Is Bitcoin an Investment or a Gamble? A Beginner’s Guide to Bitcoin

beginners guide to bitcoin

Written by Guest

February 25, 2021

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The story of bitcoin begins in a fragile time, after the 2008 financial crisis when a change was needed. The crisis brought out the shortcomings of banks and other financial institutions. It was caused by excessive risk-taking where banks participated in irresponsible lending to Americans who couldn’t pay their debts. 

The loans were deftly packaged into complex financial instruments called CMOs. CMO stands for Collateralized Mortgage Obligations. It’s what you get when you combine several mortgages and sell them as an investment. If I buy a CMO, I hope to make money when borrowers repay the mortgage. Very risky, especially if the borrowers were not creditworthy in the first place.

Back then the financial system ran on outdated architecture made of a blend of analogue and digital systems. There was no standard digital structure for quantifying these loans. This made the excessive risk gradually spread globally. 

Major economies worldwide were entangled in the American housing market. When that bubble popped, it cost the global economy trillions of dollars and burned the bridges of trust between financial titans and the public. 

Bitcoin was created as an attempt to decentralize finance from such fiscally irresponsible institutions and governments.

The best way to securely buy, manage and grow your bitcoin wallet and other digital assets is through this Ledger Nano X.

 

What is Bitcoin? How does Bitcoin work?

 

Bitcoin is a digital(crypto) currency that uses peer-to-peer technology to operate, with no central authority or banks. A peer-to-peer technology is one whose participants can engage directly without an intermediary.

It was developed by an entity called Satoshi Nakamoto, who has since gone anonymous. I use the word entity since it could have been more than one person. His anonymity allowed Bitcoin to thrive, because, as the only central source he was the single point of failure. Without him, it would be truly decentralized.  

Once it was ready for launch, Bitcoin was introduced to the world through a white paper, which you can read here. In the whitepaper, Satoshi outlines the inner workings of Bitcoin as “…completely decentralized, with no central server or trusted parties because everything is based on proof-of-work instead of trust…”  

In such a decentralized system, managing transactions and issuing of bitcoins are carried out autonomously by the network. It’s also open-source, meaning that nobody owns or controls Bitcoin, and everyone can use it. This is made possible by a technology called Blockchain.

 

What is Blockchain?

 

Blockchain seems like a complex technology that deters many from even trying to understand it. 

A blockchain is simply a kind of digital ledger where you keep track of user balances via debits and credits. In this sense, Bitcoin’s blockchain keeps track of the flow of transactions done in bitcoin, its native currency. But there’s a caveat to this; every transaction added to the blockchain (aka, digital ledger) is immutable. That is, it cannot be reversed. 

Unlike ledgers that require permission to access, Bitcoin’s blockchain is open to all. Anyone in the world can download it, and see the list of transactions from the beginning. 

Furthermore, every transaction is linked to a wallet. Think of a wallet as the basic storage unit in a blockchain, with different wallets containing different amounts of the currency.

That said, like every other record, a transaction from one wallet to another must be verified, before adding it to the ledger. This is where the magic happens.

First, the transaction is bundled with other similar transactions into a block. The block is then verified and added to a pre-existing chain of blocks, containing previous transactions. These blocks are linked such that you can’t tamper with a single block without breaking the entire chain, thus making it immutable. This way, transactions can’t be altered after verification.

 

How Bitcoin mining works

 

The people who get to verify a block of transactions and add it to the chain are called miners. 

Miners use a process called proof-of-work, which generally involves solving a cryptographic puzzle to establish the credibility of a given block of transactions.

For every block verified, miners get rewarded in Bitcoin. This incentivizes them to invest in mining equipment. It’s a process that requires high computing power, but this competition for financial reward is what keeps Bitcoin going. See this article to read more about proof-of-work.

 

How many bitcoins are there?

 

Satoshi enforced scarcity into bitcoin by setting its supply limit to 21 million. This cap theoretically ensures that Bitcoin’s value holds steady for years to come. For this reason, it has earned the name digital gold. Because, just like gold there’s only a certain amount of bitcoin in existence.

 

The rise of bitcoin

 

Bitcoin’s adoption stalled in its early years, though there are record transactions that have since made history. For instance, in what is believed to be Bitcoin’s first mainstream transaction, someone bought two pizzas for 10,000 Bitcoin. This would be worth about $446M, based on today’s value.  

Bitcoin didn’t pick up until the creation of a dark web marketplace called The Silk Road, launched in 2011. The Silk Road was a decentralized marketplace where you could buy anything imaginable including drugs and weapons. It used bitcoin as its currency, which is why bitcoin has often been associated with crime and money laundering. But you have to understand that the bitcoin community was in no way affiliated with the creator of The Silk Road.

Once the mainstream media started reporting about The Silk Road, bitcoin’s value started climbing. 

From March to April 2013, its value multiplied eightfold, from about $30 to about $230. It hit $1000 in the same year due to widespread adoption in China. 

By then it had started receiving interest for being decentralized and outside government control. It was seen as a hedge against financial crises caused by failed governments, such as during the Cyprus financial crisis. This pattern would later repeat itself in countries such as Colombia, Iran, and most recently Venezuela.

Its value increased gradually as tales of earlier buyers getting richer drew in more people. This led to speculations that made it a highly volatile asset. Yet, ten years since its founding, its value keeps climbing. 

In 2017, it gained the attention of retail investors which saw it hit an all-time high of almost $20,000. In 2021, it has drawn in institutional investors too. It stands at about $48,000, at the time of publishing this article. It’s now viewed as a hedge against worldwide inflation partly accelerated by the Coronavirus.  

 

Should you buy Bitcoin?

 

This pandemic has accelerated financial history, just as the Black death accelerated the use of coins. It’s believed that bitcoin could restructure global finance and politics. It provides a hedge against inflation and is a better store of wealth in unstable economies. 

As Bitcoin’s institutional acceptance continues to strengthen, it’s also being adopted as a replacement for gold, the traditional hedge against inflation worldwide. The world’s gold supply is worth over $9 trillion, and over $19 trillion is held in U.S. dollars. That value is leaking into bitcoin — investors have been trading out of gold as bitcoin has gone on its recent run. 

You could argue that it’s just another bubble. However, the adoption of new technology tends to be quite volatile, as evident in the early 2000s dot-com bubble. Furthermore, each time Bitcoin rallies and then folds, it folds to a higher level than the time before. You could probably take a little bit of downside risk, but hold Bitcoin for a year to five years and feel pretty good about it. In the end, what matters is how much risk you can tolerate.  

 

How much bitcoin should you buy or own?

 

One should first have their other basic financial ducks in a row. That is, have a debt payment plan, an emergency fund (you can’t invest your emergency fund in bitcoin) and have a budget that informs you how much you can afford to invest in various instruments every month.

Since it’s a volatile investment and it might take years before it becomes mainstream, my suggestion is one should invest between 1-3% of their take home in bitcoin, or whichever percentage of your take home that you can afford to lose. 

Market dynamics often override individual performance. To quote the famous economist John Maynard Keynes, “the markets can remain irrational longer than you can remain solvent.” Therefore, before buying any asset, an intelligent investor first considers his/her risk tolerance. Ask yourself, ‘if I lost this money, would it significantly reduce my net worth? Would it wipe me out?’ That’s how you gauge your risk tolerance.  

 

Where to buy and sell bitcoin in Kenya

 

In Kenya, you can buy Bitcoin through an exchange. An exchange is a platform where people buy and sell bitcoin. Some of the well-known exchanges in Kenya are Paxful and LocalBitcoins.

To create an account you’ll need to verify your identity, add a phone number, and an email. It’s also encouraged that you add two-factor-authentication, to keep your account safe. I should also mention that it’s free to create an account on these platforms.

Once your account is verified, you can easily transact with sellers and buyers. Your account comes with a wallet address. A wallet address, comprising a string of 26-35 alphanumeric characters, is all it takes to send and receive bitcoin. Any bitcoin address can be used to transfer cryptocurrency to any other address on the network.

If I want to buy Bitcoin, I’ll select a seller based on their reputation, and competitive rates. I’ll then initiate a transaction, pay them via m-pesa and the Bitcoin will be deposited into my account/wallet. It’s that simple. The seller transfers bitcoin from their wallet address to yours. The exchange is just a platform that coordinates buying and selling. 

 

Can bitcoin be converted into cash?

 

If one day you decide to sell your crypto, you can follow the same process, and money will be deposited to your M-pesa or bank account.

 

Is Bitcoin a good investment?

 

To me, an investment is something that gains value over time, but with a credible use case. I think Bitcoin has a credible use case. The world is changing. The bond market is not what it used to be. Interest rates in some countries are already turning negative.

I think cryptocurrencies like Bitcoin are the financial instruments of our time.  

 

Can Bitcoin be Hacked?

 

The technology behind Bitcoin is hard to break. It hasn’t been broken since its creation. But in the past, exchanges have been hacked. Such as the Mt. Gox hack in 2014. Nowadays, the credibility of a good exchange mostly lies in how secure it is.

If you’re still concerned about Bitcoin being hacked, you’d be glad to know about organizations such as MIT’s Digital Currency Initiative, that recently raised money to make bitcoin harder to hack.

 

Books on Bitcoin for beginner investors

 

As always, never invest in anything you don’t understand. Here is our best book recommendation for a deep-dive on the world of crypto-assets.

1. Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond by Chris Burniske

Written By:

Joseph Mugo

Joseph is a software developer, who writes about books, technology, and ideas that matter. You can read more of his work at josephmugo.com

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