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Cryptocurrency Trading Explained: What You Need To Know

Here is all the important information on regulations, risks and rewards.

20/11/2017 10:01 AM AEDT | Updated 20/11/2017 7:55 PM AEDT
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Concepts such as 'cryptocurrency' and 'blockchain' have become major buzzwords in the financial world as of late and, even if you aren't from an economics background, people are starting to realise that things like Bitcoin and Ethereum can be major moneymakers.

Investing and trading in digital currencies is quickly turning into the newest way to jump on the cryptocurrency bandwagon, and while it isn't too late to join the party, wrapping your head around exactly how to do that is one very daunting task.

To give you an idea of how big of a thing this is, a single bitcoin (currently the most popular form of cryptocurrency) was worth almost $8,000 AUD at the time of writing this article.

And while blockchain technology is still in its early stages of development and will soon become something we use without really knowing -- for most people, it's like we are back in 1994 when the internet or email was developing.

So when it comes to putting your money into what could be the next big step in technology, if you find yourself as confused as the television show hosts above, there's no need to worry -- we've got you covered.

What Is Cryptocurrency Investing And Trading?

Emma Poposka, the CEO of digital currency management company BronTech, told HuffPost Australia that there is a big difference between investing and trading in cryptocurrencies -- but both are becoming more popular among people around the world.

"Literally to invest, in the most layman's terms, is to buy a particular cryptocurrency and to wait for it to increase in price," she said.

"To trade cryptocurrencies is similar to the Forex trading with currency -- there are traders that exchange online exchanges.

"People are getting interested. Two years ago, not a lot of people were doing this but now a lot of people have bitcoin or ether [Ethereum's cryptocurrency]... There is gravity around this and people are joining in but it's still in the early stages."

In other words, if you put your own money into buying into a cryptocurrency with the hopes of its value rising so that you can then sell it for a profit -- you're an investor.

But if you're looking to swap cryptocurrencies, say bitcoin for ether, in the hopes of jumping from ship to ship to maintain the highest value you can according to market speculation (in a similar manner to working on a stock exchange) -- you're a trader.

Which Cryptocurrencies Can You Buy Into?

Here's the thing -- when it comes to cryptocurrency options you could possibly look at investing in or trading with, there are thousands. Ranging in name, value and application the list of available cryptocurrencies right now seems endless, with more and more created and added frequently.

With that said, the two biggest digital currencies that sit atop that list as the most popular and profitable options are Bitcoin and Ethereum. Let us walk you through how each of those work.

Bitcoin

CoinDesk defines Bitcoin as "a form of digital currency, created and held electronically. No one controls it. Bitcoins aren't printed, like dollars or euros -- they're produced by people, and increasingly businesses, running computers all around the world, using software that solves mathematical problems."

As a digital currency, Bitcoin was the first and the biggest cryptocurrency to be based on blockchain technology -- meaning it's decentralised, not controlled by any one person or institution and is reliant on peer-to-peer interaction to verify transactions.

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Buying into Bitcoin could cost you thousands -- luckily, they're highly divisible, so it doesn't have to be so pricey.

Poposka told HuffPost Australia that Bitcoin, being the world's first major cryptocurrency, was designed to be an alternative for the coins-and-notes currency we have now (known as fiat currency) and was only ever meant to be used for value transactions to buy things.

"Bitcoin does not have any physical representation whatsoever. Bitcoin came as a response to the big financial crisis in 2007-2008," she said.

"What [Bitcoin creator Saitoshi Nakamoto] wanted to do was create decentralised currency that was not managed by central banks and not managed by any bank -- to be fully decentralised.

"[Bitcoin's] initial purpose was to be a currency, to be an alternative to fiat money... If you hold one Bitcoin it does not mean you hold something else in the physical world. It's a simple accounting system which is a substitute for the current accounting system, which is physical money."

Ethereum

Here's where things get a bit tricky. While Ethereum is classed as a cryptocurrency like Bitcoin, Lachlan Feeney -- who is a blockchain developer at Civic Ledger, a company that uses blockchain systems to solve public sector problems -- told HuffPost Australia it is actually much more than that.

According to him, Ethereum is more suitably described as the next step of the Internet based on blockchain technology that allows other people to develop their own decentralised applications, businesses and project models that consumers can then invest in themselves.

"[Ethereum is] very hard to define, it's more of a technology. People call it cryptocurrency because that's the general term that they use to refer to these things but Ethereum is not intended to take the place of Aussie Dollars," he said.

"Ethereum is the next step in the Internet when we move from centralised applications and central servers to decentralising.

"It's a huge concept because it's just not doing one thing, Ethereum is providing a platform and framework for other people to develop on, to program and build this next wave of applications."

In other words while Ethereum is labelled as a cryptocurrency, it deals more in providing an open-source basis platform for other people to create pretty much whatever they like, using Ethereum's technology.

It's basically the same as people or organisations using the Internet as a basis to create websites such as Facebook -- except when it comes to the possibilities on Ethereum, options range across everything from online casino models to digitised energy providers.

With that said, there are essentially three main uses for Ethereum's technology -- to invest money into its internal currency (known as Ether) as you would with a cryptocurrency such as Bitcoin, to buy into business and project models built on the Ethereum network via what are known as Initial Coin Offerings (more on that below), or to create something yourself.

"There's really endless possibilities. It's like saying what sort of application can people create on the app store?" Feeney said.

What Are The Risks And Regulations?

According to Lucy Cameron, senior research consultant at the CSIRO's data innovation group Data61, the primary risk that should stick out for people looking to invest or trade in cryptocurrencies is the current market volatility.

With the potential for security risks when it comes to digital wallets as well as how the value of cryptocurrencies can be affected by international events, Cameron told HuffPost Australia online markets can often see huge and arbitrary spikes and drops.

"The market is highly volatile, that's the first thing to keep in mind. There are plenty of risks," she said.

"The main risk in the past has been the hacking of wallets and marketplaces which keep people's Bitcoins for them have gone down or been hacked in the past.

"The other thing is the volatility in the market. There are usually periods of high volatility around sudden a decline in national currencies -- so Brexit for instance when the pound went down. That saw a sudden spike in Bitcoin [value]."

What Is A Digital Wallet?

Digital wallets work in the exact same way as your physical wallet that houses your coins and notes -- except that it's entirely digitised into coding and used to store anything from cryptocurrencies to information.

Based on blockchain technology, most wallets come in the form of mobile apps in a similar manner to current online banking programs, without the need for a centralised control body such as the bank itself.

"There are two types of main wallets, one is a cold storage wallet which is offline -- so you get your [crytpocurrency] addresses and you link them to your own digital address, which is your wallet, and you can store them offline on a disc," Cameron said.

"Or you can have a hot wallet [used online such as through mobile apps] which is for trading and buying and selling things, which is an online wallet.

"There are often risks with both of those in that the hot wallet is generally more susceptible to hacking but cold wallets have also been lost because people have thrown out their hard disks or their hard disks have become inoperable."

And when it comes to the Australian regulations put onto cryptocurrencies and people investing in them, Cameron said that there isn't much out there right now apart from current tax requirements and a government warning about Initial Coin Offerings (ICOs).

""Most ICOs issue and follow a white paper (an informative document designed to highlight certain features of a business plan). This is used by the company to encourage investment and sales, but is also used by the [Australian Taxation Office] to determine what kind of investment a coin offering is," she said.

"Based on that white paper ASIC [Australian Securities And Investments Commission] assesses whether they're like a market derivative or a managed investment scheme or an Initial Public Offering (IPO) with a share in a company.

"In terms of tax, cryptocurrencies are treated like an asset and can be taxed under the capital gains tax. It will only be taxed if you cash it out and its treated as a gain."

What Are Initial Coin Offerings?

In short, ICOs are crowdfunding campaigns that are created by prospective cryptocurrency business or program founders to raise funds ahead of the launch of their product.

According to ASIC, the process involves "sending virtual currencies, such as Bitcoin or Ethereum, to a blockchain project, and in return you receive digital tokens related to that project." Those tokens can then be used to interact with the project once it has launched, or they can also be used as a type of share in the venture -- except they don't guarantee an ownership stake for investors in the company or project itself.

For that reason, the Federal Government issued regulation guidance and a warning statement to Australians in September to be wary when it comes to putting your money into an ICO of recently created start-ups that may be found, for example, on the Ethereum network.

"ICOs are highly speculative investments, are mostly unregulated and the chance of losing your investment is high" ASIC Commissioner John Price said.

"Consumers should understand the risks involved, including the potential for these products to be scams, before investing."

So, Is It Worth It?

Ultimately, that's up to the discretion of each individual investor or trader. But in the eyes of Cameron, "it really is 'let the buyer beware' territory," while still remaining highly exciting for the future.

"I don't think anyone should invest any money that they can't afford to lose. Just like the share market, things can go wrong -- these are all new ventures and new businesses," she said.

"People can see that there is this gold rush happening in cryptocurrencies and there's a lot of speculation and a lot of risk being undertaken and some of the newer coins have basically been scams.

"It's new territory for us all. We're all trying to navigate what make it work and what it's sensitive to but in terms of the longer-term futures for this, it's an exciting development."

As for Feeney, he told HuffPost Australia that he believes the potential future applications of blockchain technology and the ventures that stem from it outweigh the negatives and makes it something people should be aware about.

"The technology and the potential is a force that can't be stopped," he said.

"Ten to 15 years down the track, whether Bitcoin exists or not, the blockchain will 100 percent exist and it will have an enormous impact on the economy and the way that businesses operate.

"Blockchain will change the world whether you understand the technology or not, it's just going to take time for people to start accepting it. "

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