Tips for Newbies

With the recent hype, there are a lot of newbies around. As someone who has been holding Bitcoin for 8 years now, I figured I'd put my take out there.

Disclaimer: I'm not your financial advisor, do your own research, yadda, yadda.

BITCOIN, THE LONGEST CHAIN

First, we have to establish: Why Bitcoin, specifically?

After all, there are a lot of options out there. This new technology has spawned a vast ecosystem, and it can be daunting to figure out which cryptocurrencies to support.

The answer lies in one of the fundamental conventions of our community: the longest chain rule. I won't get into the technical details, but in very simplified terms, it means you should support the most popular one. That one will generally have the most consensus among miners and therefore be the most secure and have the widest support.

You will hear of forks, splits, altcoins, and myriad other things. It's fine to support tech you believe in. But if you understand nothing else, just remember: go with the biggest, most popular one.

Right now that is Bitcoin.

BITCOIN, THE LEDGER

There is a lot of complexity behind Bitcoin. It is easy to get lost in all of the technical details.

Let me make it simple: Bitcoin is a ledger. It is a book with numbers in it. To understand what gives Bitcoin value, you need to understand what gives a ledger value.

A good ledger is balanced. All the numbers add up. Every account is correct. You can trust it.

A good ledger is secure. You cannot change accounts you do not own. You cannot fudge numbers. You cannot hide anything. You cannot counterfeit anything. You cannot invent new value out of thin air.

A good ledger is redundant. There are many copies, and they all agree. There is no single point of failure.

A good ledger is available. You can access it from anywhere and synchronize it across borders in the blink of an eye.

Bitcoin is all of these things and probably more.

When people say Bitcoin is better than fiat, they are talking about Bitcoin, the ledger. When governments print fiat at an alarming rate, it fails the secure condition—new value is being invented out of thin air. Likewise, it also fails the secure condition when the government is able to forcefully confiscate it—they are changing accounts they do not own. When central banks practice quantitative easing or fractional reserve banking, it fails the balanced condition—the numbers don't add up. And when governments restrict you from doing business with countries they do not approve of, it fails the available condition. Etc, etc.

Bitcoin does not suffer from any of these problems.

BITCOIN, THE AGREEMENT

Now, a secure ledger is a worthy thing, but at the end of the day, it is just a book. What use is a book if no one agrees to use it?

It is like a parent giving a child an IOU. The IOU has no intrinsic value. To anyone outside the parent and the child, the IOU is worthless. This is why people say Bitcoin is worthless and has no value—they don't accept it. So they are right, in a way. But to the parent and the child, who have agreed to use it, the IOU does have worth.

I should point out here that all fiat money operates on this principle. It is why I can give the grocery store my US Dollars—they have agreed to use it. If someone gave me Korean Won, I would not value it highly because no one I know has agreed to use it. I would have to go out of my way to find someone who does agree to use Korean Won so I could arrange to trade my Won for their US Dollars, since that is my particular brand of IOU.

Bitcoin is no different. It only has worth to the people who agree to use it. It is a secure, trustworthy ledger. You either agree to use it, or you don't. The more people who agree to use it, the more useful it is to everyone.

BITCOIN, THE UNIT

One thing that muddies up the picture a bit is that none of the numbers written in the ledger actually have any real-world value tied to them. They are all denominated in a new unit called the "satoshi," so named after the inventor of Bitcoin. No one is sure what a satoshi is worth, so we let the value of a satoshi be determined by the fair market.

BITCOIN, THE SPECULATION

Market-wise, Bitcoin seems to move in 4-year cycles centered around an event called the "Halvening." This Halvening marks a sharp drop in the number of new Bitcoins minted each year. This is built into the protocol and happens on a consistent schedule.

It takes a while for the market to adapt to the decreased flow, so about one year after every Halvening, we historically see giant spikes followed by giant drops as the market figures out the new price. We are in the middle of one of these spikes right now. This is the riskiest time to speculate because a giant drop may be coming.

There is a reason I'm highlighting "giant drop" over and over. Beware.

It is important to understand these giant drops because it is easy to freak out and panic-sell if you aren't expecting it. When it comes, fear will be at an all-time high, and you will hear "Bitcoin is dead!" over and over. They will seem right, but they are wrong. No matter what reasons they attribute to this drop, it is a natural part of every cycle. They are afraid because they don't understand the cycle, so they invent their own reasons.

Dumping your fortune into a spike and then panic-selling during a giant drop is how you get burned. Hard.

Because of all the fear, a giant drop usually leads to an extended period of undervaluation for some time after. It takes two or three years to stabilize on the right value. This period is the safest time to speculate. Everyone will be afraid, having just been burned. Prices will be low. But you do not need to fear, because you understand the next cycle is coming.

BITCOIN, THE VIRTUOUS CYCLE

The four-year cycle I described above is low-key brilliant. The giant spikes lead to massive hype in the media, which brings in a flood of new awareness and increased demand. Likewise, the giant drops that inevitably follow also get massive coverage. As they say, even bad publicity is good publicity—it's free advertising. On top of all that, the cycle repeats only once every four years, giving two or three years of rest between, so you don't see fatigue. All of this media attention leads to increased demand.

And the market is all about supply and demand.

In the past, the Halvenings have consistently caused the value of Bitcoin to ratchet up every four years. If you think about it, that makes sense.

Existing holders do not want to sell because Bitcoin has a track-record of amazing returns. They have no reason to sell their best-performing asset, which makes existing supply hard to get. In fact, they are greedy for more of it.

At the same time, Halvenings make new supply hard to get. The fact that new supply is cut in half every four years means that everyone is in a rush to snap up Bitcoin because it will be exponentially harder to get in the future.

The Halvenings are brilliant not just because they reduce supply and increase demand, but because they lead to a virtuous cycle of increasingly reduced supply and increasingly increased demand.

BITCOIN, AND YOU

At the end of the day, no one can tell the future.

When it comes to your finances, all standard investment advice applies. Bitcoin is a new technology. That means it has untold potential, but that also means it has untold risk. Fortunes can be made, but they can be destroyed as well. Understand that you are speculating on an unknown future. Past performance does not guarantee future returns. Be careful not to put in more than you can afford to lose. If you are losing sleep over the price movements of Bitcoin, you have probably put in too much.

It is generally good advice to keep your finances diversified. As they say, do not put all of your eggs in a single basket. If disaster strikes, you could lose everything. It is better to have two or three strategies that you follow, rather than just one. That way, if one fails, you can fall back on the others. Full-market index funds and real estate are considered by many to be relatively safe options.

Finally, there are two virtues that tend to pay off in finances: patience and an iron stomach. Bitcoin's value seems to ratchet up every 4 years, so it makes sense that you will need to wait a similar amount of time to turn a profit. Having the patience to take a position early and hold for 10 or 20 years will put you lightyears ahead of someone looking for a quick profit, at far less risk. But doing that means you cannot just sell at the first sign of trouble.

I don't remember who said it, but this seems like wise advice: "When deciding whether to sell, ask yourself if something fundamental has changed about your investment. If the fundamentals remain intact, you have no reason to sell."

Good luck!