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What is Cryptocurrency and How Does Bitcoin Work?

Written by Hudson Adviser Michal Park

I get inundated with emails at work from various financial institutions and the like, but over the last few months, I would say that up to 30% of my emails have focused on cryptocurrency – more specifically, Bitcoin (the most well known digital currency).  I consider myself a fairly intelligent person, but I have to say, I have read article after article about cryptocurrencies and I still find the whole thing hard to comprehend!  For anyone in the same boat as me (but are too afraid to admit it!), this article is for you.

There are about 1,000 different forms of digital currency around* – I mean, as soon as something becomes the next big thing every man and his dog will crawl out of the woodwork to replicate it and ride the wave – but Bitcoin would be the most well known largely due to the fact that it was the first decentralised ledger currency and also because it is has the highest market cap of all cryptocurrencies.  Ethereum and Ripple are the next largest cryptocurrencies by market cap. I’d speculate that Bitcoin will forever be know for jumping from $US11,000 to $US19,000 in just two weeks in December last year.  It currently sits around $US8,600 (at time of writing 20 March 2018).

Bitcoin’s meteoric rise in price has cemented its place in modern financial markets as the biggest of its kind – beating “Tulip Mania”, a 17th century financial crash that became known as the first financial bubble.

Invented in 2008, Bitcoin is a digital currency that uses a decentralised ledger system called “blockchain” designed to facilitate digital transactions on a peer to peer basis between any two individuals across the internet.  Blockchain is resistant to being hacked quite simply because the records it keeps are truly public and easily verifiable.  The number of bitcoins in circulation gradually increases over time and at a rate that decreases over time such that eventually the total number of bitcoins in circulation will only ever be 21 million (and only a fraction of a bitcoin need ever be purchased, eg one millionth).  

The mechanics of “mining” bitcoin (by a person, group or company) is as follows:

  • When a bitcoin is transferred from one person to another, the network records this unique transaction, along with all others made within a certain time period, in a “block”.
  • The network of computers called “nodes” then verify the transactions and the “miners” inscribe these blocks in a digital ledger – a “blockchain”.
  • Thousands of miners then compete simultaneously to convert these blocks into sequences of code called a “hash” – essentially solving computational puzzles.
  • When the new hash is generated, it is placed at the end of the blockchain, publicly updated and then the randomly drawn winning ‘miner’ gets paid in bitcoins.
What is Blockchain Technology?


The appeal and possibilities of blockchain is wide reaching.  Our very own stock exchange announced in December last year that it would be replacing its current settlement system (CHESS) with a “blockchain-inspired technology” to improve the efficiency of the trade and settlement process.  They are the first exchange in the world to consider this and in doing so they place Australia at the forefront of this technology.

As a currency, bitcoin is yet to be accepted by any real major merchants, hence the only options for most investors are to trade it on a digital currency exchange or hold.  Bitcoin is, however, widely used as the currency of choice on the sinister sounding “Dark Web”.  The Dark Web is essentially a collection of websites that are not allowed to publish over the common internet (as most of the sellers and items on the Dark Web are illegal – think buying drugs, hiring hitmen, forging passports and laundering money etc) so Bitcoins provide the anonymity required.  There is a fairly strong stigma surrounding bitcoin in terms of its connection to the underworld.

A recent report from Australia’s blockchain industry network (the Australian Digital Commerce Association and Accenture) indicated the following stats at the end of 2017:

  • 312,633 customers registered across seven Australian exchanges
  • 2.7 million transactions processed in 12 months worth $AUD3.9billion
  • 40% of traders were between 18 and 29 years of age (the most represented group)

Another interesting Bitcoin fact – the first publicly declared Bitcoin Billionaires were the Winklevoss twin brothers who famously sued Mark Zuckerberg for $65million over the origins of Facebook.  They invested $11million of their settlement in Bitcoin four years ago when the digital currency was worth $120.  At the height of their fortune, their bitcoin value was estimated at $1.4billion and put them in Bloomberg’s Billionaire Index.  Bitcoin’s recent plunge has essentially wiped millions off their net wealth and booted them out of the Billionaire box.

In a nutshell, whilst it’s a very intriguing instrument and one of limited supply, bitcoin has no intrinsic value (like the way a stock is valued) and no real history so it is very difficult to support our Hudson members investing in it.    The value of bitcoin really is anyone’s guess – hence the speculation and hype surrounding it.  As the great Warren Buffett recently said about why he will never invest in cryptocurrencies “I get into trouble with the things I think I know something about.  Why in the world should I take a long or short position in something I don’t know about?”

Like with any speculative investment, if you must invest, our advice is to only invest as much as you are willing to lose.  

*two cryptocurrencies of note:

Coinye – established in 2014 but abandoned after a lawsuit from its inspiration, Kanye West.

Potcoin – developed to service the legalised cannabis industry

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