A beginner’s guide to bitcoin: what is bitcoin?

Not long after crossing the rubicon into bitcoin territory, you will soon discover altcoins. There are thousands of them. Keeping track of what is what is a full-time job, many times over. Once you start looking at these coins, you feel like a kid in a sweet shop. There are so many, all with different uses, functions and purposes. You’ll find yourself wanting to own lots of them.

Some are quite evolved, others have barely got started. Some have market caps of many billions, others are worth next to nothing. Some have genuine potential, others are scams. There are some that are, literally, just jokes – Dogecoin is the most famous in this category, yet it has Elon Musk as one of its fans. The Tesla founder described himself once as CEO of dogecoin, and when he tweeted about it in early February, the price went up by 1,000% in a day. Some joke.

If you simply want exposure to the cryptocurrency sphere, buy bitcoin and walk away. Bitcoin is the standard, performing the same role in the crypto economy as gold did in the global money system of the 19th century.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

There may be coins that are superior in design, but bitcoin has the network effect. In terms of power, use and perception, it is by far and away the strongest. It is the coin everybody knows. You don’t have to be a bitcoin maximalist, but any crypto portfolio should be overweight bitcoin. In fact, within the crypto segment of your asset allocation, I would recommend something like 80% bitcoin, 10% ethereum and 10% altcoins.

Ethereum – the number two cryptocurrency

Why have I pulled out ethereum separately? Ethereum is the second-largest cryptocurrency by market cap. It’s now so established that the Chicago Mercantile Exchange is about to begin offering ethereum futures. So what is it?

Ethereum is a platform for building decentralised applications. A decentralised application is one that runs on a blockchain (in other words, a decentralised network of computers) rather than one single computer or centralised bank of servers. The more decentralised apps (DAPPs) that get built, the better it is for ethereum. There are other DAPP platforms, but ethereum is the leader. It has the network.

You may have heard of the boom in DeFi (decentralised finance), for example. DeFi apps are aimed at getting rid of the need for intermediaries in the financial system. Many DeFi apps are built on the ethereum platform. So one simple means by which to play the DeFi sector is to own ethereum. Owning the coins is a bit like owning shares in the platform, app or protocol.

I own some ethereum in my own portfolio, but a couple of alarm bells are ringing. Firstly, bitcoin collapsed in 2017 shortly after the introduction of futures in Chicago. So that may be a bit of a warning sign on timing. Secondly – maybe more importantly – is that some of ethereum’s competitors may have the edge in terms of functionality (even if ethereum currently has the network).

An alternative, but more complicated means to play DeFi is via The DeFi Pulse Index (DPI). It is an index of the ten most popular DeFi tokens available on Ethereum. You would have to get that via the Token Sets platform. Don’t even bother with this unless you are an advanced user.

Other coins by which to play the DeFi boom include Cardano (ADA) and Polkadot (DOT), both DAPP platforms, and Uniswap (UNI), all of which you can buy at the above exchanges. I own some ethereum, but none of the other above coins.

Bitcoin cash is one of the most criticised coins in crypto, but I happen to really like it. I find it quick and slick. Although its price performance is not up there with some of the better coins.

I am a big champion of privacy technologies and remain convinced of the increasing importance of privacy tech in the years ahead. Privacy coins, however, have been laggard in this latest crypto bull market. Privacy coins, especially the leading coins, have a much greater chance of being made illegal than bitcoin itself, because they find the widest use on dark markets.

Monero (XMR) is the leading privacy coin, along with Zcash. If you want something really niche, take a look at Secret Coin (SCRT), which you can purchase at Binance, or Haven (XHV), which you can buy on Bittrex.

Finally, another tiny altcoin I own is Decred (DCRD), which mixes proof-of-work and proof-of-stake to create a more decentralised, "democratic" equivalent of bitcoin. It may find use in the potentially huge growth area which is decentralised autonomous organisations (DAOs).