Bitcoin: Understanding digital currency, pitfalls

Bitcoin is a type of cryptocurrency in which balances are kept using public and private “keys,” which are long strings of numbers and letters linked through the mathematical encryption algorithm that was used to create them.

The public key, similar to a bank account number, serves as the address which is published to the world and to which others may send bitcoins.

The private key, similar to an ATM PIN is meant to be a guarded secret, and only used to authorize Bitcoin transmissions

According to Investopedia, though Bitcoin was not designed as a normal equity investment hence no shares have been issued, some speculative investors were drawn to the digital money after it appreciated rapidly in May 2011 and again in November 2013.

Following these trends, many people purchase bitcoin for its investment value rather than as a medium of exchange. But their lack of guaranteed value and digital nature means the purchase and use of bitcoins carry several inherent risks.
Key terms in BITCOIN
BITCOIN: According to the official Bitcoin Foundation, the word “Bitcoin” is capitalized in the context of referring to the entity or concept.
Bitcoin: “bitcoin” is written in the lower case when referring to a quantity of the currency (e.g. “I traded 20 bitcoin”) or the units themselves. The plural form can be either “bitcoin” or “bitcoins.”
Digital currency: Bitcoin is one of the world’s first digital currencies to use peer-to-peer technology to facilitate instant payments.
Miners: independent individuals and companies who own the governing computing power and participate in the Bitcoin network
Mining: Bitcoin mining is the process through which bitcoins are released into the system (circulation), basically, it involves solving a computationally difficult puzzle to discover a new block
Blockchain: Blockchain is the world’s leading software platform for digital assets. It offers the largest production block chain platform.

Operational module:
The independent individuals and companies who own the governing computing power and participate in the Bitcoin network, also known as “miners,” are motivated by rewards embedded in the release of new bitcoin as well as transaction fees paid in bitcoin.
These miners can be thought of as the decentralized authority enforcing the credibility of the Bitcoin network. New bitcoin is being released to the miners at a fixed, but periodically declining rate, such that the total supply of bitcoins approaches 21 million. One bitcoin is divisible to eight decimal places (100 millionth of one bitcoin), and this smallest unit is referred to as a Satoshi.
According to the system, if necessary, and if the participating miners accept the change, Bitcoin could eventually be made divisible to even more decimal places.

Risks of investing in Bitcoin
Many investor alerts have been issued by the Securities and Exchange Commission (SEC), the Central Bank of Nigeria (CBN) , and other regulatory agencies in Nigeria to beware of cryptocurrency as it could be seen a another form of Ponzi scheme.
Lacks long- term record

The concept of a virtual currency is still novel and, compared to traditional investments, Bitcoin doesn’t have much of a longterm track record or history of credibility to back it. With their increasing use, bitcoins are becoming less experimental every day, of course; still, after eight years, they (like all digital currencies) remain in a development phase, still evolving.

Not for the risk-adverse

Regulatory risk
According to Investopedia, Bitcoins are a rival to government currency and may be used for black market transactions, money laundering, illegal activities or tax evasion.
As a result, governments may seek to regulate, restrict or ban the use and sale of bitcoins, and some already have.

Others are coming up with various rules. For example, in 2015, the New York State Department of Financial Services finalized regulations that would require companies dealing with the buy, sell, transfer or storage of bitcoins to record the identity of customers, have a compliance officer and maintain capital reserves. The transactions worth $10,000 or more will have to be recorded and reported.

Although more agencies will follow suit, issuing rules and guidelines, the lack of uniform regulations about bitcoins and other virtual currency raises questions over their longevity, liquidity and universality.

Tax risk
As bitcoin is ineligible to be included in any tax-advantaged retirement accounts, there are no good, legal options to shield investments from taxation.

Security risk
Bitcoin exchanges are entirely digital and, as with any virtual system, are at risk from hackers, malware and operational glitches. If a thief gains access to a Bitcoin owner’s computer hard drive and steals his private encryption key, he could transfer the stolen Bitcoins to another account.

No third party transaction

Any transaction carried out with bitcoins can only be reversed if the person who has received them refunds them. There is no third party or a payment processor, as in the case of a debit or credit card therefore, there is no source of protection or appeal if there is a problem.

Insurance risk:
Some investments are insured and Bitcoin accounts are not insured by any type of federal or government program.

Fraud risk
While Bitcoin uses private key encryption to verify owners and register transactions, fraudsters and scammers may attempt to sell false bitcoins. For instance, in July 2013, the SEC brought legal action against an operator of a Bitcoin-related Ponzi scheme.

Market risk
Like with any investment, Bitcoin values can fluctuate. Indeed, the value of the currency has seen wild swings in price over its short existence. Subject to high volume buying and selling on exchanges, it has a high sensitivity to “news.” According to the CFPB, the price of bitcoins fell by 61% in a single day in 2013, while the one-day price drop in 2014 has been as big as 80%.

If fewer people begin to accept Bitcoin as a currency, these digital units may lose value and could become worthless. There is already plenty of competition, and though Bitcoin has a huge lead over the other 100-odd digital currencies that have sprung up, thanks to its brand recognition and venture capital money, a technological break-through in the form of a better virtual coin is always a threat.