Digital currencies are still hot, even after several years of Bitcoin in the media. If you haven’t kept up with digital currencies or are wondering what the next Bitcoin will be, this is the article for you. In this article, we’ll explain everything about digital currencies, other forms of e money, and set you up with a few tricks that will give you an edge when it comes to trading digital currency stocks.
Introduction To Digital Currency
Digital currencies are also known as cryptocurrencies, meaning currencies that are of obscured ownership. Digital currencies exist only as files which contain data about how much of a given currency there is in that file.
In this section, we’ll talk about the biggest digital currency, the most promising upstart currency, and the rabble that constitute the majority of unique digital currencies.
The most famous digital currency is the Bitcoin currency, whose protocol exists since 2009.
Bitcoin, founded by a mysterious coder named Satoshi Nakamoto, is the digital currency that sparked the entire cryptocurrency movement. Bitcoin has a few features which nearly all digital currencies share:
- Obscured transfer and ownership of funds
- Transparent transactions of all funds via the blockchain
- Funds that are free from central banking authorities or government controls
- Funds that are generated by users rather than distributed via a central authority
- Funds that are backed by computational work performed rather than decree
- Core protocols which are agreed upon via user consensus
If you’re reading about a digital currency, your first thoughts should be to find how it’s any different from Bitcoin. Bitcoin is still the dominant digital currency, boasting the largest market cap, most users, widest distribution, most miners, and longest history.
Bitcoin has survived multiple market cycles, massive hacking scandals, and the explosion of a few of its trading exchanges. Suffice it to say that Bitcoin isn’t going anywhere, even in the wake of massive forks from its core user base to form new currencies like Bitcoin Cash.
Bitcoin is big enough that it has its academic journal dedicated to producing scholarly works on its valuation, creation, trading, anonymity and other core protocol features. You can buy Bitcoin on most major Wall St. trading decks, too—Bitcoin is the digital currency that made it to the mainstream in one piece.
There’s a term for digital currencies that are copies of Bitcoin, but don’t have as wide of distribution or as high of a valuation: altcoins.
Simply put, most altcoins are mere copies of Bitcoin, so they’re not necessarily worth talking about unless there’s a hot investment opportunity in one of them, which is often the case. Altcoins tend to follow a pattern of inception followed a long period of very slow adoption, a spike in valuation, and then crash after the public loses interest.
There are a few altcoins which do offer substantial improvements over the Bitcoin protocol, but these features don’t matter—altcoins just don’t have the user base to approach Bitcoin.
Though technically an altcoin, Ethereum is the first major digital currency since Bitcoin to offer substantial advancements and a unique protocol use case. Ethereum is intended for use with smart contracts, which means that it’s a digital currency for machines to use when talking to each other.
Because Ethereum is more dynamic than Bitcoin, it’s a rising star in the finance community, who sees it as a potential vector for creating autonomous corporations which can operate based off of Ethereum-backed software.
Of all the altcoins, Ethereum is the most likely to persist because it brings value to the table via its protocol rather via its valuation as a currency. Ethereum currency could be medium of exchange that the software networks of the future use to negotiate resources and functions without human intervention.
If you’re wondering what’s the next Bitcoin, Ethereum is by far the best bet—and it’s a bet that almost everyone in the digital currency space would make, too.
Who Mints Digital Currency?
Speaking of valuation, so far we’ve avoided talking about the creation of digital currency. Digital currencies aren’t created at a mint in the way that dollar bills are for a couple of reasons.
First, digital currencies lack any guarantee that they’re “legal tender” anywhere in the way that dollar bills are. Nobody can be forced to accept a digital currency as payment in the way that they can with a dollar bill.
Second, digital currencies aren’t issued by any central banking authority. In the case of a physical dollar bill, the issuant is the United States government. Historically, if someone wanted to return their dollar bill in exchange for another medium of exchange—say, gold or silver—they could do so. Dollar bills were simply a lighter way of carrying around pieces of gold, which was valuable because gold was rare and hard to mine from the earth.
Digital currencies don’t have any centralized authority, and they can’t convert back into any fundamental resource, but they do address the issue of value using rarity.
The act of minting digital currency is called mining, and it shares a few features in common with the canonical central government issued trade notes. To mine digital currency, miners configure their computers to solve difficult math problems. For every solution their computer finds, the miner reports it to the central ledger of all digital currency transactions known as the blockchain.
The blockchain recognizes that the miner’s computer has found a valid solution to the math problems, and issues them digital currency in exchange. Henceforth, if any other miner comes forward with the same solution to the math problem, it’ll be no good—the solution was already redeemed for the digital currency.
As solutions become harder to come by, the digital currency gains value via rarity and also via the work required to find it.
Fiat Currency Vs. Digital Currency
If it still isn’t clear what the difference between digital currency minting and normal money minting is, don’t worry. Since the end of the gold standard, physical money can’t trade for gold—it simply has a socially agreed upon value that’s essentially made up by economic forces.
Digital currency enthusiasts call the traditional way of minting money “fiat currency” because it only has value via declaration—fiat—and isn’t redeemable for any other resource. Digital currencies aren’t necessarily redeemable for any other resource either—after all, the energy spent on solving the math problems is irretrievable—but the point is that they imbue some value via expenditure of work.
What’s The Point Of Digital Currency?
So, digital currencies have value in ways that real physical money doesn’t or can’t. But digital currencies are used for other reasons, too. Because digital currencies exist only electronically, they can move around far more easily than fiat currency—in theory.
Take for example a situation in which you are paid in cash, and want to send money to your cousin so that he can use the cash to buy services. Your options are to put cash into an envelope and mail it—bad idea—or to deposit it into your bank account, wait until the value appears in your account, and then wire transfer your cousin the money. Once your cousin receives the wire transfer at his bank, he must then withdraw the money back into cash before using it on services.
Digital currencies cut out the middlemen by making each user their bank. Except with digital currencies, your bank is called a wallet. To send money to your cousin with a digital currency, you’d simply publish a report on the central ledger that some of the digital currency from your wallet now lives in your cousin’s wallet.
Most digital currencies have encryption and other safeguards to ensure that transfers can only occur from authorized users. But if you paid close attention to the transfer using digital currency, you’d notice one other thing: neither you nor your cousin is identified in the transfer of digital currency in the way that you would be identified in the transfer of physical currency.
Digital currency simply moves from one wallet to another wallet, as detailed on the blockchain’s ledger. Nobody knows who owns what wallet or who initiated any of the activities that a wallet can take. This is one of the most sought after properties of digital currencies in comparison to physical currencies.
This also means that digital currencies are extremely useful for evading currency controls or laws about transfers of value. Buying digital currency using one traditional source of money and then converting it into another traditional source of money is an easy way to move money across international boundaries, where there are typically many restrictions that apply.
It goes without saying that the anonymity of digital currencies also enables users to avoid taxation on any transactions that they make, which may be appealing to some.
The only problem is that you can’t purchase many goods or services with any digital currency currently. Not many retailers accept digital currency, and for those that do, they probably only accept Bitcoin. It’s also a bit of a hassle to buy anything with digital currencies because of the authentication of wallet identity confirmation steps involved on both ends of the transaction.
In fact, even if you had the chance to purchase goods with digital currencies, in their present formulation, you’d be very stupid to. Digital currencies have extremely volatile values thanks to market speculation at the digital currency exchanges.
If you spent half a Bitcoin to buy a sandwich today, that same half a Bitcoin could ostensibly be worth an entire cruise ship in a week. It’s far too risky of a proposition to spend digital currency, so most people simply sit on digital currencies like stocks or commodities.
This means that digital currencies are the target of many regulators seeking to pin them down as financial instruments rather than as currencies. Digital currencies’ involvement in the darknet drug trade also makes it a tempting target for law enforcement.
Nonetheless, many traders exchange digital currencies online in settings much like Wall St. Digital currency exchanges:
- Track the buy and sell values of currencies
- Organize trades between users automatically based on their requests
- Remove market inefficiencies by providing liquidity
- Offer a platform for traders to use that is agnostic to location or quantity of currency
Just like the real stock market, digital currency exchanges drive speculation, liquidity, market cap, outside investment, and many other properties. They’re also a major part of the reason why traditional big money power players are starting to be interested in digital currency.
Not all digital currency exchanges are reputable, but the current crop are stable enough to provide viable platforms for traders of all stripes. Traders on the exchanges can create financial instruments of their own in addition to the traditional actions like shorting, calling, putting, and other options.
Riding The Digital Currency Wave
If this article has inspired you to get involved in digital currencies a bit more, perhaps to try to turn a profit, take a brief pause. Just like the real stock markets, the digital currency markets are fierce, populated by high-frequency trading bots, and constantly pored over by veteran traders.
If you think your trader chops are strong enough, you’ll know that you have a lot of research ahead of you to understand the digital currency scene more fully before proceeding. Not every altcoin can be traded with the same liquidity and reliably as Bitcoin.
Likewise, Bitcoin will never be as profitable to mine as many of the newer upstart altcoins. Learn the lingo, keep an eye out for fresh currencies to use as digital currency stocks, and don’t be afraid to follow a currency to the moon if the sentiment is bullish.