Investing in Bitcoin – What you need to know!

Jul 4, 2017

If you are new to Bitcoin and cryptocurrencies take your time to read this blog post if you consider investing serious amounts into Bitcoin. It seems that most newbies assume that prices will go up no matter what, hoping to jump on the bandwagon of extreme price hikes. While in the long run, that could still be possible, it the short run Bitcoin is subject to extreme price volatilities. The danger is that if you don’t understand what moves and shakes the Bitcoin network, you might end up panic selling at some point because you didn’t get your facts straight in time. in this post we will cover:

  • Bitcoin Investment Tips
  • Spotting the Signs
  • Bitcoin History & Bitcoin Charts
  • Hacking the Bitcoin Network?
  • Bitcoin Basics
  • Money without Banks & Bank Managers
  • Bitcoin ETF (Exchange Traded Fund)
  • Bitcoin Halving & Limited Supply
  • Bitcoin Scaling Debate
  • Governance of Distributed Multi-Stakeholder Networks
  • UASF & BIP 148
  • Stay informed!

 

Bitcoin Investment Tips

Investing in Bitcoin or any other cryptocurrency requires a little bit of research. You don’t need to fully understand the technology behind BTC. You do however need to understand how the community and the economy around the blockchain works. Look back at Bitcoin’s history and understand what sparked previous price volatilities. As a rule of thumb:

  • Do not invest money you cannot afford to lose in something you don’t understand!
  • Never store your funds on a online exchange, except for short term trading!
    For more information on how to store and backup your Bitcoin safely click here.
  • Don’t give in to FOMO!
    History repeats itself. After huge price spikes, the price corrects itself to a certain extent. Bitcoin always gets in the news when it gains more than 20% in value. Then the FOMO (fear of missing out) kicks in: many people don’t want to miss the opportunity and rush into buying Bitcoin. A few days later the price usually crashes, and many of those who came late panic sell and lose money.
  • Always look at the big picture and consider the long term perspective.
    Don’t react to short term price changes unless you are an experienced day trader and know what you are doing.

 

Spotting the Signs

  • When mainstream media like CNBC starts writing multiple articles about the Bitcoin price this is the time where you need to start thinking about the crash.
  • When major exchanges start going offline because of user overload
  • Look for government announcements which would have negative effect on the price like the one from December 5, 2013

 

Bitcoin History & Bitcoin Charts

Let’s start off with a chart to give you an overall idea of correlation of events. The red line is the search term “PayPal, ” and the blue one is “Bitcoin.” As you can see Bitcoin has not reached its all-time high from 2014, but believe me this will change very soon. Funny enough last month was the worst for PayPal regarding Google searches. Are these going to switch places one day?

Now lets look at the Bitcoin price chart from Juli 2010 until May 2017:

Do you see a pattern here? Both charts look somehow similar. In fact, if I had switched them you wouldn’t have noticed the difference except for the first spike in Google Trends. So let’s analyze some of the most notable dates in the history of Bitcoin.

# April 10, 2013 (top $213)
Mt. Gox , the biggest Bitcoin exchange at it’s time, was hit with a great influx of traders on the heels of Cyprus’s bailout announcement which overwhelmed Mt. Gox’s servers, causing trades to stutter and fail. People originally thought it was a Distributed Denial-of-Service (DDoS) attack. Speculative concerns about the exchange’s hiccups fed a powerful panic-sell that saturated the market and drove prices down to pre-rally levels, before rising again a few days later (Source).

Did you notice I used two charts for the event on April 10 2013? The first one looks dramatic and the second one looks like nothing special happened. Always look at the big picture and consider the long term perspective!

Lets analyze some other dates where external events triggered short term market reaction. As you can see comparing the facts below with the chart above is that external events like DDoS attacks and major breaking Bitcoin news from the US, China, and Japan were the major influencers of the Bitcoin price.

# November 18, 2013 ($685)
After the take down of Silk Road, the US Senate holds a hearing on Bitcoin titled: “Beyond Silk Road: Potential Risks, Threats, and Promises of Virtual Currencies,” hope for the U.S. Government panel’s discussion is dim among the Bitcoin community leading up to the hearing. As the proceedings commence, however, many of the panelists and Senators agree that Bitcoin holds great promise. The general consensus is summed up by Jennifer Shasky Calvery, Director of the U.S. Government’s Financial Crimes Enforcement Network (FinCEN), who testified, “We want to operate in a way that does not hinder innovation.” (Source).

# November 20, 2013 ($641)
A couple of days after the US Senate hearing, China announces that people are free to participate in the global Bitcoin market. The Price skyrockets to $1,242 USD (Source).

# December 5, 2013 ($1022)
The People’s Bank of China declares Bitcoin not to be a currency. The policy change prohibits any financial institution to trade, insure, or otherwise offer services related to Bitcoin. Over the following weeks, further restrictions slowly strangle the Chinese cryptocurrency markets, as exchanges repeatedly try to find innovative, lasting ways to stay in operation, and prices around the globe sink dramatically (Source).

# February 7, 2014 ($717)
Mt. Gox, Bitstamp, and BTC-e all experienced a stoppage of trading due to massive DDoS attacks that were apparently aimed at exploiting transaction maleability in the exchanges’ software. Mt. Gox halted withdrawals first, on February 6, evidently contributing to a sharp drop in BTC price; the DDoS attack was detected on February 11, 2014. Mt. Gox faced a series of problems around that time, therefore it is unclear that the DDoS attack responsible for the problems they experienced on Feb 6th (Source).

Note that the Bitcoin Network itself has never been hacked. Cryptocurrency exchanges however – selling and trading bitcoin on centralized server infrastructure, managing funds of thousands of Bitcoin investors in online wallets – were hacked. This kind of vulnerability is not related to the Bitcoin Network at all. The vulnerability is related to traditional web based client server infrastructure, the very architecture the Bitcoin Blockchain replaces with a distributed ledger. For more information on how to store and backup your Bitcoin safely click here.

 

Hacking the Bitcoin Network?

Because of the incidents stated above, the major fear keeping many people from putting money into Bitcoin is the security. They are scared of somebody hacking Bitcoin and claiming their money. So, how would hacking the Bitcoin network theoretically look like?

The Bitcoin network is backed by computer power. In order manipulate data on the Bitcoin Network – like stealing money or pretending to have Bitcoin you don’t have – a hacker would need to have at least 51% (most likely much more) of the network computing power of the current block of transactions, but only in the case where a hacker wants to manipulate a transaction that is happening in the current block. If on the other hand you would want to manipulate a transaction that happened 10.000 blocks ago, you would need a majority of the computer power of the current network times the amount of blocks going back in time, which is a lot of computing power, which means that you have to spend a lot of money.

Let’s put this into perspective and compare the Bitcoin network power to the top 500 supercomputers in the world. This comparison is not fair because the supercomputers are multi-purpose systems while the Bitcoin network is designed to do only one task called SHA256.

So it turns out the Bitcoin network is 50 000x faster than the Top500 supercomputers in the world combined (Source1, Source 2).

 

Bitcoin, more than just Money!

Many people still don’t understand what Bitcoin really is and reduce it to electronic cash. While Bitcoin was designed to be “a peer-to-peer electronic cash system” the Blockchain technology behind it introduced a new era of economics, also referred to as crypto economics, that eradicates the need of bureaucracy and traditional organizations.

The Bitcoin token not only acts as a store of value or means of speculation, Bitcoin tokens serve as an incentive mechanism for Bitcoin miners to maintain the integrity of the Bitcoin network and as a protection from DDoS attacks. It introduced a new form of distributed network economy where stakeholders of a network are automatically aligned by code instead of management.

 

Money without Banks & Bank Managers

While Bitcoin was designed to be a currency, it is also an economy run by a community of people who do not know or trust each other, and who are distributed all over the globe. This economy is automatically enforced by the governance rulesets defined in the Bitcoin protocol. By collectively creating value in the physical world Bitcoin gains in price and incentivizes the network stakeholders even more.

All stakeholders of the Bitcoin network provide services on the fly, just as they would for their employer, supplier or client. Providing IT infrastructure (Bitcoin Miners), write code (Bitcoin Developers), provide value added services (Bitcoin Exchanges), do marketing (any stakeholder promoting the idea of Bitcoin through blogs, social media channels, private communication , online or offline). They perform actions in the physical world because Bitcoin’s incentive mechanism makes it profitable for them to do so. Bitcoin, therefore, proved that economic coordination on the global scale, traditionally requiring high transaction costs of managing an organization, is now possible with simple auto enforceable software

 

Bitcoin Scaling Debate

Satoshi defined the idea for Bitcoin in the White Paper in 2008, based on this paper developers around the world started writing the code in an open source manner, deployed it and early 2009 the first Bitcoin was mined based on the implemented code that from then on would be automatically enforced when the conditions to the pre defined code where met.

While auto machine consensus through auto enforceable code & smart contracts of the Bitcoin Network is very powerful, it can only be as smart as the people who coded it based on the information they had or anticipated at the time of coding.Codified governance rulesets can only depict known knowns and known unknowns, but have very limited capabilities to properly deal with unknown unknowns — aka all those events, that cannot be anticipated, or have not been considered at the time of writing/agreeing on the code (see Blockchain’s Problems with Unknown Unknowns).

But conditions have changed over the last 8 years. The biggest challenges Bitcoin Network is currently facing are

  • Scalability
    The speed of the network, or lack thereof, with only a handful of transactions getting verified per second, which is not enough for scalable business applications.
  • Transaction Fees
    Bitcoin transaction fees are on a steady rise, eliminating the competitive advantage that bitcoin once had. The VISA network is capable of doing 20 000 transactions per second, more at peak times, Bitcoin can currently handle around 4 transactions per second. Not enough to build scalable applications on top of it.

While most people in the community acknowledge this as a practical problem to widespread adoption of the network, the solutions proposed vary greatly, the two most prominent being

  • Segregated Witness  (SegWit)
    SegWit has been proposed by Bitcoin Core developers, who develop the market dominant Bitcoin Client, with over 90% market share, who are funded by a private company called Blockstream. SegWit proposes a so-called “soft fork” of the network, which means that it needs a 95% approval rate of all Bitcoin miners to upgrade the protocol to SegWit, over a period of 12 months. A few months into that “voting process” it looks like many miners don’t agree with this approach, calling it a workaround. Critics argue that the SegWit solution is not what Satoshi Nakamoto would have had in mind as it provokes the necessity of too many software changes. While influential leaders like Andreas Antonopoulos and Brian Armstrong seem to support the idea, there is enough resistance from the miners who ultimately get to vote.
  • Increasing Bitcoin’s block size
    Other, less market dominant bitcoin client developers, seem to favor on-chain scaling solutions like block size increase over SegWit. One of the most outspoken through leaders is Roger Ver, who supports Bitcoin Unlimited, a full node software client. Compared to the Bitcoin Core where the block size is limited to 1MB, Bitcoin Unlimited removes the hard limit, allowing the users to determine the block size by consensus.

 

Governance of Distributed Multi-Stakeholder Networks

Since there were more than two proposals on how to scale Bitcoin, the community has to agree on one of these solutions with super mayority in order to activate the upgrade.Instead of a top down chain of commands it is a fuzzy democratic process. This debate spun off enormous discussions on Reddit and the Bitcointalk forums about the pros and cons of these proposals. The Bitcoin subreddit split in two (r/Bitcoin, r/btc) and has become a political issue.

Questions like who governs Bitcoin becomes relevant in the light of protocol upgrade. It shows that permissionless blockchains like Bitcoin are very powerful as long as the systems does not need to be upgraded, but when it does, the questions of power structures in distributed multi stakeholder networks, the question of who gets to decide what and when become relevant and are still unresolved. Currently, the most powerful stakeholders in the Bitcoin blockchain are the miners. Bitcoin miners are the ones to implement protocol changes by updating their clients. If they don’t agree on a change, they can not be forced to perform it.

 

UASF & BIP 148 & BIP 91

Bitcoin Users got fed up miners blocking their Segwit and decided to take matters into their own hands. BIP 148 is a proposal which describes how users can force miners into activating SegWit, which currently seems to be supported by a majority of the Bitcoin community. The idea behind UASF (user activated soft fork) is to fork off those parts of the network that do not signal support for SegWit. As a result the UASF fork consists solely out of nodes that only relay pro-SegWit blocks which in turn achieves the required SegWit activation threshold of 95%.

The activation of SegWit is set for 1 of August. All nodes not supporting SegWit will not be able to participate in the network. There is a small chance that we might witness a chain split where two parallel Bitcoin networks co-exist. If such thing happens, we might be seeing a massive price dump.

BIP 91 is another Bitcoin Improvement Proposal which requires 80% of miners to signal for it. If activated before 1 Aug 2017 BIP 91 will supersede the UASF and will activate SegWit. Later in 2017 this proposal will force the network to increase the block size to 2MB thus improving scaleability.

So: Keep your eyes and ears open on the 1-st of August. This might effect the price of Bitcoin before and on August 1st 2017.

know your bitcoin hardforks

Source: adesblog.com, by @ades twitter

 

Bitcoin Halving & Limited Supply

As mentioned before, the Bitcoin token has more than one use. In addition to regular users (Bitcoin Token holders), the Bitcoin network needs miners to operate. Miners validate Bitcoin transactions. Their role is to secure the Bitcoin network. They use specialized mining hardware, which costs them money and resources (like electricity). Their incentive is that the Bitcoin network awards them with Bitcoin every time a block is found. It is a constant competition where the fastest miners get to validate a block of transactions. In the first four years the award was 50 BTC for each block. After 48 months the award got halved to BTC 25. On July 9, 2016 another halving happened and the block reward got reduced to 12,5 BTC. So every time a halving occurs the issuance of new bitcoins gets reduced by 50%. The Bitcoin protocol limites the mining of Bitcoin to 21 million. After that no Bitcoin will be mined. Since the amount of Bitcoin in circulation will be limited, this will affect the price if demand for Bitcoin rises beyond it’s mining rate.

 

Bitcoin ETF Approval

The Bitcoin ETF (Exchange-Traded Fund) is a type of ETF that will mimic the price of Bitcoin on exchanges enabling people with a brokerage account to trade the coin without the need of buying the actual asset and safekeeping it. The first and most prominent ETF was proposed by the Winklevoss twins in 2013. Many times it was rejected by the SEC(Securities and Exchange Commission). The latest rejection after a revision was in March 2017. The ETF was the most anticipated event in Q1 2017 and was a major player in the appreciation of the asset. After the rejection in March, there was a downward correction which did not last long and managed to regain value. Why is the ETF important? If you are investing in Bitcoin, keep an eye if any ETFs are about to get approved since this might very likely push the price upwards.

 

Stay informed