of Bitcoin wallets: Desktop, Mobile, and Web based. Desktop: If you want to setup a bitcoin wallet on your personal computer, the best choice would be to download Bitcoin-Qt—the original bitcoin client. A Desktop-based Bitcoin wallet stores all the private keys on your hard-drive. If you wish to get experimental, other bitcoin wallet options include— Multibit (crossplatform), Hive (For Mac users), Armory (advanced security features) and DarkWallet (anonymous and light-weight). Mobile: Mobile-based wallets stores the private keys on your bitcoin addresses, and allows you to transact through a smartphone app. It uses features like NFC and QR code scanner to lets you pay for things in the real world with your phone. Some mobile-based bitcoin wallets include: Android: Blockchain (recommended), Bitcoin wallet, Mycelium, and Xapo. Web: Desktop-based wallets are a decent option, but they do not provide mobility and ease-of-access. Mobile-based wallets, on the other hand, are platform specific, and cannot be used across different devices. Unlike both, web-based wallets provide a convenient cross-platform solution that store your private keys on their servers, and can be linked with your mobile and desktop wallets, letting you transact anytime, anywhere, from any device. Some upcoming web-based bitcoin wallet services are Coinbase, Circle and BlockChain. However, a major disadvantage of web-based wallets is security. Unless implemented incorrectly, you could risk losing all your bitcoins. How to keep your bitcoins safe is discussed in the latter part of the chapter. 4.1.2 Sending and Receiving bitcoins Once you‘ve a bitcoin wallet, you‘ve a set of private keys and bitcoin addresses—the pre-requisites for sending and receiving bitcoins. In order to send bitcoins, you would need the Bitcoin address of the receiver. It looks something like this: ABC-DEF-GHI-JKL-MNO-PQR-STU Once you‘ve the receiver‘s bitcoin address, you would need to initiate a bitcoin transfer request from your bitcoin wallet. The Bitcoin network would take up to ten minutes to verify your transaction via the block-chain mechanism, and once the transaction is verified by the network, the public ledger would be updated, and the coins would be sent to the recipient. In order to receive bitcoins, you just need to provide your bitcoin address. That‘s all. Once the Bitcoin network verifies the transaction, the public ledger would be relayed, and the received bitcoins would, now, hold against your bitcoin address. 4.2 How to get bitcoins You can only transact through bitcoins when you hold bitcoins, but, then, how do you hold bitcoins? Here are three popular ways of getting bitcoins in your wallets: 4.2.1 Buying bitcoins Perhaps, the simplest of all options to get bitcoins in your wallet is to just buy them. You can buy bitcoins from exchanges, or directly from people selling them. You can pay them in a variety of ways ranging from hard cash to credit card/debit card transactions to wiretransfers. 4.2.2 Mining bitcoins One of the most popular ways of getting bitcoins is to ‗mine‘ them. However, with the difficult of the network increasing and the bitcoins deflating, mining bitcoins through personal computers is no longer sustainable. Sophisticated hardware with increased processing power are now being built to mine sustainably and effectively. We explore the concept in detail in the next chapter. 4.2.3 Accepting bitcoins for services/products Another way of getting bitcoins is to simply accept them as a mode of payment. If you run an online store, you can start accepting bitcoins in exchange for products by integrating payment services like BIPS and CoinKite. For brick and mortar businesses, there are point-of-sale apps provided by Coin of Sale, XBTerminal, BitPay, and Revelthat allow you to accept payment in bitcoins. Some of the services even let you convert bitcoins into fiat currencies instantaneously at the time of transaction. In case you don‘t want to sign up for any of the services and want to opt for person-to-person payments, you can just download smartphone apps like Blockchain and Bitcoin wallet to start accepting bitcoins right away. 4.3Securing your wallet If you lose your bitcoin wallet, you lose your private keys, and in turn, lose all the bitcoins that were linked to those private keys. So, losing your wallet implies losing out on all your money. Technically, your money would still be there in the public ledger; it‘s just that you won‘t be able to prove that it‘s yours without your wallet. That‘s quite a scary thought in case you start accumulating a lot of bitcoins. Here are a few tips that would help you in securing your wallet. 4.3.1 Maintaining balance As they say, never out all your eggs in one basket. Since bitcoin wallet can get corrupted with a hard drive cash, and information from online wallets can be stolen, it‘s a much better practice to distribute your bitcoin balance across multiple wallets, so that even if you lose some due to a catastrophic event, you don‘t lose all of it. 4.3.2 Encrypting your BTC wallet It‘s also a good idea to encrypt your online/offline wallet with a strong password. This makes it difficult, if not impossible, for the thief to get access to your wallet. For more information on how to encrypt your wallet, Bitcoin‘s wiki page is a good start 4.3.3 Backing up You can back up your bitcoin wallet and store it in a safe location, so that in case you lose your working copy, you have a copy of your private keys and bitcoin addresses. It‘s important, however, to back up your bitcoin wallet completely and store it in multiple locations. A safer option would be to also upload it to online file sharing services like Dropbox, or Google Drive. 4.3.4 Setting up cold storage Cold storage, as the name suggests, is an alternative option of storing bitcoins at a safe and secluded offline location. Since cold storage wallets store private keys offline, they cannot be stolen from the internet. It‘s a good idea to store bulk of your bitcoins in a cold storage and transfer a little amount to your bitcoin wallet for transactions. That way, even if you lose your laptop or smartphone, you just lose a small amount. 4.3.5 Creating a Paper Wallet A Paper wallet is a pictorial representation (often QR code) of your public and private keys that make up a wallet. The benefit of a paper wallet is that it‘s not prone to cyberattacks or hard-drive crashes. For more information on how to create a paper bitcoin wallet, click here. Chapter 5: How to Mine Bitcoins Mining bitcoins is now a serious business. The emphasis is on the word business as it‘s no longer a light-weight activity that you could run in background. It requires investment for buying sophisticated and specialized hardware that can compensate for the increasing difficulty and electricity costs. Also, with the bitcoins to be mined reducing year-on-year (remember, bitcoins are deflationary), without the right tactics and techniques, you could risk being a lost cause. If you‘re serious about mining bitcoins, you first need to understand the dynamics of bitcoin mining—why and how bitcoins are mined. After that, we would plunge into the mining techniques and have a look at how profitable is the mining business. 5.1 Dynamics of bitcoin mining 5.1.1 The Block-Chain Concept ‗Mining‘ bitcoins is a metaphor for working long enough to actually help the bitcoin network and in turn being rewarded for your effort. Here‘s why you need the concept of mining: People are sending bitcoins to each other over the network, but since there‘s no central authority, someone has to keep track of who paid what, and write all the information to the public ledger. The verification of transactions in the bitcoin network is done through a ‗pool‘ of machines collectively working towards solving a ‗block‘ or set of transactions. Since a lot of transactions occur over a period of time, the network arranges all transactions in a chain of blocks in order to maintain their synchrony. This concept is also known as the Block-Chain mechanism. In simple words, it just means arrangement of bitcoin transactions in the order they were initiated. When a block of transaction is successfully verified by a pool, the pool is rewarded with new bitcoins, and the newly updated ledger is passed on in the network. The Bitcoin network ensures that not more than one pool solve the block, which implies that pools would have to compete against each other to solve the block. This mechanism helps sustain the bitcoin network and also helps in introducing new bitcoins. 5.1.2 The Difficulty Metric Difficulty metric decides the amount of processing power needed to verify a block of transactions in the Bitcoin network. It‘s also known as the Hash rate of the network. The mining algorithm has been designed in a way that it becomes increasingly difficult to mine new bitcoins, thereby increasing the hash rate incrementally. For instance, two years ago, you could mine with your personal computer, but the difficulty metric has now increased, and mining with your normal computer is no longer a feasible solution. The reason why the bitcoin network has to make it increasingly difficult to mine bitcoins is to prevent their devaluation. If everyone could mine easily, bitcoins would lose its value and thereby its significance. 5.1.3 Pools ‗Pools‘ were created to increase everyone‘s chance of solving a block, since if you mine solo, your chances of solving a block and getting the reward are slim. When you join a pool, you‘re a part of the network that‘s solving the block of transactions, and hence you‘re rewarded every time your pool successfully verifies a block. The reward money for solving the block is distributed based on your contribution to the pool. If you‘re a beginner, joining a pool is a great way to get started and reap rewards. In case you‘re confused about which pool to join and want to know the options available, here‘s a good place to know the options you have. Getting started with any pool is straight-forward. You‘ll just need to visit the pool‘s website and register an account to create a ‗worker‘. Once you‘ve setup a worker and entered your Bitcoin address for receiving the payments, you‘re on your way. 5.2 5.2.1 The Mining Ecosystem How to mine bitcoins using your system Theoretically, you could use your personal computer to mine bitcoins, but, practically, it‘s so slow that there‘s no point of mining it. You would also hear about terms like GPU mining, but the truth is that the difficulty has increased so dramatically that it‘s almost dead these days. Therefore, we would strongly advise against mining bitcoins using your system, but in case you still want to proceed, you can follow the detailed instruction guide. Basically, you would need to download a mining software and a bitcoin client. Once you‘ve the mining software, you would need to enter the credentials of the pool, and then you just need to run your worker. There are both- command line and GUI based mining software available for PC, Mac and Linux users. You can browse the list of available software available for your platform, here. Though bitcoins are no longer a sustainably mineable digital currency as far as personal computers are concerned, you could always mine other cryptocurrencies like Litecoin. Unlike bitcoin, litecoin uses an algorithm (scrypt) that‘s optimized for CPUs and GPUs. We would discuss more about Litecoin in the latter part of the book. Litecoins are similar to Bitcoins and can be mined by downloading a software called cpuminer. Here‘s a detailed guide on how to configure your system to mine litecoins. In case you want to get serious about mining bitcoins, we would suggest taking a look at some of the advanced mining techniques mentioned below. 5.2.2 Advanced Mining Techniques ASIC Bitcoin Mining: ASIC (Application Specific Integrated Circuits) are tailor-made to do just one thing--mine bitcoins at blazing speeds with relatively low power consumption. Since these chips are designed specifically for mining, they‘re expensive and difficult to manufacture. However, they mine bitcoins at mind-boggling hashing speeds and consume low electricity—making mining sustainable, and over the time, profitable. Vendors like Butterfly Labs, Avalon, Antminer, BitFury, CoinTerra and KNC have their flagship ASIC models that deliver varying speeds depending on how costly they are. Before buying a model, it‘s important to assess how much profitable your investment would be, and how serious you‘re about mining, since these devices are expensive and you might risk betting too much for too little. 5.2.3 Profitability of bitcoin mining If you‘re planning to enter the mining industry, you firstly need to consider factors like your initial investment, hash rate of your rig, electricity costs and the current bitcoin price into your equation. After all, if you‘re not making more than what you‘re putting in, there‘s no point of doing it. Investment: If you‘re into serious mining, you would need to invest in sophisticated hardware like ASIC chips that let you mine bitcoins at blazing fast speeds. Since these chips generate a lot of heat, you would also need to invest in a decent cooling unit to prevent your rig from heating up. The cost of power cables, adapters, and delivery charges also need to be considered while assessing your total investment. Hash rate: Hash rate is the speed at which you‘re mining bitcoins. A better hash rate implies you make more bitcoins, but the better the hash rate—the costlier and more power intensive the rig is. Electricity costs: The amount of power your rig draws while mining bitcoins continues to burn a hole in your pocket every month, and can get a bottleneck over time. Therefore, it‘s important to cut theses expenses down. You can reduce the costs by opting for a more efficient power-supply unit (PSU). It‘s important to understand the difference between consumption and efficiency. You should ideally buy a PSU that provides more power, thereby allowing your rig to overclock, but you should look to buy a more efficient power supply (>97%); you would be able to make up for the extra cost from how much you save. Also, you should look to invest in a cooling kit or fan as excessive heat generated by the rig reduces the computational efficiency of chips, thereby reducing your hash rate and increasing power consumption. Bitcoin price: Bitcoin prices are ever fluctuating and unpredictable. The investment that may seem profitable now, might not seem profitable when the value of the bitcoins dips (which happens so very often). In such a scenario, you would be faced with the choice of either selling them at a lower price or holding your coins till the time it becomes profitable. You need to re-evaluate the risk factors of both the scenarios before you start mining. Difficulty: The difficulty of the Bitcoin network, which determines how hard it is to solve transaction blocks, is going to increase progressively over time. Therefore, it‘s perhaps the best and the safest strategy to start with the best mining equipment in the market. You can use this online profitability calculator to simplify the calculations, and get an estimate on your ROI (Return on Investment). Chapter 6: How to Trade Bitcoins Trading bitcoins is a risky game, since Bitcoin market is notoriously volatile and unpredictable. Without the right tactics, you could end up burning a lot of real cash. Therefore, it‘s really important to get a grip on the current market trends and to time your entry and exit well, so that you outweigh the involved risks and make money out of trading bitcoins. In this chapter, we‘ll have a look at the current Bitcoin market, and why, despite being a riskier affair, investing smartly in Bitcoin could fetch you handsome returns. We further explore the dynamics of the Bitcoin market and give you a brief overview of the involved stakeholders. In the final section, we share some of the popular trading strategies that you could use to trade bitcoins. 6.1 Why Invest in Bitcoin Investing in bitcoins is riskier than investing in conventional markets, since it‘s a speculative market that‘s still under metamorphosis. The risk factor is driven by the simple fact that a cryptocurrency has no intrinsic value and is only valued till the time people see value in it. Also, Bitcoin‘s market cap is still relatively smaller (compared to traditional markets) and is driven largely by sentiment and herd mentality. Therefore, any push and pull in the price is largely amplified by traders who catch up on the tide or jump off the boat in a cascading effect. But, despite the high risk factor involved, the return on investment on bitcoins is way higher than any other form of investment.For instance, your investment of $1000 in bitcoins two years ago (at the price of $28/BTC) would now be worth $10000.Need we say more? We‘ll have a look at some of the factors that make the Bitcoin market lucrative—the ones that would help you in taking the plunge. 6.1.1 Current Market: Trends & Analysis As an investment market, Bitcoin may be relatively new, but with a trading volume of just around $10 million US dollars and over 1 million daily transactions, it‘s certainly growing in volume. Ever since the cryptocurrency lost almost half of its valuation after China cracked down on its usage, it has regained momentum and is slowly marching towards stability. It‘s a huge plus as far as Bitcoin trading is considered, since previously, it was almost impossible to predict the bearishness and bullishness of the Bitcoin market, with the prices falling and skyrocketing in dollars in just one trading day. Though the Bitcoin market is still risk-driven, the unpredictability curve seems to be going spirally inward with time. However, as more and more investors infuse money into the Bitcoin architecture, the cryptocurrency is becoming an increasingly safer, liquefiable and tradable asset like gold, stocks or property. 6.1.2 High Profitability Despite fluctuating abruptly, bitcoin has still managed to outgrow every hot stock in the market, and can easily be termed as the most profitable investment over the past couple of years. The profitability stems from the fact that bitcoin is getting increasingly popular, with people seeing the potential behind a payment system that‘s not regulated by any central authority. From being valued in a few cents, Bitcoin has gone on to be valued at $1000—a staggering 10,000% increase in valuation. But just like any other investment, profits come at the cost of risk. You would need to analyze and research your markets meticulously in order to minimize risk and maximize returns. With markets reaching stability, do not expect any more breakeven points. However, the price would surely surge as the demand for cryptocurrency increases with its adaptability, and with the market currently running low—now might be the right time to dip your feet and gain the most out of the opportunity window. 6.1.4 Long term v/s Short term Gain Cryptocurrencies are risky when it comes to short-term investment, since the cryptocurrency market is driven by a lot of extrinsic factors that are hard to predict. However, with bitcoin moving towards a minimum base price and gaining support from the online community, the current market looks well poised for day trading. If you can afford to take calculated risk, and don‘t mind giving up some money to learn the trading tactics, short-term trading is your game. The returns are insanely high if you know what you‘re doing. If you‘re in for long term, chances are that you would reap very high returns on your investment eventually. But, frankly speaking, since Bitcoin is a speculative market that operates without regulation of any central authority, long-term investments might not be a safer alternative. A lot of times bitcoins get stolen from Bitcoin exchanges, leaving the investor utterly helpless. Hence, for long-term holding, a much better strategy would be to keep an eye on your investment and sell-off whenever you‘re making substantial profits. The bottom-line is that you should see Bitcoin trading as means to diversify your investment. You should not invest all your life savings in Bitcoin. Only invest money you can afford to lose. Remember that in trading, in order for someone to win, someone has to lose, and since you‘re playing against a lot of odds here, you should be ready to take a few blows before you finally hit it off. 6.2 Getting started 6.2.1 Forex Trading v/s Bitcoin Trading Bitcoin trading is no rocket science. It‘s a lot similar with Forex trading, and we compare both the approaches side-by-side to help you better understand the bitcoin trading market. Similarities ·Bitcoin trading is driven by demand and supply. Just like stocks, the price increases with surge in demand and decreases when there‘s no real demand. ·Trading bitcoins is almost similar to Forex trading, and you could trade bitcoins through different platforms (like Forex-Metal, NovaFX, and more), just like you trade stocks using your traditional Forex account. Differences ·There are only a limited number of bitcoins in circulation, unlike stocks that have huge liquidity. ·Bitcoin has a relatively smaller market ($ 10 million) compared to Forex, which has a net liquidity of over $4 trillion. That makes Forex trading less susceptible to volatility than Bitcoin trading. ·Being a speculative market, bitcoin pricing is driven largely by news on social media and online publications, and the impact of every news story can be catastrophic. A cover story on how bitcoins are being used to buy drugs online? Sell quickly. An article on how bitcoin could be the future currency? Buy right away. ·Bitcoin exchanges are prone to hacks, unlike Forex exchanges, which are relatively safer. 6.2.2 Setting up a Trading account Setting up a Bitcoin trading account is as simple as setting up a Forex trading account. All you have to do is sign up on a Bitcoin exchange, create a username and verify your email address. We recommend AltoCenter (altocenter.com), which is one of the most easy-to-use and trustworthy Bitcoin exchanges. Once you‘ve signed up, you would be asked to verify your physical address by uploading a scanned copy of government issued photo-ID. That‘s it. You don‘t have to reveal any personal information like your SSN number. Once your account is setup, all you have to do is deposit funds into your account and start buying or selling bitcoins. The Bitcoin exchange might charge you a .25 percent to .60 percent fee on your transactions, which the exchange uses to make the trading business sustainable. 6.3 Market stakeholders 6.3.1 Bitcoin Exchanges Bitcoin exchanges store your bitcoins, facilitate trading of cryptocurrencies, and allow you to purchase bitcoins in exchange of fiat currencies. You would need to register with at least one of the many bitcoin exchanges in order to trade bitcoins, and right now, there are a lot of options to choose from. The primary factors that should be considered while choosing a Bitcoin exchange are its total volume and security. Total volume indicates the permeability of the Bitcoin exchange, while security provides reliability of transactions. Some of the reliable exchanges include AltoCenter, BTCChina, Bitfinex, BTC-e, and Bitstamp. You can signup with any of these exchanges to get started with trading bitcoins. 6.3.2 Traders Bitcoin traders are individuals or a group of individuals who take advantage of the fluctuations in the cryptocurrency to make profits. Traders support the Bitcoin system by infusing the necessary liquidity, thereby maintaining the demand of the currency in the market. Their key strategy is to buy bitcoins at a lower price (support level) and sell them a higher price (resistance level). Though most traders operate through exchanges, there are traders who buy bitcoins from local buyers as well. Traders use different form of strategies like margin trading, short-selling and automated trading to maximize profits. We dig up the quintessential techniques in the latter part of the chapter 6.3.3 Miners Miners support the Bitcoin network by validating every transaction through the blockchain mechanism and ensuring the steady and sustainable growth of the Bitcoin economy. Without miners, the Bitcoin trading network would cease to exist, since it relies extensively on the computational power of its largely decentralized mining network to validate and process the transactions. At the current difficulty level, it takes around eight to ten minutes to successfully verify a transaction. Though miners do not engage in trading activities, they actively support the trading system by validating every bitcoin transaction and writing it to the public ledger. 6.3.4 Hedge Fund Investors Hedge fund investors support the Bitcoin network by infusing liquidity in the market, and by providing it with the much necessary financial firepower. Hedge funds bring the big money from the Wall Street and look to capitalize on the volatility of the Bitcoin market to make hefty profits. They are backed up by wealthy individuals, families and institutions, who are eager to multifold their investment by investing in a rapidly-growing market. Hedge funding also makes the Bitcoin market resist negative market sentiments, and prevents the cryptocurrency from stumbling rockbottom. Currently, the Bitcoin network is supported by hedge funds like Global Address Bitcoins Investment Fund, Pantera Capital, Bitcoins Reserve, Binary Financial, Coin Capital Partners, and many more. More hedge fund investments would only instate more liquidity in the market, thereby making bitcoin trading a more sustainable and profitable activity over time. 6.3.5 Coin Developers Coin developers develop, maintain, and improvise the underlying bitcoin architecture to make trading a more secure and sustainable activity. With hackers getting more sophisticated and the volume of cryptocurrencies being traded increasing, it has become extremely important to ensure that appropriate measures are taken to maintain the integrity of the network. Coin developers play a pivotal role in maintaining the security protocols and ensuring that the network is free from any foul play. With the advent of altcoins, more innovative features are being introduced and pushed into the digital payment network. If Bitcoin intends to stay on top of its game, it has to keep on innovating and keep pushing new features. Coin developers, therefore, are responsible not only for making the existing network secure, but also for making the Bitcoin network sustainable in the near future. 6.4 Trading strategies In the final section of the chapter, we would like to share some of the popular trading strategies that you can use to make quick and consistent profits. 6.4.1 Trading Bitcoin with Arbitrage Trading bitcoin with arbitrage is perhaps one of the widely popular and profitable strategies used by traders. This technique uses the discrepancy in bitcoin pricing at different exchanges to make profitable trades. As the Bitcoin network is deregulated and decentralized, there are wide variations in pricing of bitcoins across different Bitcoin exchanges, and you can take advantage of that fact. Here‘s how this actually works: 1) Buy bitcoins from exchange A at a lower price. Let‘s say you buy ten bitcoins at $250. Total investment: $2500 2) Transfer bitcoins from exchange A to exchange B. You lose 1-2% in transfer fees. Costs incurred: $50 3) Sell bitcoins from exchange B at a higher price. Let‘s say you manage to sell them at $255. Net profits= $450 Generally, the price discrepancy across Bitcoin exchanges ranges from 1%-5%. If you know how to play the numbers, you could make a huge amount of profit just by starting with a substantial capital and iterating the steps mentioned above. 6.4.2 Margin Trading Margin trading is a high-risk strategy that can yield huge profits if implemented correctly. Using the following trading strategy, you can lend funds from peer liquidity providers or bitcoin exchanges to trade bitcoins. So, what it basically means is that you can start trading bitcoins without making a capital investment. You can then look to analyze the patterns in the price variations, and start buying bitcoins at support level, and selling them at resistance level. Bitcoin exchanges allow margin trading on leverage, which means that you can borrow only a limited number of bitcoins from the exchange. The ratio is normally around 1:1 to 2.5:1, and you are also subjected to pay the accrued interest for the funds you take in. Here‘s how this actually works: 1) You decide to buy 10 bitcoins on margin, hoping that the price would go up. The system will let you borrow 10 bitcoins at the best rate possible. Let‘s say you buy them at $220 and the decided rate of interest is 10-12%. What‘s worth noting here is that you don‘t need $2200 to make the trade happen; the system borrows the required assets for you. 2) You close your position at let‘s say $ 250 after two days. The system would then charge you the accrued interest for that amount of time and the total amount would be recovered from the final closing. In case you make a loss, the loss would be settled from your trading wallet, and in case it runs out of balance, your position would be force closed to prevent further losses. Margin trading can be extremely profitable if you can accurately predict the market trends and look to short sell on every profitable opportunity. The flip side, however, is that you could lose a lot of money if you leverage too much. 6.4.2 Automated Trading Do you want to make money while you sleep? Do you want to invest in bitcoin, but do not have time to understand the markets and trade it? Are you looking to minimize risk and maximize returns on your Bitcoin investment? Automated trading comes to your rescue. Trading bots run on servers that detect trends and patterns and are used to predict the overall market direction. They‘re used to find and execute opportunistic buying and selling on sudden hikes and dips in the trading market. The timing and scale of the trade is dynamically optimized to suit any market condition, which means you don‘t have to tune it to suit the current market levels. However, you can always customize the bots based on your learning to optimize profits. Many automated bitcoin trading systems available in the market run on cloud, which means you do not have to install any software on your computer. Some of the wellestablished automated trading systems include CryptoTrader, TradeWave, ButterBot - all of which offer different features and are backed by different pattern searching and market analyzing algorithms. In case you‘re wondering how profitable can automated trading be, here‘s a reality check. Last year, an MIT research lab, reportedly, built a trading bot that nearly doubled a bitcoin in just mere two months. Considering the volatility and the unpredictability of the Bitcoin market, automated trading, by far, is the safest trading strategy. The technology is only going to get more sophisticated over time with more predictable and scalable systems being developed to crunch up the statistical data. Chapter 7: Other Cryptocurrencies: Altcoin 7.1 What are Altcoins Altcoins, as the name suggests, are alternative cryptocurrencies to Bitcoin. You would be surprised to know that there are hundreds of types of cryptocurrencies in the digital world other than Bitcoin— each having its own distinguishing feature. Although most of them are mere clones of Bitcoin, changing only minor characteristics like transaction speed, hashing algorithm or relaying methodology, there are some cryptocurrencies that improvise and provide useful features that Bitcoin does not offer. Many Bitcoin enthusiasts argue that altcoins are completely unnecessary, as they don‘t stand a chance against the ubiquity of Bitcoin, but then let‘s not forget the very goal of Bitcoin, which is decentralization. Altcoins offer further decentralization by allowing you to choose between currencies and also lets the community experiment with innovative features. If enough users are attracted to a feature provided by an alternate cryptocurrency, the Bitcoin developers would be forced to adapt that feature or risk losing its place as the dominant cryptocurrency. Therefore, Altcoins induce innovation with decentralization. We would be exploring some of the most promising and idiosyncratic cryptocurrencies that are trending right now. 7.2 7.2.1 Types of Altcoins Litecoin Litecoin, one of the very first altcoins, stands third to Bitcoin in market cap ($600 million) and is branded as ―silver to Bitcoin‘s gold‖. The number of litecoins units are higher and it uses a different algorithm (Scrypt) than Bitcoin (SHA-256) to optimize mining for personal computers. Though Litecoin infrastructure is not as developed as Bitcoin and only few exchanges accept it, speculators expect to gain a huge return from Litecoin in the forthcoming years. The analysis comes from the fact that Litecoin has grown nearly 300 times in a year, which means an investment of $100 in litecoins a year ago would now be worth $30000. 7.2.2 Ripple Ripple takes advantage of IOUsto create a network of gateways and pathways to transfer money. Ripple improvises the Bitcoin concept by taking the Bitcoin exchanges and other central authorities out of the picture. Ripple network accepts all forms of currency, including Bitcoins and other fiat currencies like dollars, and converts them into its decentralized native currency (XRP). Since the consensus ledger in the Ripple network is updated every 2-5 seconds, the payments are instant and cheap. The network has also been optimized to be energy-efficient and claims to have a more secure architecture than Bitcoin. It‘s currently the second most popular open-source digital payment network in the world after Bitcoin. 7.2.3 Peercoin Inspired by Bitcoin, Peercoin uses proof-of-stake and proof-of-work systems to devise a relatively secure and sustainable cryptocurrency. It‘s the fourth largest cryptocurrency by market capitalization. Unlike Bitcoin, Peercoin does not have an upper limit, but it‘s programmed to deflate annually at the rate of 1%, thus making it more energy-efficient and scalable. As of December 2014, the market cap of Peercoin is just over $12 million USD. 7.2.4 Darkcoin Darkcoin was created to facilitate completely anonymous and private transactions through a system called Darksend. Instead of conventional hashing, Darkcoin uses a chained hashing approach to add security and privacy to transactions that drastically reduces computational power, thereby improving energy efficiency. The demand of Darkcoin has spiked since it started gaining acceptance in the black market due to its anonymity and privacy. It‘s currently the 10th most valuable cryptocurrency with a market cap of $9 million USD. 7.3 Investing in Cryptocurrencies Cryptocurrencies, in general, are drawing increasing interest as potential investments due to huge returns on investment over a short span of time, but like every other investment, there‘s a fair amount of risk involved, and you need to assess the current market and its volatility, before you take a call. Here are some of important factors that need due consideration and understanding: 7.3.1 Risk and volatility Theoretically, a cryptocurrency has no intrinsic value; it‘s only valued till the time people see value in it. That clearly defines the risk factor—if a large group of people start losing interest in a currency, the value of the currency would stumble. However, cryptocurrencies are slowly gaining increasing acceptance in the digital world, providing a powerful new way to conduct e-commerce. That‘s where investors see potential, but the risk factor is that it could really go both ways. Since most cryptocurrencies other than Bitcoin are currently in their metamorphosis state, their prices are driven more by speculation than demand. It‘s very difficult to predict the sustainability and acceptability of any cryptocurrency, and therefore it‘s advisable to diversify your investment in different cryptocurrencies and analyze the potential of the altcoin before you invest in it. The risk-factor is largely determined by your expected return and the amount of time you‘re willing to hold your investment. 7.3.2 Metrics The key to smart investment is knowing the numbers. If you wish to explore trends like market cap, pricing and volume of different cryptocurrencies over the time, you can catch an in-depth analysis, here. Though the numbers do not give you the whole picture, it would help you in understanding your investment better. 7.3.3 Return on Investment The actual valuation of any cryptocurrency can be estimated by its transactional demand (demand) and its current reserves (supply). A cryptocurrency that has higher transactional demand and relatively less reserves would have a better monetary base in future. And a better monetary base implies better returns. Cryptocurrencies have appreciated faster than shares of the hottest technology stocks. For example, consider the following stats: $100 worth of Litecoin became worth $30000 in just a year. A Bitcoin was worth 4p in early 2010, and it touched a high of $1000 in 2013. That‘s an insanely high return of 25000%. ―Growth demands a temporary surrender of security.‖ – Gail Sheehy Although there‘s a higher risk involved, cryptocurrencies offer unmatched returns on investment—much better than any other asset or stock. If you get your numbers right, have realistic expectations, and invest conservatively, there‘s no reason why the returns would not overshadow the risk factor. Chapter 8: The Future of Bitcoin What‘s the future of Bitcoin?—that‘s the question most financial experts around the world are trying to predict and understand. Is it worth investing in Bitcoin? Would its volatility decrease over the period of time? What are some of the challenges that Bitcoin would face? Would Bitcoin replace the fiat currency, and become the currency of the future? There‘s a mysticism around the future of Bitcoin, and though we don‘t know all of it, we try to explore the trends, the expected growth, and their implications. 8.1 Estimated Growth Bitcoin‘s estimated growth can be explained by understanding the market literature by Rogers Curve. According to the adoption model, ● ● ● ● ● 2009-2010 was the Experimentation phase where bitcoin had no real value and developers were just analyzing the source code. 2011-2013 was the Early Adopters phase where bitcoin started gaining attention from investors and therefore bitcoin exchanges, processors, wallets, etc. came into market. 2013-2014 was the Venture Capital phase, where Bitcoin network received a strong inflow of cash. An estimated $90 million were put in 2013 and more than $300 million would be put in 2014. The next phase would be the Wall Street Phase, where the investors, banks, and brokers begin investing in Bitcoin. We would then move towards the Global Consumer Adoption Phase, where vendors would look to expand the cryptocurrency to make it safer and acceptable everywhere. Though there‘s a recent downfall in the Bitcoin market, the network seems to deepen and strengthen, moving towards achieving stability. Also, the Bitcoin network is getting more and more secure every day to prevent pitfalls and instate stability in the market. Following the Cyprus crisis, investors now realize the importance of having a decentralized currency system that‘s not scrutinized by bad governance. Therefore, there‘s also an increase in cash influx from investors all around the world, helping in increasing the trade volume of the bitcoins. All of the above factors point towards a sustainable and promising growth of Bitcoin network. With the right impetus from the global community, it can move towards becoming a truly stable, equitable and efficient currency for the digital world. 8.2 Challenges Bitcoin network faces a lot of challenges, which are both intrinsic and extrinsic. Intrinsic challenges: Lack of security and innovation are the two biggest intrinsic challenges that the Bitcoin network faces. The security architecture encompassing the Bitcoin exchanges needs to be improved, so that people feel comfortable and safe using the new form of currency. Also, the Bitcoin network would have to take constant cue from other cryptocurrencies and keep improvising its feature to prevent itself from being dethroned. Extrinsic challenges: Some of the biggest extrinsic challenges the Bitcoin network faces are volatility, adoption and regulation. For the Bitcoin network to flourish, it has to remain unregulated and independent, else there would be no point of having a decentralized currency. Adoption, on the other hand, can be improved by overcoming the intrinsic challenges and by creating safe and secure payment interfaces. 8.3 Bitcoin- The Currency of the Future Is Bitcoin the currency of the future? Frankly, we don‘t know, neither does any financial analyst in the world. However, what we do know is that Bitcoin is the perfect template for what the future currency of the world would look like. What we do know is that Bitcoin has helped in changing the way people percept money. “Interestingly, any regulated form of information that’s accepted by a majority of the community can become a currency. ― That‘s what a currency really is—a piece of information that‘s widely accepted. And with Bitcoin‘s innovative block-chain mechanism, we do not need any central authority to regulate the cash-flows and investments. We now have a self-regulated system of information exchange; if we can make the mechanism secure, convenient, and easier to use, there‘s no reason why it won‘t become the dominant currency. We always try to resist change; it took us a while to adapt to Internet, to getting used to email, to see the potential behind mobile technologies. Did the whole world jump the boat instantaneously? No. But, just see the change now. It‘s impossible to imagine our lives without email, internet, or a smartphone. That‘s how a trend is set. As soon as people start finding a thing convenient and helpful, they slowly and gradually start integrating them in their lives, eventually making the trend an indispensable aspect of their lives. We‘re not saying that Bitcoin would be the currency of the future. That‘s very unlikely. Although Bitcoin has a sustainable market right now and currently dominates the cryptocurrency world, it‘s very likely that a better, safer and simpler currency network would take its place over time. Maybe, we would have Bitcoin version 2.0 or Bitcoin version 3.0, but the currency would certainly evolve over the period of time to become something better. All in all, the concept of Bitcoin promises a great future. It practically gives you free banking. It gives you a currency that‘s universally acceptable. It gives you a block chain mechanism that can be used for creating a secure and reliant transaction system. More than anything, Bitcoin gives us a concept—the one that will change our world just like emails, smartphones and Internet. https://altocenter.com/