I have never been a fan of Bitcoin (“BTC”). Of course you would have made a fortune if you had purchased some back when it was first invented in 2008 and released as open source code in 2009. Since then the price of BTC has soared from around $0.0008 per BTC to a peak of almost $20,000 in late 2017. It currently stands at just over $9,000. In 2010 someone decided to buy two pizzas for 10,000 BTCs. Those two pizzas were purchased for a value of $90,000,000 at today’s exchange rate.
One good thing about cryptocurrencies (“crypto”) is it upsets the Green lobby greatly. Research in 2019 at the Technical University of Munich estimated BTC’s carbon footprint as the equivalent of Las Vegas, this will increase significantly as more and more computing power is required to mine the crypto. Add the other cryptos in existence and you can imagine Greta’s horror. I’ve seen research from the crypto community trying to make the carbon footprint seem smaller, but they would say that, wouldn’t they?
I have always viewed Bitcoin as a trade rather than an investment. Without understanding the mechanics that drive price movements I’d always been reticent to get involved. What’s changed my mind? The mass printing of fiat currencies and the increasing trend to electronic payments leads me to worry that my predominantly sterling-based savings are ripe for wealth taxes and dividend cuts. My preferred route to gold exposure is a convertible that is backed by physical gold, but since the convertible is also electronically held my gold holdings are also ripe for taxation.
Hence my thoughts turned to BTC and other crypto. Since I am not looking to trade between crypto but to just hold a sum I decided not to consider the smaller crypto but to go with the daddy of them all, BTC. The crypto show quite high correlations anyway. If BTC moves up the rest of the crypto tend to move up, in much the same way that the equity and bond markets started to exhibit “risk-on, risk-off” movements post 2008. So I set about looking at how I could buy some, and how I could hold it. BTC can be held in a variety of ways, and storage for are called wallets. Different types of wallet have different characteristics, as well as being defined as “Hot wallets” which are connected to the internet, and “Cold wallets” which are more secure since they are not connected to the internet.
Wallet Types
Paper Wallet
The first type of wallet is a “Paper Wallet”. This works in much the same way as a bearer bond, it is a physical piece of paper that often has a QR code on it. Paper wallets can be generated using software provided by online companies. The paper wallet has two pieces of information on it, a public address for receiving BTC and a private key that allows you to spend or transfer the BTC held at that address.
Since the paper wallet is held offline it is impossible for hackers to get at it. Of course like any piece of paper if you lose it or it gets damaged in some way you will lose the coins forever. For those of you with an added sense of paranoia it’s recommended that you run the software to generate the wallets whist you are offline and preferably having booted your PC with a LiveUbuntu OS to ensure no malware is in operation.
Physical Wallet
The second type of wallet is Physical BTC. These are literally coins which had the private keys hidden under a peelable hologram. When redeemed the coins lost their value. These coins fell foul of the authorities however, as they were deemed to be a money transmitter.
Mobile Wallet
The third type of wallet is a mobile wallet. These are apps that run on your smartphone, which makes paying in BTC whilst out-and-about easy, but equally they are prone to hacker attacks and the potential for loss if someone gains control of your ‘phone. Because I wasn’t thinking I would be using BTC on a daily basis and wanted a more secure wallet I did not consider this to be a useful wallet for my purposes.
Web Wallet
Web wallets store your private keys on a remote server; these servers are designed to be permanently online and accessible via web-based technology, allowing you to access your crypto on multiple devices. Of course these remote servers are prone to hacking attacks and there have been several instances of exchanges shutting down and making off with their users’ funds.
Desktop Wallet
Desktop wallets are installed on your computer with your private keys stored on your hard drive. These are less prone to hackers than mobile and web wallets but still carry some risk. I went with this option as I was not going to use my BTC regularly to make payments and I wanted a more secure store for my BTCs. I will describe the process of setting one up shortly.
There are a range of different desktop wallets with different features. Since there are many different crypto you should pick one that allows you to store your private keys for all the crypto that you wish to hold. Different desktop wallets have varying levels of security and functionality.
Desktop wallet providers include: Electrum; Exodus; Bitcoin Core; Atomic Wallet; Wasabi Wallet; and Bitcoin Armory. Most of these wallets are available for Linux, OSX and Windows operating systems and are free to download. If you are going to go down the desktop route do research these wallets carefully to make sure you get the one with the right features for your needs.
Hardware Wallet
The final type of wallet is a hardware wallet. These are the most secure wallets as the private keys are stored on a dedicated hardware device, however they do cost money to purchase. The three main providers of these wallets are: Ledger Nano S; Trezor; and KeepKey. If you lose your hardware wallet you can still recover your funds through inputting a string of random seed words into a replacement wallet. Again if you lose these seed words then you will lose your wallet entirely.
Setting up the wallet
Having looked at the pros and cons of the various wallets I had decided that the desktop wallet was my preferred solution. It would be offline whilst not open on my computer, making it much harder to hack, and I did not see any need to purchase a hardware wallet since I would not be storing large amounts of BTC. If I decided to buy a lot of BTC or other crypto then a hardware solution would make more sense from a security perspective.
Since I was only interested in BTC and liked its feature set I chose Electrum. It’s not the prettiest interface but it suited my needs regarding security etc. This is free to download and setting it up on my PC was a relatively simple exercise. Since Electrum works with VPNs and the Tor browser you can also protect your IP address when using it.
There are two key items you need to set up the wallet, your password and the “seed phrase” which is a randomly generated string of 12 words. The password and seed words are not sent to any of Electrum’s servers, so if you forget your password you will need to use the seed phrase to regenerate your wallet and choose also a new password. If you lose both then you have lost your BTC as well. Obviously the stronger your password the less likely your wallet is likely to be hacked whilst online.
I use a password manager for most of my passwords these days to ensure greater security. I’ve had too many emails from people threatening to release video of me “enjoying myself” in front of my PC screen whilst citing old passwords obviously hacked from insecure websites as “proof” they’d done this. Since my PC doesn’t have a camera or microphone attached I’m slightly sceptical that these threats are real.
Cryptocurrency exchanges
Having set up your wallet you now need to buy some crypto to put in it. There are a variety of exchanges that will sell you crypto. These exchanges will typically also allow you to hold wallets with them but this becomes a risk from hackers.
For example Mt. Gox was an exchange based in Tokyo which launched in 2010. Going into 2014 it was handling 70% of all BTC transactions. In 2014 it suspended trading and filed for bankruptcy after it announced that 850,000 BTC were “missing and likely stolen”. In April 2015 the security auditors looking at the theft concluded that “most or all of the missing BTCs were stolen straight out of the Mt. Gox hot wallet over time, beginning in late 2011.”
Another exchange was Quadriga, Canada’s largest crypto exchange. After its founder, Gerald Cotton, went missing presumed dead in India in 2018 up to US$190mn went missing since only Cotton held the private keys to the off-line cold wallets and the entire business was being run from a single encrypted laptop. Since then attempts to trace the money suggest that the entire scam was a ponzi scheme. This was the fourth largest crypto fraud.
There are quite a few exchanges for crpyto including:
Binance – originally Chy-na based but moved to Malta with a Jersey outpost. Binance discovered a large-scale security breach in 2019 where hackers stole $40mn of BTC. In Feb 2020 the Maltese announced that Binance was not authorized by the MFSA to operate in the crypto sphere and was therefore not subject to regulatory oversight.
Upbit is a South Korean exchange founded in 2017. Within two months Upbit was the top global crypto exchange by volume. Upbit is certified by the Koreans and ISO for security. Despite this Upbit still lost $48.5mn of Ethereum crypto due to a hack.
CoinBase is a US-based exchange founded in 2012. It is licensed to trade by the New York State, and in 2017 was ordered to report all users with more than $20k of transactions to the US IRS.
I decided that rather than go direct to an exchange I would find a broker who would transact the BTC trade on my behalf. A perusal of the interweb led me to a firm called BC Bitcoin which is the trading name of J&M Trading Ltd, based in the financial heartland of Hertfordshire, Broxbourne. My research was based to a large extent on the reasonable rating on Trustpilot (currently 345 reviews of which fewer than 1% were Average, Poor or Bad). Trading Bitcoin is not a regulated activity, so caveat emptor and doing your own research is key to choosing where to trade. Despite boldly displaying a “Certificate of Compliance” from “SecureTrading Financial Services” it is clear when you read the blurb on the certificate that the certificate was issued on the basis that J&M Trading “completed a self-assessment questionnaire”. Hardly compelling but that’s crypto for you.
I registered with BC Bitcoin (registration includes their rather rudimentary Know Your Client (“KYC”) which means sending them ID, a recent utility bill and a photo of yourself holding up a sign agreeing to their terms and conditions. Given how quickly this was turned around I’m not entirely convinced these were looked at before I was accepted and decided to test them out with a small trade I could afford to lose. Because they are a broker they can trade in pretty much any crypto. I sent them the princely sum of £200 and put the order on to buy as much BTC as that would get. BTC are split into subdivisions called satoshis. There are 100,000,000 satoshis per BTC, with future subdivisions possible if the price rises too far. Since there is a cap on the total number of BTC this is less of a worry than fiat currencies.
To their credit the fees to trade are fully disclosed before purchase. In my case they represented 4% of the total. They keep 1% of the trade total and pay a 3% spread to the exchange. Larger trades should be cheaper. I then requested they send my new BTC holding to my desktop wallet. This is done by generating a receive code in the desktop wallet and sending this code to the broker. I sat back and waited. Much relief when a few minutes later a tiny fraction of BTC appeared in my wallet. It worked.
I now needed to try and see whether I could use the BTC supposedly in my wallet for a payment to someone elsewhere. I fired up my Tor browser and went to a website that accepted BTC. I chose their cheapest subscription and requested a BTC code from them for me to send my BTC to. Once this code was generated I went to my wallet and input the right amount to send them and input their receive code and pushed the button. That amount disappeared from my wallet and vanished into the ether
After a long wait I refreshed the screen of the target site and low and behold I was a premium subscriber. Bingo. Given the sasatoshi is such a small fraction of a BTC it is important to check you enter precisely the correct number of decimal places when you trade. Not rocket science for someone who had worked in the City; fat fingers do happen, however. The largest error trade I ever saw was someone who assumed short sterling was the same contract size as the gilt future and put on a short sterling trade for £1bn instead of the £100mn they thought they were trading in.
A caveat is the cost of transfer of BTC. There was a time that coffee shops etc would accept BTC as payment, but the transaction costs of sending BTC (given the price rise) now make the practise expensive relative to the cost of any small ticket purchases. The benefit is the anonymity of sending such a payment versus PayPal, bank transfer or credit cards. You can dial down the transaction costs but this then takes longer to reach the recipient.
Conclusion
My experiment worked. I now have a tiny amount of BTC sitting in a wallet on my desktop protected from hackers by multiple levels of security. If my house burns down I can retrieve this wallet and its contents so long as I remember the master password of my password keeper. Will I be buying more? Probably as a hedge against the mass printing of money but I wouldn’t bet the whole farm on crypto. They were the best performing asset of the 2010s by some margin but then so were tulip bulbs in the 1630s and look how cheap they are now.
© Captain Black 2020
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