Bitcoin and Cryptocurrency: What You Need to Know

Online currencies were created to circumvent traditional money – but does the spiking cost of Bitcoins and others mean a bubble is about to burst?

The value of Bitcoin has spiked in the past few weeks – but will the bubble burst?

On Halloween of 2008, a pseudonymous math genius named Satoshi Nakamoto officially unveiled to the public a white paper which detailed the mechanics of a new form of currency: Bitcoin. At its core, that's all Bitcoin is, a digital currency. One that you could buy, trade, and invest in online.

Even though a number of cryptographers saw its potential as early as 2009, there still needed to be a way for the general population to use cryptocurrencies. That's where the illegal online bazaar, Silk Road, comes into play. In the two years and a half years of its existence – from 2011 to 2013 – Silk Road only accepted Bitcoin. That was because Bitcoin transactions could be anonymous, secure, irreversible and you could trade it from anywhere in the world with an Internet connection.

By the time Silk Road was shut down in October 2013, it had nearly 1 million registered users, according to the FBI. That means at least 1 million individuals were probably using Bitcoin on that one site alone. But even though Silk Road shut down, Bitcoin remained. By that point, enough people saw the benefit of using cryptocurrency, not just for illegal activity, but as a new investment and form of digital currency with seemingly unlimited potential.

In the past year, however, interest in Bitcoin has peaked – and is being employed by some much more legitimate users. Stories of Bitcoin have graced the cover of numerous magazines, including Time, Newsweek, Forbes and Bloomberg Businessweek. In the past three weeks alone, the New York Times has published over a dozen articles about Bitcoin. On December 13th, Google released its "Year in Search" for 2017 which revealed that "What is Bitcoin?" was the second most searched "what is" question in the United States, following "What is DACA?"

As the frenzy over Bitcoin reaches an all-time high, here's everything you need to know about the past, present and uncertain future of Bitcoin and cryptocurrency.

How does Bitcoin differs from cash?
The currency is completely digital and has multiple safeguards to prevent hacking and theft. One of the main allures of the new form of currency, however, is the fact that it doesn't rely on a third-party banking or other financial institution. Bitcoin is decentralized, and rather than be secured by people or trust, it is secured by math, specifically strong cryptography – or techniques for secure communication – hence then name cryptocurrency. 

Cryptocurrencies use a complex cryptographic approach to tracking and exchanging digital currency, one that builds on a digital ledger called a "blockchain." More simply, a blockchain or "digital ledger" is a way for many people to have one common record of all transactions. It would be similar to if everyone had a digitally connected notebook. Each time someone wrote in it, recording the purchase or sale of an item, the words appeared in yours and everyone else's notebook. This notebook also has safeguards to prevent people from lying about their purchases, or buying items with money they don't have.

How did the 2008 financial crisis affect Bitcoin? 
Following the financial collapse, many individuals lost trust in the current financial system, including fiat currencies. Fiat currencies, like the US dollar, are controlled by the national government's supply and creation. Therefore, they are solely backed by faith and trust in the government.

Compare to this to natural resources sometimes used as currency, like gold. Gold holds an inherent value because it is scarce. Additionally, gold doesn't have a central authority that arbitrarily regulates its creation and distribution. This means that gold is unlikely to experience hyperinflation, as the government cannot produce five metric tons of gold out of thin air, where they can simply print more money. Bitcoin, too, is finite, with only 21 million Bitcoins in existence. They are being mined (or acquired) at a steadily controlled rate. In fact, it's estimated that the final Bitcoin will be mined in the year 2140. It's because of these properties that Bitcoin has been repeatedly called "digital gold."

What are other forms of cryptocurrency?
Others saw the power in having a digital currency that was decentralized, requiring no trust in a third-party financial system. This led to the creation of other forms of cryptocurrency, sometimes called altcoin (i.e., alternative coins to Bitcoin). These various forms of cryptocurrencies, like Litecoin and Ether, use slightly different cryptographic algorithms and/or have other technical differences from each other. One, NEO, a Chinese-based cryptocurrency, supports up to 10,000 transactions per second, compared to Ethereum, currently the most heavily traded cryptocurrency other than Bitcoin, which only supports about 15 transactions per second. This becomes important as more consumers begin to use cryptocurrency. Having more transactions per second allow more people to use the cryptocurrency, instead of just a few.

This doesn't mean that one cryptocurrency will eventually beat out the rest. Each one offers something slightly different with regards to safety, privacy and efficiency. In fact, given the relative ease of exchange between various cryptocurrencies, it's possible that multiple cryptocurrencies remain once the market settles. There's not only room competitively, but there's actually a necessity, because of scale and function of different currencies. In this regard cryptocurrency are likes cars. There are trucks, SUVs, sedans and two-doors – while every automobile gets you from point A to point B, each one provides something different with regards to speed, storage and functionality.

Why has the value of Bitcoin and other cryptocurrencies skyrocketed in recent weeks?
A combination of hype and actual potential is why Bitcoin has seen such huge rises in value in the past few weeks. In addition to the great potential for cryptocurrencies, as well as its theoretical advantages to fiat currency, hedge funds and investors have just begun to invest in cryptocurrencies, which potentially means further growth for the cryptomarket.

However, this growth hasn't been linear. It took 8 years for the crypto market to reach 200 billion dollars. In the past month, the market cap has reached nearly 600 billion dollars (at the time of writing).

Kumesh Aroomoogan, is the co-founder and CEO of Accern, an artificial intelligence startup that alerts users of stock and cryptocurrency trading opportunities by scanning about 1 billion websites, message boards and niche blogs. He believes that when institutions, like asset management firms and hedge funds, become more involved in cryptocurrency, the market will stabilize.

"Right now, individual consumers are buying Bitcoin, as opposed to institutions," he says. "Institutions are more systematic in their approach, and don't involve their emotions in their investment strategies."

Currently, the value of Bitcoin other altcoins isn't inherently linked to the value of the coins – the vast majority of folks aren't buying Litecoin right now because they believe that its differences from Bitcoin make it a superior form of cryptocurrency. They're probably buying it because it's relatively cheap, tradable on easy-to-use exchanges like Coinbase (which allows you to easily buy and trade cryptocurrency), and hoping that it will skyrocket in value like Bitcoin. Everyone is hoping to make a quick $100,000.

This is why there's a high degree of speculation that the crypto will inevitably lose its value. In fact, in the past two days, Bitcoin has dropped nearly 30 percent. While this could be a sign of the bubble beginning to burst, the drop in price could be more related to various end-of-the-year factors. For example, folks perhaps wanted to sell off their cryptocurrency before the holidays because they were going out of town, and knew they wouldn't be able to check or sell at a moment's notice. Additionally, the stock market often dips the last week of the trading year, and increases again in January. That's what could be happening with Bitcoin. Lastly, it could have something to do with taxes. People are pulling out of Bitcoin now to make taxes easier for 2017, but are then planning to reinvest come January.

Or then again, maybe it is the beginning of the end…
Many people are currently investing large sums of money in cryptocurrencies at random. There are new cryptocurrencies that have seen 500- to 1000-percent returns overnight without any news or development announcements from the company. On coinmarketcap.com, you can view the 1,360 cryptocurrencies currently on the market, many of which do not offer any new advancements in blockchain technology or cryptocurrency. At the present time, many individuals entering the market are working irrationally and operating out of fear of missing out.

Is too late to invest in cryptocurrencies and other blockchain technology companies?
The short answer is no, as long as you don't think the crypto bubble will burst in the near future. However given the trends of the past 48 hours, it's necessary to invest with great caution. If you're looking to make a quick million by jumping on the cryptocurrency bandwagon right now, understand that you're playing with fire. Nevertheless, even with the dip in value of cryptocurrencies in the past two days, there are plenty of undervalued cryptocurrencies that are designed with newly-developed advancements in blockchain technology. If you do invest, it's worth spending the time to understand the technology and who is developing it – just like investing in a tech stock.