If you read the financial papers on a regular basis, you’ve likely noticed increased coverage of Bitcoin in recent months. Cryptocurrency is a hot topic, but while it’s been around since 2009, it’s still unfamiliar territory for many. As we all grew up with traditional monies, it can be difficult to wrap your head around a virtual currency that was created in modern times and has no ties to any country or region. As Bitcoin gains in popularity as a currency and an investment, it’s important to have a baseline understanding of its origin, benefits and challenges.
What is a cryptocurrency?
Bitcoin and other competing cryptocurrencies, such as Litecoin, are digital forms of money that use cryptography to perform secure, sometimes anonymous transactions.
Cryptography originally referred to the act of coding and decoding text for the purpose of securing information in the presence of third parties, often in times of war. For example, military messages were encrypted to ensure secrecy in case of interception. This infographic shows how the use of cryptography developed over the years, from Roman ciphers to today. In modern times, cryptology is used to protect data online. You may be familiar with encryption in the context of wireless Internet connections – an unencrypted connection at a coffee shop, for example, is much less secure than an encrypted connection in your home or office. What cryptocurrency really is, is a peer-to-peer digital currency that uses data encryption to secure holdings and transactions online.
How does it work?
Bitcoin users install an app on their computer or mobile phone, creating a virtual wallet. You are assigned a Bitcoin address which functions similarly to an email account and is used to send and receive funds. A block chain, which is essentially a shared public database or ledger, is used to secure payments through your online wallet. Your Bitcoin wallet uses a private key (part of the encryption process) to complete transactions. All transactions happen directly between users without banks or other parties, hence the peer-to-peer description. Bitcoin ledgers are maintained by miners, who ensure that the currency is not double spent and of course, they are paid in Bitcoin for their work. As users do not have to identify themselves, transactions can be anonymous. In fact, the creator of Bitcoin is still unknown as they used a pseudonym: Satoshi Yakamoto. Today, the creator has moved on to other projects and many different developers work on Bitcoin.
Is digital currency high risk?
It depends on what you mean – as a user, or as an investor? In truth, there is a certain level of risk in either scenario. There have been a number of recent online scams that prey on Bitcoin users in Canada. In these cases, users were coerced by fraudsters claiming to be from Canada Revenue Agency, police officers or other agencies demanding payment. Of course, to be fair, there are versions of this scam that use traditional currency, and it is not unique to Bitcoin. If you are vigilant about fraud prevention, you may be able to avoid this type of incident.
As an investment, Bitcoin and additional cryptocurrency options are very much in the infancy stage. Block chain is a revolutionary technology that is likely to disrupt the modern world the same way the Internet did several decades ago. Google, IBM and Microsoft are already leveraging their cloud infrastructure systems to support private block chain systems used by banks and other organizations. When it comes to currency, there are many opportunities and challenges ahead. There are possible data breaches, regulations that are yet to be introduced, and other unforeseen issues as this technology continues to develop.
We hope this brief summary of bitcoin provides you with a better understanding of what it’s all about. If you know of anyone who may find this article useful, please feel free to pass it their way!
The Wooding Group at CIBC Wood Gundy 780 498-5021