This is a high level primer on cryptocurrency. In this primer, the objective is to provide enough information to understand the topic as well as the basics and relevant information needed in order to make an informed decision on using it for investment or as an alternative to fiat currency.
What is Crypto-Currency
In short, Crypto-Currencies are digital assets that are built on blockchain technology. They hold value in relation to traditional currency (fiat currency) and are purchased through something known as an Exchange. The difference between a crypto currency and and a traditional fiat currency is that crypto currencies are decentralized, meaning that they operate and do not require a bank, organization or government in order to function or equate value. The most common and well known crypto currency is Bitcoin, followed by Ethereum which is an “alt” coin but is the second largest so it can be considered to be a main coin, there are other “alt” coins, which is short for alternative coins.
How does it work
Block chain technology is a method of storing data in a decentralized way. In crypto currency, the information, most commonly the ledger (account balance) is the data stored. An easy way to picture this is to think about a credit card or bank statement. Each line on that statement is a transaction where you have spent money IE, transfered money from you to a vendor. This is how the bank or credit card company keeps track of your transactions. In blockchain the line items for transaction information creates a certain amount of data, It is similar to how a file on your computer has size and a song takes up about 3Mbs, the transaction information takes up some amount of data to store. For bitcoin, the block size is 1Mb. Every 10 minutes a new block is created, which holds 1Mb worth of transaction data. After the block is created, it is attached to the end of the chain.
Each type of crypto currency has a different block size and stores different amounts of information along with transactions. The fact that the block is attached to the end of the chain gives a chronological and immutable (read non editable) record of every transaction the way it is able to that is because information about the previous block in the chain is encoded in each block, that way there is no way to mix up the order, each block only recognizes/attaches to the block before it and each block is unique. Because the data is decentralized and immutable, no one organization has control over the function of it and manipulation or fraud becomes very difficult. It also means that if a country’s economy collapses like what has happened in history and creates hyper inflation, see link at the end for examples, the crypto currency cannot be dissolved.
How is the value derived
As we have seen in the past years, the value of bitcoin and other crypto currencies has risen as it has become more widely known and accepted. The value of crypto currency comes from a number of factors:
- The speculation on the value of the technologies usefulness in the future as a means to transfer money as a form of electronic payment or it’s use in something called smart contracts.
- The use as a way to protect against the fluctuation or inflation of fiat currency. For example there is a finite supply of bitcoin. Other currencies such as ETCH does not have a hard limit but there is a constant reward per block which keeps inflation down.
As the value increases, crypto currency will continue to draw more attention, thus forcing the technology to improve. Much like a social network, the value of crypto currency will rise as the number of users increases.
Pros and Cons
- Decentralized method of electronic payment, no reliance on banks for wealth maintenance.
- Lower cost to transfer wealth, cheaper that Credit Cards or Wire Transfers.
- 24 hour accessibility to your wealth
- 100% Transparency – because the blockchain is public, all transactions are available for review giving the ability of accountability meaning there is evidence that money was sent.
- Anonymity – wallets contain no personally identifiable information meaning that while the blockchain is public and all transactions are visible, there is nothing that identifies an individual in real life to that wallet.
- Scalability – as the number of transactions increases and the number of users increase current technology has not been able to match speeds of visa. IE Bitcoin: 4.6 Trxns/sec Visa : 1700 Trxns/sec
- Market fluctuations – as it is not a stable currency, it’s value is highly volatile and that is difficult to hold wealth in something that changes frequently.
- Anonymity – anonymously held wealth can be used by the black market to ransomware hackers with no way to track them.
- No protection from losses – like cash, if you lose your keys to the wallet or send a transaction that money is gone and there is no way to recover it.
The easiest way to get started is to purchase cryptocurrency through an exchange. Exchanges are places where you can buy/sell/transfer crypto currencies. A very popular and easy to use exchange is coinbase. I use coinbase and my referral link is below.
In a simple way, when you purchase crypto currency on an exchange the amount you hold is linked to that account and they actually hold your crypto currency. If you would like to have more control over your wealth, the next step would be to send your crypto currency to a wallet. There are many types of wallets depending on your needs from electronic to physical with pros and cons of each. It would make sense to start with relying on the exchange, then when you have a level that you would want to store or keep in a separate wallet, get an electronic wallet. Electronic wallets, also known as hot wallets, are usually free. Finally when you hit that next tier, would be to look into a physical wallet. Physical wallets, also known as cold wallets, do not connect to the internet, and are safer as they cannot be hacked.
Using Crypto for payment for Goods and Services
As a Buyer:
If you are using crypto as a form of digital currency as a buy it is very easy to send crypto using the exchanges. In essence if you are a buyer of goods or services it is very easy. You can use one of the many crypto exchanges that are very popular. Here are a few examples of the easiest to use and my referral links:
- Coinbase (https://www.coinbase.com/join/esteve_mkd)
- Cash App – Bitcoin only (https://cash.app/app/CGLSDRH)
- Robinhood App – (https://join.robinhood.com/christe228)
Through these apps you are able to connect to your bank account and exchange fiat currency for crypto currency as well as send it. Note that these are not wallets but are merely exchanges.
As a Vendor:
A preface – The complication comes with selling goods and services using crypto currency. This is because the United States IRS does not recognize crypto currency as a currency, but instead looks at it as an asset. What this means is that when you sell a good or a service you must record the equivalent USD value at the time and date you received it. If you sell the crypto currency at a gain, you are subject to capital gains taxes.
What this means is that when you receive crypto you need to record the current value of the crypto currency at the time of transaction in order to record that as income. There are a few ways to go about this, two of them are covered below.
In order to facilitate the acceptance of crypto currency for use in business there companies that exist serve as that intermediary this overview will cover these two:
- Coinbase commerce (requires Coinbase account)
Bitpay allows for the settlement of transactions to take place in fiat currency. This means that as payments come in, as long as they exceed the minimum amount for an ACH transaction ($20USD) they are converted into USD and deposited into your bank account. Because of this the documentation for taxation is simple.
In order to Sign up for a merchant account you must provide the following in order for you to pass the compliance requirements for Know Your Customer(KYC) onboarding:
- Live website with your products/services available for purchase.
- A valid government issued Business Tax ID number.
- Incorporation/Organization documents or business registration documents.
- Principal/director/owner(s) photo identification.
- Proof of current physical business address.
Coinbase Commerce does not settle in USD, it maintains the crypto currency and allows you to transfer them for withdrawal to a Coinbase Account. It also provides you the ability to export transactions and withdrawals in order to ensure you’re following tax guidelines. In order to export you must have a regular coinbase account as this is where the underwriting will take place. You will need:
- Personal Information – Name, Address, etc
- Valid government issued ID
- Social Security Number or Business Tax ID number
In testing both of these platforms, Coinbase was much easier to use as well as had more built in features and accepted more types of cryptocurrency. Bitpay was strictly for use with bitcoin, and did not include many other features, however it was compatible with integrations with more types of ecommerce applications. Coinbase was only able to integrate with WooCommerce and Shopify.
Note that Quickbooks online has a Coinbase integration
Regardless of which platform you use, there are many, the ones here were chosen for their ease of use for someone just getting started. If you are looking for something else feel free to let me know and maybe I can help with that.
But what about Volatility
It’s true that crypto currencies are increasingly volatile today. With the rise of new people to the market looking to invest both long term and short, this volatility is hardly a place where one would want to store money. There are some crypto based solutions that provide some hedge against this, one that this write up will go into is stable coins. Stablecoins are a type of crypto currency that is designed to hold a set value. There are a few types of Stablecoins:
- Fiat Backed – A stablecoin crypto currency that is tied to the value of a fiat currency. In order to increase the supply of this currency, the equivalent amount of fiat currency is held. Examples of this are: USDT and USDC both of which are backed by the USD
- Crypto Backed – A stablecoin crypto currency that uses the value of another crypto currency to maintain the value. An example of this is DAI which uses MAKER as the cry
- Precious Metals Backed – A stablecoin that uses a precious metal to maintain the value of the crypto currency. These coins have the equivalent value in precious metals held in reserve. The trust must be within the organization or government to maintain the respective balance of precious metals. Examples of this are: Perth Mint Gold Token (PGMT) which is held/backed by the Australian Government. Pax Gold Coin (PAXG) the American based gold backed stable coin that is regularly audited by a third party.
- Algorithmic Stablecoins – coins that control the value or base the value by decreasing the supply based on the velocity of money.
Deeper reading (in no particular order)