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How does cryptocurrency actually work?

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It’s not just dog fans who are blown away when they see a Shiba Inu (that’s the name of the breed): some cryptocurrencies  have dogs in their logos, and millions of people are putting money into it. And much more in Bitcoin. But how do these currencies actually work – and is it worth joining in the hype?

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When Marina Kröger invested in cryptocurrencies for the first time in August 2020, it took a lot of courage. The mother of three children had no experience whatsoever with investing, not even in classic investment options such as ETFs or funds. But the 43-year-old Berliner, who works for a fashion agency, had one goal: “I earn less than my husband, but I wanted to get more involved in the family finances and become financially independent,” she says

. They had also just built a house and signed a 30-year loan. “Since then, there hasn’t been much left over for major failures every month.” Kröger wanted to be able to contribute to the missing nest egg himself in the future.

Kröger was unsure how to start investing, but Bitcoin and Co. had long tempted her – after all, the media was reporting all over the place about this new hype. “But at first I couldn’t imagine anything underneath it,” she admits. A friend told her about an online beginner’s workshop just for women.

In it, Kröger learned the basics, after which she registered on the Kraken crypto exchange. Her first investment: 500 euros, mainly in the cryptocurrency ether, but also in bitcoin and polkadot. At that time she still doubted whether her entry point was well chosen, an ether was worth 320 euros. Today, Kröger can only smile about it. Your investment has multiplied.She’s glad she stayed. Every month she invests between 50 and 100 euros in her crypto depot. 

Who invented it?

The rapid ups and downs in the courses make many curious about cryptocurrencies. The largest and most well-known is Bitcoin, it has only been around since 2008. Behind it is an anonymous person or group with the pseudonym Satoshi Nakamoto.

The vision: a digital currency that people can trade directly with each other – in a matter of seconds.And still tamper-proof, because the currency is stored on a blockchain, i.e. a decentralized database. You can think of it like a notepad on which buyers and sellers write down their transaction.

The notepad gets thicker with every new transaction on this blockchain, it then gets a new entry. Because every user of the blockchain has a full copy of the entire notepad, nothing can be erased or tampered with. This makes blockchain technology fraud-proof. Therefore, no trust authority – no bank, no state – needs to intervene.

Today, Bitcoin is the most important cryptocurrency in the world with a market share of around 40 percent. And with considerable growth: A coin of the digital currency was still worth around 9,000 euros in September 2019, and at the beginning of January 2022 the price was around 36,000 euros.

In El Salvador, Bitcoin has even been the official national currency since September 2020 alongside the US dollar. Salvadorans can now pay for everything from a taxi ride to a McDonald’s order with bitcoin.

However, there were many technical problems with the introduction. It remains to be seen to what extent the cryptocurrency will actually become established as a means of payment.

In this country, too, you can already pay for more and more things with Bitcoin – such as a meal delivery at Lieferando or a booked trip at Expedia. Companies always use the current price.

The very first bitcoin transaction for a real asset shows what disadvantages this can have: in May 2010, a crypto enthusiast paid for two pizzas with bitcoins. According to the state of the cryptocurrency at the time, he paid exactly 10,000 digital coins for the baked goods – that was equivalent to $41 at the time. Today, those coins — and the pizzas — would be worth around $425 million as reported by GIN.

High flight or belly landing?

Opinions are divided. Some consider digital money to be far too risky due to the strong price fluctuations and short history and see an investment as gambling. Economics Nobel Prize winner Robert Shiller speaks of a Bitcoin bubble.

Some criticize the lack of state and regulatory regulation. Others, on the other hand, see possible regulations as a danger – after all, payments with cryptocurrencies are now banned in Turkey or China, for example.

Another point of criticism is the environmental impact: The production of a bitcoin, also called “mining”, requires a lot of computer capacity.Numerous computers around the world are simultaneously solving complex equations that are presented to them by an algorithm. This is to guarantee protection against counterfeiting. Whoever comes up with a solution first sends it to the other computers.

If they find the result correct, the miner whose computer the solution came from saves it in the blockchain and receives a bitcoin in return. With each new bitcoin, these arithmetic tasks become more complex and require more capacity – and therefore more electricity.

According to the University of Cambridge’s “Cambridge Bitcoin Electricity Consumption Index,” bitcoin mining currently consumes more than 120 terawatt hours per year, which is roughly as much as the entire country of Sweden.As long as the electricity does not come entirely from renewable sources, the technology is CO2-intensive.

In addition, there are now rows of black sheep among the cryptocurrencies who lure with false price promises. The financial supervisory authority BaFin, which, for example, has already banned the supposed cryptocurrency “Onecoin”, also warns of this. But caution is also required with reputable cryptocurrencies: “Bitcoin, Ethereum & Co. are not legal tender, but substitute currencies. Where they will be accepted as a means of payment and whether they can assert themselves on the market can hardly be reliably predicted,” warn the consumer advice centers.

The democratization of payment

Proponents naturally see many of the points mentioned differently. For example Katharina Gehra, 38, co-founder of Immutable Insight and one of the most renowned experts on the subject. Gehra is certain: Blockchains are the infrastructure of the future. Fear of this new technology, like fear of the railway in the 19th century, will soon be a thing of the past.

“If the technical development of the diesel engine had stopped, we would never have arrived at electromobility.” Your company analyzes blockchains, advises business and politics and offers investment opportunities in blockchains and various crypto tokens, i.e. digital assets.

Above all, Gehra emphasizes the social opportunities that cryptocurrencies open up. Up to two billion people in the world do not yet have access to banks and the money market, so they have to do their business with cash – which always means a great security risk. “A blockchain enables everyone in the world who has a smartphone to participate in the financial system, regardless of their gender, race or race,” she explains. “This empowers many, they can now be connected to the financial system without banks or states. Cryptocurrencies contribute to more democratization and rights for the individual.”

In her view, the issue of sustainability should also become weaker and weaker as a counter-argument for cryptocurrencies. “There are 800 blockchains and more than 340,000 tokens.

But it feels like Bitcoin and its impact on the environment are always being discussed.” New methods of coin generation promise significantly lower energy consumption. What is meant is the new Proof-of-Stake (POS) procedure, to which the Ethereum blockchain, for example, is to switch this year. POS enables significantly more transactions per second and is much less energy-hungry than the so-called proof-of-work method used to mine bitcoins.

And the strong price fluctuations? “The prices of Bitcoin, Ether and Co. are now moving very strongly in both directions, which is sometimes due to the fact that the crypto exchanges are open 24 hours a day, 365 days a year,” says Gehra. Investor fears and current events also often play a role. And one or the other tweet from Tesla boss Elon Musk.

In February 2021, the multi-billionaire tweeted that his company would accept bitcoins as a payment method in the future – the value of the coin then jumped to over 55,000 US dollars. In May, Musk changed his mind about the environmental impact. The price promptly fell to around 40,000 US dollars at times.

Billions with fun currencies

It gets even crazier: Actually, the programmers Billy Markus and Jackson Palmer only created their own cryptocurrency called Dogecoin in 2013 as a Bitcoin parody. The image of a skeptical-looking bitch of the Japanese Shiba Inu breed was popular on the Internet at the time, a so-called meme – they used it as a logo. Thanks to numerous crypto nerds (and Elon Musk) who cheered for Dogecoin on the internet, it is now the 12th largest cryptocurrency in the world.

The fun currency Shiba Inu, which has been around since August 2020, also shows the dog in its logo. And the next crazy chapter was written by Elon Musk again: he posted a photo of his own Shiba Inu puppy named Floki on Twitter last September. The prices of all – previously unknown – cryptocurrencies that have the word “Floki” in their names immediately shot up.

How to get started with crypto

Cryptocurrencies are of interest to more and more people in this country because money market and fixed-term deposit accounts are currently hardly generating any income, some banks even charge penalty interest and inflation is reducing the purchasing power of money. But how do you approach the first crypto investment? Elisa Spiess has the answers to that.

With her company FemmeCapital, the 38-year-old offers crypto workshops for women full-time – this is how Marina Kröger found her way into the business. First of all, according to Spiess, investors should decide on a crypto exchange.

Spiess, who is actually an ethnologist, gives neither purchase recommendations nor specific advice, but shares her knowledge from eight years of crypto experience with other women.She considers the Kraken crypto exchange to be particularly user-friendly.

Other trading platforms are, for example, Coinbase, FTX or Bison (an app from the Stuttgart Stock Exchange, where savings plans are also possible); Bitcoin, Ether and a few others can also be bought from the online brokers Trade Republic and Scalable.

As with opening a securities account, registering with a crypto exchange involves verification by showing your ID card. Potential hackers should be made as difficult as possible: “The e-mail address used should be secure. And make sure you use a password that you don’t use anywhere else,” says Spiess.

The opinions of experts as to what proportion of assets should be invested in crypto vary – usually one to two percent, sometimes five percent, i.e. a small addition to the portfolio. Ultimately, it depends on the individual risk affinity.

“It is important that you only invest money that you will not necessarily need in the next three to four years,” recommends Spiess. As with shares, a long-term investment is recommended. “Those who don’t urgently need to get hold of the money tend to endure lows longer,” says the expert.

And in which currency should I invest now? Similar to other investments, Spiess advises diversification, i.e. not just betting on one currency. She recommends newcomers to stick to Bitcoin and Ether. “These are the two currencies with the largest market capitalization, so that’s where most investor money is. Compared to the others, they are less risky.”

A few months ago, Katharina’s Gehra’s company floated two certificates that private investors can use to participate in the potential return of several currencies at the same time: “Kryptobest” (30 to 50 tokens and cryptocurrencies, including Bitcoin, high returns, but also high fluctuations possible) and “Sustain Liquid” (about ten CO2-neutral staking blockchains, lower fluctuations, expected return of about five percent per year).

The minimum investment amount is 1000 euros, they are traded daily on the Stuttgart Stock Exchange and can be purchased from many custodian banks (e.g. S-Broker, comdirect, ING, Consors).

And how much would the tax deduct?

Anyone who invests in Bitcoins, Ether and Co. has an allowance of 600 euros. Profits above this must be taxed at the individual tax rate, which is higher than the capital gains tax on shares, for example. But: Profits on cryptocurrencies are tax-free from a holding period of twelve months.

NFT: Digital Art and Bored Monkeys

In March 2021, auction house Christie’s sold a digital collage for US$69 million. Artist Beeple’s work is called “Everydays: The First 5,000 Days” and is the most expensive NFT to date. The abbreviation stands for ” Non-fungible Token”,  roughly translated as “non-exchangeable asset”. In principle, it is nothing more than any other image file that you can look at on the Internet. 

However, with the NFT you buy the ownership right to the work of art, so you have the “original”. NFTs are mostly built on the  Ethereum blockchain stored, it’s not just for artworks, but trading cards, music, tweets, and anything else that people might collect digitally.

For example, the currently hyped NFT series “Bored Ape Yacht Club” consists of cartoon images of bored apes and is limited to 10,000 copies, one of which rapper Eminem recently bought for around $460,000. Corporations such as Adidas or Nike have also recently started offering NFT objects, such as  sneakers or hoodies,  for sale.

So far, Mariam Misakian has  associated the topic of cryptocurrencies primarily with self-proclaimed Bitcoin millionaires in swanky cars who show on the Internet “how you too can get rich quick”. The experts of this article have shown her the topic from a serious side.