Dear readers,
after a "short" introduction round in my first post I want to seize the moment and familiarize you with my little darling, the so-called cryptocurrencies.
But don't be deceived by the young age, because cryptos can go pretty wild and are unwillingly tamed.
However before starting with my guide about passive investing in this space, I want to explain some terms and provide the needed tools for it. We want to aim high, but without the proper fundament this will rather end in an act of self-sabotage than in an exciting climbing tour.
That's why this post needs to be understood as a collection and explanation of specific terms in the crypto universe, however, hopefully without boring you to death!
If there are still some question marks in your head flying around at the end of this post, just let me know it by commenting, so I can edit this text and solve some incomprehensibleness.
In the case of just wanting to give negative feedback, please do this in the form of sad kitten pictures, because I'm also just a sensitive human being with a soft and tender heart.
What is a Blockchain and why the heck can't I just hold this Bitcoins in my hand?!
Blockchain is the buzz word of this technological time (despite of artificial intelligence maybe) and we will be seeing it at least a couple of times. That's why I swallow the bitter pill and start the Sisyphean task of an explain train:
Blockchain:
The main focus and the killer app of Blockchain is the fact, that its use can be trustless between the cooperating participants. Based on a calculated mathematic cryptography model, coupled with a touch of game theory and the decentralization of all competing protagonists, it is almost impossible to change it's already approved content (exceptions prove the rule and unfortunately there exist some attack vectors).
The way that content looks like depends on the implementation of the technology and the blockchain is simply a framework.
If we look at a Bitcoin transaction for example, the content contains a sender, a recipient, the amount of transmitted Bitcoins, a checksum and a hash total of all the previous transactions that took place (let's keep a secret about the other complicated technical components). This hash sum, that confirms all previous transactions and is calculated decentralized by all the protagonists, is the reason for the security of this technology.
Another feature is its freedom of use, as long as there is a working network around. This way the boarders of the countries of this planet are nullified and every transaction can get approved.
The Blockchain is neutral, there are only valid or invalid transactions, but they will never be censored, limited, or judged by the social or ethnical background of its users. This is disruptive and also intimidating for a centralized government, that was always in control until now.
Imagine that it's like a big book, where every page of it is representing a block of the Blockchain. There are millions of people transparently writing on that page about what and when to give someone else their property. There is a time when this page will be fully covered with writing and it will get validated with the previous pages, based on mathematical algorithms. If this entries are not in contrary to each other, then the latest added page will be declared as valid by every protagonist of the book and everyone can happily start again scribbling new notes on the next page.
The consensus of the validity is never made by a single entity and is also immutable.
Cryptocurrencies:
So much for theory, but now follows the practical part in form of different cryptocurrencies that make the Blockchain alive. At the time of this writing, there are over 800 different kinds of cryptos out there and some of them even have their own fundamental concepts and aren't just a copy & paste of the old ones.
I would like to carefully examine the most relevant representatives in upcoming posts and keep an eye on the technical as well as the future-proof aspects.
Essentially, cryptocurrencies represent a clearly defined storage space in the Blockchain and you can access them with a so-called private key.
Just imagine the Blockchain as our earth and your keys are representing, for instance, an access to a property or your beloved car. Every group of assets would embody a cryptocurrency with unique attributes, but it would be pretty painful to trade them among one another ("offering 1 house for 2 cars, a bicycle and a rubber ducky").
Blockchainexplorer:
A quite handy tool, where you can track every transaction that happened on a specific Blockchain. A beautiful example is this site. Even *rich lists are displayed there, that allow to see which address in the chain possesses how much of the percentage of its related cryptocurrency. This can be a really useful and important information to see if there is a fair distribution of the currency and it can also be interpreted as a warning sign, if a huge stakeholder is beginning to sell.
Block:
This represents the whole amount of transactions that are validated in a specific time frame (blocktime) and a clearly defined size (blocksize). The validation process is executed by the decentralized network through calculating and verifying hashes. The first entity that is able to find a valid block normally gets rewarded with a so-called blockreward.
However the solution of this task isn't as trivial as it sounds and the difficulty (blockdifficulty) linked to this computation is dynamic and thus requires nearly always the same amount of time. Even so, the process of finding a solution can differ among cryptocurrencies.
Ethereum for example uses a different method (hashing algorithm) than Bitcoin what can offer advantages and disadvantages at the same time (more about that in the detailed description about the coins).
Node:
A note is acting like a kind of server in the Blockchain. Transactions get send, received, verified and forwarded there. Furthermore they have a say in the state of the network and can vote for future updates. If that vote achieves success depends on the majority of the participants. For instance the Bitcoin protocol demands a majority of 95% of the voters to implement a smoothly update. Some cryptocurrencies also have so-called masternodes, that offer advanced functionalities and therefore get financially rewarded with a fee caused by transactions in the Blockchain.
Mining:
In this case we are not talking about digging for gems or precious resources, but this rather stands for the computation of "difficult" hashing algorithms in a specific Blockchain. The chain therefore determines the most effective way of computing and also what hardware needs to be utilized.
For example Ethereum is using the so-called "Dagger Hashimoto" algorithm that can be efficiently calculated by a graphics card, while Bitcoin uses the "SHA-256" algorithm and you need a special hardware (ASIC Miner) to profitably mine it. The goal of the miner is being the first in guessing a nonce (yeah you heard it right :D!). This nonce together with the checksum of all the previous transactions in the Blockchain will be hashed and afterwards needs to match a specific string (e.g. "0000..."). This string can be altered to even increase the difficulty of guessing it right.
Proof of stake:
In times of the current climate change debate, the previously mentioned mining has to be looked at a bit more critically. There is a huge "waste" of electricity, because of the never ending tasks linked to it. The amount of work that is getting put into the calculation serves as protection for the related Blockchain and is also-called proof of work. There is a real physical process behind this because of the conversion from electricity to computing power and every attacker of the Blockchain needs to perform at least a huge part of that whole work, before there is a possibility of manipulation.
On the contrary to this, there also exists the so-called proof of stake concept. In this case, the network is backed by active nodes, that need to be vested by a specific amount of cryptocurrency and get paid by a so-called stake reward. The node needs to be connected to the network all the time, to be able to verify and process the transaction. The chance of an attack is also possible here, if one node owns more than 51% of all the coins in existence. This is a safety issue that needs to be considered. However, you don't need to buy costly hardware and the power consumption drops drastically (in some cases nodes can even be hosted via an economical Raspberry Pi).
Especially as a private investor this proof of stake concept is pretty interesting and that's why it make up a large part of the coming guide.
Fee:
Nobody wants to work for free (I guess?) and that's why fees in the decentralized network were made to incentivize the nodes to verify, forward and confirm transactions (unfortunately there are no fees for normal nodes in Bitcoin yet). Therefore a lot of cryptocurrencies use their own "fee model" and charge a different amount, depending on the used storage that is required for a transaction. Normally, the higher the paid fee, the faster your transaction will get processed.
Wallet:
Great to speak about all of that, but how the heck can I get this cryptocurrencies and where can I keep them?
This is a legitimate objection and also the reason why so-called wallets came into existence. Steemit also uses an integrated wallet and the attentive user on this platform should have already noticed that. It's an address space in the Blockchain and reserved for a specific user. In this space you can, for example, do transactions like sending, receiving and signing.
To have access to you own wallet you will need a so-called private key. That's why you never hand the control over them to any other person (not even to your lovely grandma!), because after doing so you are no longer the owner of that cryptocurrency in that adress space.
Some wallets provide special protection mechanisms to keep your private keys safe and a good example for that are hardware wallets*. Let's just take a closer look at one of them, the so-called Trezor:
This hardware wallet saves the private keys internal without access from the outside and is shaped like a kind of USB flash drive. You confirm all of your transactions external via this device and it's also safe from key logger attacks, because every time you initialize your Trezor you need to enter a pin code and the numbers for it are displayed on the device but randomly rearranged for every use.
Security is an important aspect and that's why I want to write more about this topic in an upcoming post.
Exchange:
An exchange is a place where you can trade currencies with each other by a given rate. This also represents one of the few possibilities to convert our Fiat money (Euro, US Dollar etc...) into cryptocurrencies. That's why regulators keep a close eye on them and exchanges often need to enforce strict AML/KYC laws (anti money laundering and know your customer).
If you live in Europe, then I can highly recommend the Kraken exchange. They allow SEPA transfers, so the deposits are nearly free of charge. Having a residence in Germany, I would also recommend a Fidor Bank account, because they are crypto friendly and you can make deposits and withdrawals to Kraken from there in minutes.
Unfortunately, the supply of specific coins can be limited and so you have to switch to other exchanges if you want to buy more exotic ones. Good and well-known representative for this are for example Poloniex and Bittrex.
White paper:
This represents the concept of a technology at the moment of its origin. The most famous author in the crypto space is the pseudonym Satohsi Nakamoto, who invented the Bitcoin protocol. The work is covered in only 9 pages, but provides more content than quite a few encyclopedias. If you have some spare time, then I would highly recommend to read it here. I'll be worth it!
Contrary to the white paper, there also exists a so-called roadmap which is more future-oriented and documents upcoming updates and features of the specific technology.
Oh my god, this boy has nothing better to do than just writing this huge wall of text... My head is spinning and I want a short break...
All right, break's over and let's move on (:
Until now we only learned about the technical terms and so it's time for the more enjoyable part and some important investment terms.
Market capitalization:
The most famous place right now to find information about the current price performance in the crypto space is the website coinmarketcap. It provides the latest average prices, the related trading volumes (in 24 hours), charts, the amount of circulating coins, their maximum supply and last but not least the whole market cap.
However you should be pretty critical here!
The market capitalization is calculated as the product of average price * current coin supply. This leads to being manipulable and doesn't always reflect the reality.
Let's look at this example: Today I create a new coin, with a maximum and also circulating supply of 1 trillion coins. Now I sell one of this coins a friend to of mine for 1$. After his transaction the current market capitalization of my new coin adds up to 1 trillion dollar... That's the reason why you should always keep your eyes open about this numbers and scrutinize them.
As you can see there are different caps for the coins and they are not mandatory static, but can rather be inflationary and emit new coins into the market. I want to talk more about every coin, their caps and which of them are threatened by a loss of value, in my upcoming guide about passive investment.
ICO | Initial coin offerings:
This seems to be the flavor of the month. Released by focused marketing, a fancy white paper and enormous hype, crypto investors are made to believe, that they should trade their valuable coins for shares in the upcoming and new cryptocurrency.
Unfortunately, this can create massive overvaluation and I would be cautious about them and always do due diligence.
Furthermore you could ask the legitimate question about the legality of this offerings, because they seem to be pretty similar to selling securities and so there will be more regulations about them ahead.
Whale:
A whale is a person with a huge stake in one or more cryptocurrencies. This way they can manipulate the price in markets with low liquidity and trigger psychologic effects like fear of missing out (fomo) or panic selling because of huge price movements in either way. Whoever tries to trade against such whales should rethink their strategy and instead use this behavior as an advantage. Oftentimes this price manipulations will lead to a so-called pump and dump, because the price gets artificially increased and afterwards dumped.
Smart short time traders recognize an early trend change and start selling their positions before the trend reached its top and start buying back in after the crash. Let's see if I can find the time to talk about day trading and look more closely at such a cycle.
Weak hand / strong hand
The financial sphere differentiates into two kind of investors, the so-called weak hands and the strong hands. Weak hands are people who start selling their positions if there is the smallest sign of the market going against them. This happens partly because of psychological fear of loss and also because of general uncertainty and clever media manipulation. But as long as there are no fundamental changes in an investment, you will just be a victim of smarter investors who want to find a cheaper way to increase their positions.
If you should notice that you behave this way, then it's definitely time to consider your position size and also work about eventual psychological problems.
In contrast to that, strong hands understand how the market works. Instead of panic selling during a dip, they see this as a great opportunity to increase their current holdings in a cheap way, because fundamentally nothing changed and the market is just driven by psychological phenomenon.
* Small piece of advice: Don't be a weak hand! :D*
Risk tolerance / Pillow test:
Nobody says that it's easy to have money at risk. We have a deep emotional connection to it and sadly think that it's essential for survival. Therefore its loss means a potential danger for our health.
*As long as you believe this, you should only risk small amounts of money that you can afford to lose.*
A nice method to find your personal limit is the so-called pillow test:
If you invested some money and start thinking about it at night in your bed, with an uneasy gut feeling, then the position size was definitely too high and you should reduce it to avoid impulsive reactions. But if you can sleep calm and relaxed like a little child, you can increase that positions, if you have sufficient funds to do so, because you seem to be psychological stable (or you just had one or two drinks too much... :D )
Bubble:
Bubbles come and go in the world of finance. Beginning with tulips, to Beanie Babies, the internet or the great housing crisis, wherever there are people blinded by greed, irrationality will rise and utopian profits will be promised. This massive speculation leads to enormous overvaluation and unrealistic expectations. It's like trying to build a house of cards on a starting plane.
("... this is absolutely safe and totally normal to have a thousand fold increase in your money in 10 days, trust me...").
This promises are often linked with so-called Ponzi schemes that ensure fixed return. I can only ensure you one thing:
Somebody will make a hell a lot of money, but this somebody won't be you!
The world of cryptocurrencies creates bubble as well and that is pretty normal in a development cycle of a disrupting technology. Even with the introduction of the railway similar things happened. Nevertheless, this unreasonable investments help in building a new infrastructure and thus have something good about it. The trick is to keep a cool head and understand what is currently overvalued and what still has some room to breathe.
Bearish / bullish:
This terms reflect the general mood in a financial market. Expecting a retreat of prices in an indefinite period of time, the market is called bearish, because it gets pushed down by the huge paws of a bear. Whereas, if there is an expected rise, then it's a so-called bull market, because the bull pushes it upwards with his horns. Amusingly enough, you can make money in both phases, but most people don't see this opportunity in a bearish market.
Dollar cost average:
This describes a strict investment strategy within a well-defined time period and also a well-defined amount of money to invest. The advantage here is being able to neglect negative psychological effects and not having to care about the entry and timing in the market. The profits and losses average out, because you buy in every phase of the market. This surely can be stress relieving if you are satisfied with average rates of return.
This strategy can also be adjusted in downtrends of a market to cheaply increase the position or to reduce the amount of new investment capital in a bullish market. The most important thing is just to have a set amount of rules in a specific time frame, to avoid psychological negative or impulsive decisions.
Time horizon:
What do I want to achieve and how fast do I want to do that
Assuming that we would never die, then even an annual rate of return of 0.01% with an investment of 1$ would make us a millionaire one day (let's keep the fact of existing inflation here a secret hush).
But because of one or another of us here is not having that much time, you need to define a clear time horizon yourself before you start to invest and select your assets based on that.
Am I a short term and impulsive trader, or some kind of mid to long term investor? Please choose by yourself.
Portfolio:
You should never put all of you eggs into on basket, or should you?
This definitely depends on the size of your eggs and the basket! If the eggs correlate, that means they show a similar behavior in a specific situation, then it's an unnecessary decision. A good overview about the correlation of Bitcoin and other crytpocurrencies can be found here.
But diversification still has a right to exist in form of distribution of risk, if it's used the right way. I want to talk about this in a longer post of its own, where I can explain the setup of a portfolio with sufficient diversification. Right now I just want to mention, that it's not about the amount of the "eggs", but rather about their qualities!
To be able to keep an overview about my investments in the crytpo space all the time, I use this handy tool from cointracking.info and I'm really pleased with all the functionalities it offers.
Hodl:
This is a special kind of meme and a part-time euphemism, that was originally created in this post . Meanwhile it's a common part of the language in the crypto space and it tries to motivate people to hold their positions, instead of selling (keyword: strong hand), even if the market moves against their holdings.
So lovely community, which is invested in cryptos: HODL!
Moon:
Last but not least we arrived at the final highlight and the most favorite meme of every crypto investor, the moon. It describes an undefined goal, that can never be reached, but every price tick upwards will bring us one step closer to it and let's be honest, who doesn't dream about a little ride to the moon with your own personal crypto rocket (:
You did it for now and the end of the post is within reach!
Again, I want to mention politely, that it is desirable for me to read about your incomprehensibleness in the comments below. This way I can correct or add them. Furthermore, I appreciate every other word suggestion so we can build a whole compendium on our own.
What's next?
After building a solid fundament in vocabulary the next step is to begin my guide about passive investment. I will start with talking about the mother of all cryptocurrencies and take a closer look at Bitcoin.
Thank you very much for reading this long wall of text. You have been brave and actually you should be the one who gets rewarded :D
I "promise" that the next article will be shorter. If not, then please rap me on the knuckles!
Well, ladies and gentleman, it's time to bring your seat into an upright position, fasten your seatbelts and enjoy the upcoming gently but also turbulent flight straight to the moon.
If you have any questions or suggestions about cryptocurrencies, please feel free to contact me, otherwise enjoy your time here on steemit.
Kind regards
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