Addition on 8 September 2022: note that I never published a follow-up for this due to how obvious it is that a lot of crypto is a scam, and how ethically dubious a lot of practices are. As a layperson, assume you will get fleeced when you enter the ecosystem. The amount of tinfoil and conspiracy theories in this scene promote Fear/Uncertainty/Doubt (FUD) which aims at getting new people to add money to the crypto ecosystem in order to prop up prices for folks already invested. Sound familiar? Yep, it's a huge pyramid scheme! See also: Line goes up, a good video that breaks down the ecosystem and issues.
Why now?
Two of my friendly colleagues disappeared into a crypto-shaped black hole over the last three months. They re-emerged, talking with great enthusiasm about it. They have doubled their seed money, and talk about all the potential for the technologies in the space. I must admit, they have broken down some of my long held skepticism, so it’s time to look at it again myself and see if their hype is real.
For context: I’m coming at this as a crypto skeptic software developer. I looked at Bitcoin when it was very new (5+ years ago?) and did not get it. It seemed like speculation on a virtual coin without intrinsic value or purpose. It smelled a lot like a pyramid scheme. Association with black market trade did not help. In the last few years the negative environmental impact of Bitcoin has not made me a fan either.
I’ve looked into speculative trade before. I’ve had a good look at ForEx in 2012-2013, doing paper trading, lots of reading, and some programmatic stuff, before deciding the speculative stuff was not really for me. Similarly I’ve read up on stock market investment, including Benjamin Graham’s classic book.
The crypto world has developed a lot in the last few years. It’s not just Bitcoin anymore, so let’s dive back in to see what’s up with it now.
In case it’s not obvious: I’m not an expert, this is not financial advise, etc. Feel free to point me in the direction of more solid info where I can learn.
Setting goals
It’s good to clarify what your goals are when you start with something. It helps you direct your search for information, and might help a bit against temptations.
My high level goals:
- Try to understand how it works
- Try to understand what you need to get started
- Try to get a basic setup working to interface with the systems (buy/sell coins, use a smart contract, etc)
- How do you make money? Look at fees, fundamentals and historic trends/behaviors… is there a minimum amount of money at which you “need” to start to mitigate overhead and fees? How is starting with €100 vs €1000 vs €10000? What trade strategies are there and how do you balance risk vs reward? Are certain coins/tokens better than others? Can stock/ForEx strategies be adapted, index fund strategies? Why (not)?
- Actually try to make money if the previous goal resulted in something which gave me enough confidence that it might work. Again, try to come up with a plan that balances risk vs reward (I’m inclined towards spreading risk and draining profits at set percentage increases; ideally I withdraw a fixed percentage of my profits so eventually I’m only working with my profits)
- Making stuff: how hard is it to write a smart contract?
- Making stuff: how hard is it to build tools that interface with the systems? DAPs (?) / distributed applications are a thing.
The very basics: how does it work?
First goal: I want to understand how things work in crypto in 2021. Below is my understanding so far. It will probably be wrong on a lot of accounts, but that’s why it’s nice to write down so I can correct it later.
Which pieces are there on the market? What types of coins/tokens/contracts/etc are there? My very limited understanding right now is:
- Coins. Stable or not. Serious or not. I’ve heard the term “shitcoins” multiple times already, so not all coins have the same esteem.
- Tokens, fungible or not (fungible is another word for interchangeable, fiat currency is fungible, because each euro is the same as another euro. A non-fungible token is closer to a signed and numbered limited edition collector’s item, one is not the same as another). What is the difference between a coin and a token?
- Smart contracts.
- Programming angle: is there one programming language, or many? How generic or domain specific is this? What are best practices? What are common pitfalls? How does debugging work? How does your toolchain look: is there versioning and source control? How does testing look? Static analysis? Are there code libraries or dependencies?
- Functional angle: how are they used? What other classes of products are stacked on top? I heard about contracts being deployed as neutral agents who just operate protocols defined by the contract (or by multiple contracts), with ownership voided so they truly are running the way they are until the end of time. How have folks dealt with bugs, viruses, etc? How does the infrastructure work that powers this? Who pays for it and how?
- DeFi, decentralized finance. Mumble, mumble, “and then you buy your house via DeFi because banks don’t have money so they don’t underwrite mortgages anymore.” Yeah, I’m still a bit puzzled about this. This would involve pretty good real-world legal contracts to defer transfer of ownership to a smart contract, and to have the smart contract somehow enforce that the offline land registry (that’s what we have in the Netherlands at least) is updated to reflect the actual owner of a piece of land.
Where do coins/tokens come from?
I know Bitcoin has miners who burn CPU/GPU/FPGA time to calculate hashes in order to process transactions and create new bitcoins in the process. Transactions are relatively slow and expensive (a Google search led me to this which claims 1MB per 10 minutes of transaction bandwidth, currently you pay 3-10 USD per transaction depending on how much of a hurry you are in (10-60 min delay). That’s relatively little if if your trade is for thousands of dollars, but a lot for a cup of coffee.
Look into how/why Bitcoin has a 4-year periodicity in its prices. There’s something about regularly scheduled restrictions in how many new coins are mined, so total new supply decreases and as such value doubles. This makes huge waves and affects all coins, apparently. My friends keep talking about how the next few months will have huge gains and then it’ll dry up. Why?
How do the other coin types do this? There are Proof of Stake coins (vs Bitcoin’s Proof of Work) where there’s a finite supply of coins which are setup via smart contracts, have a buy-in ahead of time and then freely trade once they go live. There’s a thing about burning coins as part of the protocol so they get more valuable over time. There’s also a thing about staking claims, where you freeze your coins temporarily in exchange for a percentage of the transaction fees? Time periods here are daily or weekly, so it’s all incredibly rapid compared to the yearly rates traditional banks pay.
What are the fundamentals here?
Analogy to the stock market, where each stock represents a piece of ownership of a company. Shares earn dividends for you merely holding on to them. There’s also profit/loss based on the resale value of the share. Companies have revenue, profit, equity, capital reserves, etc. A lot of metrics you can contrast to the share performance.
Based on this you can choose to go long on a share (i.e. you buy it and just hold on to it), avoid it, or do risky things such as shorting (that is, you borrow a share to sell it now and promise to buy it back later; if it works you pocket the profit, if you fail your loss has no hard limit other than the share price). While at it: don’t every borrow money to invest. Only play with what you can afford to lose.
Do things like stop/loss orders exist in crypto? What are the new options that have no analogy in the classic markets?
How does it connect back to the real/offline world?
How can you use it, right now? Better question: how is crypt used right now? How mature are the products? What are common pitfalls, and how have those been mitigated?
How user friendly / approachable is crypto? How close are we to my parents (who are tech late adopters) using this for something useful? How close are we to them being able to explain it to someone else?
Tooling & usability
My friends mentioned that there’s a lot of rough edges and opportunity for quality of life tools. What would be useful? Is there a reason these don’t exist yet? Is there an opportunity to monetize some of this?
Risk management
To manage risk you have to be aware of risks. What are the obvious ones?
Crypto exchanges / brokers can run away with your coins, and apparently that’s just a risk you have to accept. Crypto is dog-eat-dog world, like the game Eve Online. Don’t trade with what you can’t afford to lose. How can you identify trustworthy ones, besides just going with what everyone is doing? If you can’t do this, how can you identify the (obviously) untrustworthy ones?
Wallets, ledgers, accounts. Somewhere to store your coins/tokens/etc. In my mind it’s close to how your SSH keys also control your bank account. Public/private key encryption. Is this model accurate? Be cautious and careful. What are good practices for keeping things safe?
Who are the big fishes in each pond, and what are their interests? When they move, they can generate huge waves. Stop/loss orders which normally might make sense could get triggered hard due to big fish movements. My friends mention that folks trading on margin tend to have their contracts enforced at the end of the day/week/month/quarter. The quarterly ones were unexpected to them due to the volatility they caused. Knowing what/when happens means you can anticipate it.
There is the obvious loss of value, loss of trade volume/liquidity, risk of the huge fishes in the market making splashes, problems with underlying things (i.e. if one coin is connected with others, they have a relation).
Where/how to start?
Writing this down helped me get a picture of what I think I know. Plenty of questions and uncertainty, so next is filling in the gaps and double checking myself, then checking with my friends if my understanding matches theirs.
I’m going to work the high-level goals from top to bottom, I think.
Feel free to reach out to me via Twitter or email. Besides my foray into cryptocurrencies, I’m a freelance Ruby software developer with a focus on back-end systems and an obsession with code quality. I’m also developing a smart RSS reader over at Infinity Feed (beta should go live soon-ish).
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