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WTF Is The Blockchain? A Guide for Total Beginners

WTF Is The Blockchain? A Guide for Total Beginners

Blockchain: the single most confusing term since Bitcoin. Everyone has a vague idea of what it does. It’s either the ultimate evolution of financial technologies, or a ditzy fad that can be summed up in the disconcerting phrase: “dogechain.” In reality, major companies around the world have already shown favor to the burgeoning money exchange system and it may become firmer and tighter to stay away from the financial dark art.

In reality, it is all relatively effortless to understand. The Blockchain is a public ledger where transactions are recorded and confirmed anonymously. It’s a record of events that is collective inbetween many parties. More importantly, once information is entered, it cannot be altered. So, if the blockchain is the public record, what is being recorded? What are all of these “transactions”?

Cryptocurrencies, like bitcoin, are currencies that exist solely in digital. There are no physical golden coins with a big “B” on them. Moreover, possessing these non-real coins entails a fresh idea of “ownership.” You don’t literally have it in your forearms, or even in your bank account, but you have the capability to transfer “ownership” to someone else simply by creating a record in the blockchain. Rather than using bills, your transfer is unspoiled data.

Where exactly is this chain located? Due to the open nature of cryptocurrencies, and the importance of the public having access to other blocks, the blockchain isn’t located on just one fellow’s large computer. For example, the bitcoin blockchain is actually managed by distributed knots. These knots all have a copy of the entire blockchain. Knots will forever come and go, synchronizing their own copies of the chain with those of other users. By distributing copies and access, the chain can’t simply “go down,” or vanish. It’s a decentralized system that is both sturdy and secure.

All of your dogecoins are in a row, but what do you do with them? Whether you’re using them IRL or online, the blockchain makes it happen. There are many reasons people are falling in love with cryptocurrencies: it’s anonymous, decentralized, and there are no fees or third parties attempting to grab a percentage. However, if there were absolutely no regulations in place, the fresh currency would quickly become a greedfest of users attempting to screw each other over. The public nature of the blockchain means that anyone can check it. It is effectively anonymous, yet public, at the same time, and it is in the best interest of users if it remains so.

A DIY Bitcoin mining equipment, by Paul Anderson.

You can accept and trade coins, or you can mine for them. Miners can spend thousands of dollars on the right equipment just to mine coin. But what do they truly do? What miners do is fairly similar to real-world miners in that they are actively looking for something. Their computer repeatedly works through complicated calculations to find a very specific reaction.

Miners solve problems, but how in the world is that helpful? Brief story, miners are actually verifying that transactions posted by other users are legitimate, and the numbers all add up. Long story…

Miners collect transactions and put them into a single block. A block generally contains four chunks of information: a reference to the previous block, a summary of included transaction, a time stamp, and Proof of Work that went into creating the secure block. The blocks are strung together into a chain—a fluid chain that does not permit for any inconsistencies; this means there are no “bad cheques” in the system, and transactions entered are necessarily valid and can be processed. By checking the blockchain and confirming transactions, the entire system is effectively self-regulated and fully secure. No, that doesn’t mean some kid cooped up in a basement can just click “okay” and confirm a billion dollar transfer. Blocks generally need numerous independent confirmations, and the equations are intended to be hard to crack. Not to mention, the hardware required is far more specialized than the average laptop. Eventually, what’s to stop someone from simply going back and editing existing blocks? Each block is securely hashed—meaning it is rendered into seeming gibberish and almost unlikely to invert or undo. Once it’s in the blockchain, it’s there forever.

A rough idea of what a block chain may look like, courtesy of Yevgeniy Brikman

So, why waste time and resources helping other people, or the blockchain? Why not let someone else do all that “confirmation stuff,” while you just mine? Because, you don’t necessarily have a choice. Confirmation of the blockchain is central to mining. It’s part of the actual mining process; however, miners are generally given incentives. For example, after solving a problem (and creating a fresh hash) they are rewarded with coins.

Will you be eyeing a blockchain-styled ledger in your future? Brief reaction: oh yes. Blockchain and cryptocurrencies have caused fairly a stir over the past years. However, it seems their real importance has yet to be fully realized. The future isn’t just in businesses around the globe sporting glad “Now Accepting Bitcoins” signs, but rather emerging companies (and revolutionary existing ones, too) finding fresh uses for the cutting edge technology. VC firms and investors are placing their bets on the blockchain because there is untapped potential. Identity management, international contracts, and all sorts of complicated bank transactions can be greatly altered with the public ledger system. The process could (in an ideal world) work seamlessly, crossing boundaries where banks, logistics or a plethora of other obstacles once existed. They could be combined with the Internet of Things to create a more connected and automated world. Future companies may be able to absorb mountains of fresh data, or even digitize real-world things that are hard to quantify. Unluckily, many big companies are remaining mum on the studies in the blockchain field for evident reasons.

However, it is public skill that nine major banks (including JP Morgan and Goldman Sachs) recently joined a partnership to develop blockchain technologies. That’s not to say major companies are getting in on the cryptocurrency game; rather, they realize that the blockchain system, itself, could be a powerful implement for efficiency. With a system as versatile and secure as the blockchain, there may many unexpected innovations in the coming months and years.

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The Worst Way to Buy Bitcoin – The Motley Idiot

The Worst Way to Buy Bitcoin

Investing in bitcoin isn’t effortless. It’s an online currency for the tech-savvy, difficult to buy and perhaps even stiffer to store securely. Thus, many investors and speculators have turned to an lighter way to own bitcoin, the Bitcoin Investment Trust (NASDAQOTH:GBTC) .

The Bitcoin Investment Trust was designed to make holding bitcoin as effortless as buying a stock or exchange-traded fund. Traded over the counter, the trust holds about 0.093 bitcoin for each share outstanding. Wielding a share is thus the equivalent to wielding about one-tenth of a bitcoin.

But like anything, shares of the Bitcoin Investment Trust are governed by the laws of supply and request, and impatient speculators are willing to pay more for each share than the trust’s bitcoins are worth. The fund recently traded for $531 per share, or 105% more than the underlying bitcoin is worth, according to my calculations.

Why this happens

It isn’t unusual for closed-end funds to trade at a price that differs from their net asset value. Some funds trade at premiums, while the majority trade at a discount. But what is unusual is the size of the premium — a 105% premium is a massive outlier to the rest of the closed-end fund world. Historically, closed-end funds have traded for a Four.5% discount to their net asset value, on average.

Bitcoin Investment Trust investors could lose money, even if bitcoin prices keep enlargening. Picture source: Getty Pics.

The sponsor of the trust, Grayscale Investments, recently filed to list the trust on the NYSE Arca exchange, where you’ll find most legitimate ETFs. At the same time, it suspended the creation of fresh trust units, which means that there won’t be any fresh shares created, at least not any time soon.

Even when it was actively issuing fresh units, creation wasn’t keeping up with request. Securities and Exchange Commission filings showcase it created only 31,400 shares in two thousand seventeen in the days leading up to its S-1 filing. With no fresh supply and an enlargening amount of request, the premium has widened quickly. Shares have traded at an average premium of 39% to underlying value of the bitcoin, according to my calculations.

Photo source: Author.

A big risk

Speculators who pay a premium to buy shares of the trust are taking a big risk by assuming that the supply and request imbalance is permanent. But things could switch, and quickly: Bitcoin could fall out of favor, or speculators could find lighter ways to buy and sell bitcoin quickly and in quantity. After all, as recently as April 13, shares traded at a mere 8% premium to NAV.

I find the premium difficult to justify. If anything, I’d argue shares should trade at a discount, given the trust’s 2% annual management fee that leisurely licks away at the bitcoin backing each share per year.

Closed-end fund investors often capitalize high management fees at ten times when valuing a fund. A fee of 2% per year capitalized at ten times means shares should theoretically trade at a 20% discount to the market value of the underlying bitcoin. The share price would have to fall by as much as 60% to get to a 20% discount to their net asset value, assuming no switch in the price of bitcoin.

I have no particular insight into where bitcoin will go from here, but I do know one thing: Fund premiums to net asset value have a tendency to revert to the mean. Investors who hold Bitcoin Investment Trust shares could thus stand to lose money even if bitcoin prices keep moving higher. Buyer beware.

Jordan Wathen has no position in any stocks mentioned. The Motley Idiot has no position in any of the stocks mentioned. The Motley Idiot has a disclosure policy.

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