How the cryptocurrency works

Bitcoins are considered the new gold. How does the cryptocurrency work? Where can you get Bitcoins? Read here whether it is worth investing in cryptocurrencies.

Bitcoins - the digital coins

Bitcoins are popular, but extremely risky: In October 2021, bitcoin had marked a new all-time high at more than 66,000 dollars and more than doubled within three months. The hype has come to an end for now.

Bitcoins have only existed since 2009. At the beginning of 2011, the Bitcoin price was one dollar.

Virtual Bitcoins, managed in the blockchain

The term Bitcoin is composed of the word for the smallest digital unit, the bit, and the English word coin. A certain Satoshi Nakamoto is responsible as the inventor - although it is still not clear which brain is behind it. It is possible that this is a group of people.

There are neither coins nor bills of Bitcoins, BTC for short. They exist only virtually, as a digital string. Even though they are often compared to gold: There is no real value behind them. New Bitcoins are created by the users themselves with the help of mathematical processes. The credits and payments are managed in a decentralized network, the blockchain. In order to post a transfer with Bitcoins, complicated calculations have to be solved. The first person to do this gets Bitcoins as a reward. This is known as mining, or the "digging of Bitcoins".

The dark side of Bitcoins

In the past, Bitcoins were primarily regarded as currency for dealers who used them to conduct arms and drug transactions on the darknet. Literally translated, the darknet is the dark side of the Internet, where users can surf largely anonymously. Bitcoin also hit the headlines in connection with ransomware.

The end is reached at 21 million Bitcoins

According to the website Coinmarketcap, there are a good 18.8 million Bitcoins so far, and the end is supposed to be at 21 million. However, the growth is slowing down more and more. You can also trade fractions of Bitcoins, for example Millibitcoins.

Other cryptocurrencies

Bitcoin's price growth is attracting imitators. According to the CoinMarketCap platform, there are currently more than 17,000 cryptocurrencies. Bitcoin is the market leader with a market capitalization - the number of coins multiplied by the current value - of around $750 billion. Ethereum is in second place with $330 billion, followed by Tether with around $77 billion. Around 80 of the digital currencies now bring their market capitalization to more than a billion dollars, including Polkadot, Solana, Ripple and the fun coin Dogecoin. A few years ago, only about two dozen cryptocurrencies had a ten-digit market capitalization. There are still numerous small currencies that are not even worth a million dollars.

Beware of crashing and theft

Those who enter the world of cryptocurrencies not only have to deal with extreme price fluctuations. The reasons for this are often not easy to understand. Sometimes closures of Bitcoin exchanges play a role or the fear of government regulation. Time and again, digital money comes under pressure because hackers have emptied a platform. Even those who store Bitcoins on their private computers should protect themselves against theft.

2021 was a record year for cryptocurrency fraud. According to a report by the analytics firm Chainalysis, users had a total of $7.8 billion stolen from them. The pure theft of cryptocurrencies increased by over 500 percent year-on-year to more than three billion dollars. This involves cryptocurrencies being stolen by hackers from crypto exchanges, such as BitMart in 2021, or private wallets. 2.8 billion dollars were attributable to the fairly new "rug pull" type of fraud. In this case, supposed developers pretend to create cryptocurrency projects. For this, they collect money from investors and then disappear. The largest case of fraud can be traced back to the Turkish internet platform Thodex, where the founder absconded with a lot of investors' money.

Buy and mine Bitcoins

If you are looking for a thrill and want to become a bitcoin owner, you have several options.

Bitcoin Wallet. The classic option is to get a Bitcoin wallet, an electronic wallet in which the Bitcoins are stored. There are various providers for this. The wallet has a public account number and a private key that can be used to lock it. Investors should secure their computer well to avoid becoming a victim of theft.

Bitcoin Account. Another option is to set up an account at one of the numerous Bitcoin trading platforms. In this case, the Bitcoin are not stored on your own computer or cell phone, but on the platform.

Tip: Bitcoiners should pay attention to a fair price and - importantly - the costs. There have been times when a transaction cost more than 30 dollars

Mining - a computationally intensive task

Payments with Bitcoin need to be confirmed. For example, it must be clarified whether the person making the payment even has enough Bitcoins to do so. In addition, the new data blocks with the current payments have to be linked to the previous data blocks of the blockchain. To do this, certain computational tasks have to be solved. Those who do this and confirm payments receive Bitcoins as a reward. This is called mining (prospecting). The miners need not only technical know-how, but above all appropriate computer equipment.

In the meantime, the demands on computing power are so high that it is virtually impossible to get involved on a home PC. Mining is therefore, unlike in the early days, largely in the hands of mining pools or companies founded specifically for this purpose.

Bitcoins as climate killers

As the demands on technology increase, so does energy consumption. Years ago, the Bundesbank pointed to calculations in an interview with Handelsblatt according to which a single Bitcoin transaction corresponds to the monthly power consumption of a single-family household in Germany. Environmentally friendly is different.

Financial products with Bitcoins

Not only private investors are interested in Bitcoins, but the financial industry also does not want to miss out on the hype. Hedge funds invest, US futures exchanges have introduced futures on the Internet currency, with which speculators can bet on rising and falling prices. Banks are issuing certificates. In October 2021, the first ETFs on Bitcoin started trading in the USA.

This is how the Bitcoin ETF from ProShares works.

The ProShares fund does not invest in bitcoins, but in futures, i.e. forward contracts. With them, one does not bet on the current price of Bitcoin, but on its future price. The advantage: an ETF is a regulated financial product and therefore safer than buying Bitcoin via unregulated platforms on the Internet or wallets, digital purses that can be emptied by hackers, for example.

However, due to its construction with futures, the ETF does not develop in the same way as bitcoin itself. When a future expires, the money must be invested in the next future. So-called rolling losses can occur in the process. The procedure is known from commodity ETFs, which also do not invest in the commodities themselves, but in futures. The Bloomberg Commodity Index, for example, which tracks the price development of commodities, has gained 82 percent since its low at the end of March 2020. The comparable index on futures is up only 61 percent (as of Dec. 31, 2021).

The ETF is not authorized for trading in Germany. Investors can switch to other financial products.

Betting on bitcoins with certificates

One of the papers with which investors can speculate on bitcoin increases is the bitcoin certificate of the Swedish issuer XBT Provider (Isin SE 000 752 533 2). It costs 2.5 percent per year. On top of that, there's a spread - that's the difference between the buying and selling rates.

The Swiss bank Vontobel is also on the scene with certificates that allow investors to participate in the price development of bitcoin. Two of them (Isin DE 000 VL3 TBC 7 and DE 000 VL6 LBC 7) expired in mid-September 2021. Another certificate (DE 000 VX1 BTC 7) in a smaller denomination is new to the market, priced at around 375 euros in mid-January 2022.

The advantage of certificates: They are securities that anyone with a securities account can buy in the usual way - on the stock exchange. The disadvantage: certificates are debt instruments and as such are not protected in the event of the issuer going bankrupt. The way certificate providers map the performance of cryptocurrencies can also differ. There is no such thing as an official Bitcoin price.

ETCs function similarly to certificates

The British company HANetf, for example, also offers a participation certificate on the Bitcoin with the HANetf BTC etc Bitcoin exchange traded crypto (Isin DE 000 A27 Z30 4): Investors participate in the development of the cryptocurrency. Legally, however, this is not a fund with special assets. An ETC is not an ETF, but a debt security with similar functionality and risks as certificates. According to the provider, the security is backed 100 percent by bitcoin for hedging purposes. The annual total expense ratio (TER) is 2 percent.

Offers from brokers and exchanges

Recently, the well-known fintech Scalable Capital created a separate section for crypto trading. Investors can buy so-called exchange-traded products (ETPs) there. Although the abbreviation is similar to that of ETF (Exchange Traded Funds), it is - as with ETC - debt securities. The ETP are backed by the respective cryptocurrency, says Scalable. Savings plans with ETP are also possible.

Investors can also buy cryptocurrencies at neobrokers such as Trade Republic or Justtrade. For the custody of bitcoin, Trade Republic and Justtrade work with third-party providers. The cryptocurrency is held in trust there, and there is insurance against theft. Investors can also buy ETPs at finanzen.net Zero.

The Stuttgart Stock Exchange also offers trading in cryptocurrencies. With the app Bison, a limited selection of other cryptocurrencies can be traded there in addition to Bitcoin and Ethereum. Since November, savings plans can also be concluded via the app. Bison creates a wallet for the user in the background. However, purchased cryptocurrencies can also be transferred to a separate wallet. The app charges a "spread", i.e. the difference between the buying and selling rate, of 0.75 percent of the purchase amount.

Bitcoins in funds

Funds are not allowed to invest exclusively in a single asset because of diversification requirements in this country. However, they can bet on Bitcoin with part of the investor money, for example, via Bitcoin certificates or ETC. This is what the Acatis Datini Valueflex mixed fund did, for example. The second largest single position in the fund is a bitcoin certificate. Other balanced fund managers are also showing interest in investing in bitcoin certificates.

Caution Risk of Crash

Anyone who buys Bitcoin directly or speculates indirectly on price gains, for example with certificates, should only use money for this purpose that he does not need. A total loss is possible, prices fluctuate strongly and quickly - much more than other financial investments.

Bitcoins as a means of payment

Bitcoin was created as a decentralized currency, without control by third parties. Whether it is a currency in the classical sense, however, may be doubted.

Currencies work differently

Bitcoins are not legal tender in Germany. No one is obliged to accept Bitcoins and only a few do so at all, like a few stores, cafés or pubs in some German cities or the food delivery service Lieferando. Wikimedia, the foundation behind the online encyclopedia Wikipedia, accepts donations in Bitcoins. Mozilla, the operator of the Internet browser Firefox, can also be supported with Bitcoins.

A salary for a villa or five buns

A currency should be suitable for transferring value - which is hardly possible given the violent price fluctuations in bitcoin. Imagine a salary in Bitcoins. One month you could use it to pay the rent, the next month to buy a villa - and the month after that possibly just a few rolls. No one would play this game if their livelihood were at stake. The euro would be better. However, Bitcoin can have a protective function in countries with high inflation or capital controls.

Legal tender in El Salvador

At the beginning of September 2021, El Salvador introduced the Bitcoin as legal tender. Residents of the Central American country can now pay for their daily purchases with Bitcoin and also remit their taxes in the digital currency. The state had its own app programmed for this purpose. Vending machines have also already been set up.

Acceptance among the population has been moderate so far in view of the strong fluctuations. However, payments in Bitcoin could save Salvadorans, many of whom work abroad, money transfer fees. It is possible that people without bank accounts will now also have access to the banking system - provided they have the technical equipment.