Getting started with Bitcoin
So perhaps you’ve learnt something about Bitcoin and you’re ready to take the plunge. Here we take a look at how to get hold of your first bitcoin. Remember you don’t have to buy a whole bitcoin and can choose to purchase a fraction of a bitcoin instead. After all, a bitcoin is rather expensive these days. There are 100 million satoshis in a bitcoin, so you can purchase as small of a fraction as you like.
Should you buy any bitcoin?
If you consider the historical price of bitcoin from April 2013 till today (Figure 1), you will certainly notice that it is very volatile. The price can fluctuate a lot and fast. This is an important consideration. What’s more, there is no guarantee that the price will not go to zero. Bitcoin is decentralised and there is nobody that you can complain to if it did. With this in mind, you would be well-advised not to spend more money on purchasing bitcoin than you are prepared to lose.
Though there is certainly volatility, you must surely observe something else that is obvious: the price has gone up a lot. This is more apparent if we view the same data, but plotted with a logarithmic scale on the \(y\) axis (Figure 2). Now we can observe a steady progression in the price.
It’s important to stress here that historical data is not evidence of future performance. Any extrapolation from this data is dangerous to rely upon. At the end of the day, a decision to buy bitcoin should be based on an understanding of the principles that Bitcoin is founded upon and a measure of your confidence on the chances of it realising its potential. The advice to do your own research (DYOR) is commonly heard in the world of crypto and aligns with a general ethos of taking control of your own money, as well as your actions. Unfortunately, in an industry where people’s statements cannot always be trusted, due to the financial incentives offered to commentators and ‘influencers’, it is particularly important to do the hard work of carefully forming your own opinions, before making any financial commitments. The practice of shilling is commonly observed in this space and it is best to be wary, before you are fully equipped to make judgements of ‘expert’ advice.
Dollar cost-averaging is said to be the smart way to build up your bitcoin holdings and reduce the risk of losing out due to the large volatility inherent in this asset ( 1, 2). Otherwise known as stacking sats. The other term you’ll no doubt hear is hodling. Many Bitcoin enthusiasts will proudly state their intention to hodl, no matter what happens. If you think this simply looks like a misspelling, you’d be right, as it hails from a drunken posting on a Bitcoin forum ( 3), but which has retrospectively turned in to an acronym, meaning to ‘hold on for dear life’. It is common to hear tell of early adopters selling their bitcoin for what seemed like unbelievable profits, when the price hit values then thought impossible, like 100 dollars. If only they’d hodled. Spare a thought for the guy who bought a couple of pizzas for 10,000 bitcoins ( 4). Today that amount of bitcoin would be worth about 300 million US dollars!
Your first bitcoin purchase
Your first bitcoin purchase will most likely involve the use of an online exchange. Of course, there are other ways to get hold of bitcoin: by offering a service or selling something and receiving bitcoin as payment. You can also purchase bitcoin over-the-counter (OTC), or privately. Here we will stick with what is simple and typical for buying and storing your bitcoin. As with anything, there are benefits and limitations associated with the methods used. This is particularly true for storage and this point is probably worth expanding upon in another post. For now, though, buying and storing your bitcoin can be accomplished at the same time. Integrated into whichever platform you use to purchase your bitcoin will be a wallet that will allow you to store your coins and to initiate transactions to the holders of other wallets. Platforms often include additional features, user-friendly interfaces and the convenience of being accessible through a browser or mobile app. The disadvantage is that you are trusting a third-party to secure your funds. Bitcoin is no longer the ‘wild west’ that it was in the early days and the risks associated with having a company holding your bitcoin on your behalf is probably a great deal lower than it was, but you might want to look at other means for storage, after learning more. Particularly if you end up purchasing a decent amount of bitcoin.
As Bitcoin moves from being viewed as a form of money only suitable for cypherpunk, anarchist outlaws, towards becoming regulated and suitable for the mainstream user, exchanges have had to begin playing by the usual institutional rules you would expect if using a bank. Therefore, purchasing bitcoin through an exchange will usually require signing up to use their platform and being asked to provide some information. Fulfilling know your client (KYC) and anti-money laundering (AML) requirements will involve verifying your identity and possibly being asked to provide some other information. Converting your hard-earned ‘normal’ money into bitcoin can then be achieved by bank transfers or card payments.
The convenience of a web-based wallet
A web-based wallet, which you will have after registering with an exchange, is stored on the cloud. The cloud is ever-present and has become so ingrained in our everyday lives that we have become habituated to our frequent interactions with the services offered through this medium. Web-based email, social media and internet banking are just some of the many applications that we expect to be able to make use of anywhere and at any time. Web-based wallets offer this type of convenience, being available through web-browsers or mobile apps, on our computers or smartphones.
We are so familiar with the cloud, in fact, that it is worth reminding ourselves what this actually involves. Generally, we are talking about a company providing a platform that is stored, centrally, on servers that they control. This generally means that you do not have ownership of the private keys that secure your funds. The crux here is a question of who has custody of your bitcoin, when using the services offered by a third-party.
Mt. Gox was the largest cryptocurrency exchange back in 2014, when it suffered a hack and theft of approximately 850,000 bitcoins ( 5). This Tokyo-based exchange had grown to be a corner-stone of the crypto community, since its launch in 2010. By February of 2014, it was bankrupt. The theft of such a large quantity of bitcoin, accounting for 6% of all bitcoin in existence at that time, had huge ramifications for the industry. What about the individuals, though, who had their bitcoin stored on the exchange (Figure 3)? Despite promises of paying these people back their lost funds, to date this has not happened and they must come to terms with the fact that these bitcoin may never be returned.
Figure credit: ( 6)
The hack of Mt. Gox is the most famous example, but is not the only occurrence of such a hack. Unfortunately, there have been many hacks of exchanges ( 7) and although potential solutions are on the horizon, for the present time, this must be considered. The decentralisation of exchanges holds much promise for solving this problem. More on that shortly.
Not your keys, not your coins
You’re kidding yourself if you think that an exchange actually stores your bitcoin in a specific wallet just for you, with a unique private and public key, even if that is what it seems like on the surface. In reality, they simply change some numbers on an entry for you within a database. In fact, there is no guarantee that exchanges hold sufficient funds to pay out all users if they requested their deposited funds at the same time. The phrase ‘not your keys, not your coins’, made famous by Andreas Antonopoulos ( 8), is a warning that if you don’t have the private keys that secure your funds, at the end of the day, you are not in custody of your bitcoin. You are trusting that whoever does will always allow you access to your funds. Further, if those funds are lost by this custodian, either by theft or incompetence, who loses out? You, or them? That is certainly true for centralised exchanges, but what about decentralised exchanges?
Centralised and decentralised exchanges
The traditional model of crypto exchanges as centralised holders of all their users’ funds, which must be paid in and then withdrawn, is not without problems, as outlined above. A decentralised exchange, or DEX, uses the actual tools that the development of cryptocurrencies has provided, such as blockchain and decentralisation, to counter these problems. The result is that DEXes are non-custodial and never take control of users’ funds. Instead of operations taking place on a database in the background, a DEX offers the opportunity to trade directly from a privately owned wallet. What’s the catch? Well, not having to use all these tools gives centralised exchanges advantages of efficiency. DEXs are developing fast though and certainly look like the future.
In addition to offering the opportunity to buy and sell bitcoin, exchanges also allow the purchase of altcoins. An altcoin is defined as an alternative coin to Bitcoin, the original cryptocurrency. There are a lot of altcoins! Some will argue that there is no need for any of these altcoins and that, in the long run, Bitcoin alone will be sufficient to deliver everything promised by the ‘crypto revolution’. These people are referred to as Bitcoin maximalists, a term that gained prominence after a blog post by the Ethereum founder, Vitalik Buterin ( 9). In this post, he describes such people as believing it both ‘righteous and inevitable’ that Bitcoin takes a monopoly position and that it is undesirable to have an environment of multiple competing cryptocurrencies. Others argue that there are limitations to what Bitcoin can offer and a healthy ecosystem of alternatives has an overall positive affect. I’m sure you will develop your own opinion, but inevitably you will come to accept that there is a lot more to ‘digital, internet money’ than just Bitcoin.
Examples of online exchanges
The US-based platform Kraken was founded in 2011. In crypto terms, that is a long time. It has a feature-rich, user-friendly interface and a reputation for comprehensive security.
Figure credit: ( 10)
Use of this platform will require verification, to satisfy legal requirements, but the process is smooth and straight forward. Kraken was the first digital asset company to receive a bank charter under federal and state law and has stated an intention to offer a number of cryptocurrency-focused financial services, both in the US and globally ( 11).
Relatively new and still evolving, Nash attempts to occupy a ‘sweet spot’, by offering the performance of a centralised exchange, combined with the security and non-custody features of a DEX. The exchange is run on their own servers, but they cleverly manage to integrate this with wallets for which you have custody of the private key and is done in a way that avoids them gaining knowledge of it.
Figure credit: ( 12)
Nash is playing the long game, seeking to adhere strictly to the regulations that currently exist and adapt to those which are being formed, as this young industry develops. This is not true for many other exchanges. For this reason, it doesn’t have all of the bells and whistles of other exchanges and if you are looking to trade altcoins, it currently lists relatively few. That said, they are progressing steadily and are starting to release features and products that not only match other exchanges, but actually better them. For example, 0% fees for buying and selling bitcoin, in addition to some other cryptocurrencies. Due to the regulatory route they are taking, this is only available for those based in Europe, for now, but will surely become available elsewhere before long.
1. GODBOLE, Omkar. Missed the Bitcoin Rally? Here’s a Low-Risk Strategy to Ride the Bull Market [online]. 2020. Available from: https://www.coindesk.com/dollar-cost-averaging-investment-strategy. Accessed: 2021-01-23. Archive: https://archive.vn/6gCMW
2. SMITH, Graham. Dollar Cost Averaging - The ’Boring’, Sensible Bitcoin Investment That Could Double Your Money in 2.5 Years [online]. 2020. Available from: https://news.bitcoin.com/dca-bitcoin-investment-double/. Accessed: 2021-01-23. Archive: https://archive.vn/3SzHc
3. GAMEKYUUBI. I AM HODLING [online]. 2013. Available from: https://bitcointalk.org/index.php?topic=375643.msg4022997#msg4022997. Accessed: 2021-01-31. Archive: https://archive.vn/MhMg5
5. MCMILLAN, Robert. The Inside Story of Mt. Gox, Bitcoin’s $460 Million Disaster [online]. 2014. Available from: https://www.wired.com/2014/03/bitcoin-exchange/. Accessed: 2021-01-31. Archive: https://archive.vn/vqBhp
6. LIAO, Shannon. Mt. Gox says it may start paying back creditors as soon as next year [online]. 2018. Available from: https://www.theverge.com/2018/6/22/17493628/bitcoin-exchange-mt-gox-debt-pay-back-creditors. Accessed: 2021-01-09. Archive: https://archive.vn/ZeQgk
7. FOUNDATION, Selfkey. A Comprehensive List of Cryptocurrency Exchange Hacks [online]. 202AD. Available from: https://selfkey.org/list-of-cryptocurrency-exchange-hacks/. Accessed: 2021-01-16. Archive: https://archive.vn/72Ap2
9. BUTERIN, Vitalik. On Bitcoin Maximalism, and Currency and Platform Network Effects [online]. 2014. Available from: https://blog.ethereum.org/2014/11/20/bitcoin-maximalism-currency-platform-network-effects/. Accessed: 2021-01-09. Archive: https://archive.vn/pMlSK
10. KRAKEN. Kraken website [online]. 2021. Available from: https://www.kraken.com. Accessed: 2021-01-31.
11. KRAKENFX. Kraken Wins Bank Charter Approval [online]. 2020. Available from: https://blog.kraken.com/post/6241/kraken-wyoming-first-digital-asset-bank/. Accessed: 2021-02-01. Archive: https://archive.vn/n5RbB
12. NASH. Nash website [online]. 2021. Available from: https://nash.io. Accessed: 2021-01-26.