Digital Currencies Part 1: Using Digital Currency to Increase Your Capital

A digital currency transaction on a mobile deviceThis is the first part in a series on digital currencies.

Sometimes I think I know a thing or two about money. I subscribe to the Wall Street Journal, after all, and I even read it once in a while. Then I look at my bank account, overdrawn and bank fees accumulating, and I remember that although I may feel like a guru when it comes to advising friends on how to manage their finances, I’m an astounding failure at managing my own cash. I can’t even manage to remember to put spare change in a piggy bank. Perhaps this is why I’m so interested in digital currency these days — particularly, how to turn some of my few remaining dollars into a windfall of cash through some form of digital transactioning. That’s what everyone is doing these days, right?

We’re all exchanging currency online — not just financial currency but social currency (which I’ll talk about in my next article in this series) — and though we’re not quite to the point where we’re sending restaurant servers to space through our mobile devices (as demonstrated in the video above), there’s certainly an indication we’re headed in that direction. At this time, however, I’m going to provide an overview of two digital currencies that you can use today: one for business purposes and the other more for play (or speculating).

PayPay logoPayPal often comes to mind whenever we think of ways to exchange currency through the Internet. This form of electronic money has been around for over a decade now and has become one of the most widely used financial services providers online. It’s a very simple service to use; all you have to do is have a bank account attached to PayPal to begin buying and selling services and goods online. I regularly use PayPal to purchase all manner of goods and services on the Web, such as books from Barnes & Noble, electronics from Best Buy, and video content from… well, other sites. PayPal is currently even making its service available in brick and mortar stores; in some Home Depot stores you can already purchase a new hammer by simply entering your mobile phone number and a personal identification number at the cash register.

Though I first began using PayPal to purchase or sell items I’d won or sold through eBay, I now use the service’s credit offerings — a credit line you can obtain under certain circumstances, such as demonstrating you are a reliable customer — as my main source of funding for anything I can purchase using PayPal. That way I can buy something even if my bank account doesn’t have enough funds to cover the purchase. It’s a fantastic system, and it’s even helped me improve my credit score.

Although PayPal is a convenient way for me to exchange currency electronically, I haven’t been all that successful at making money using the service. I’m running out of things to sell on eBay, and I’m not quite ready to resort to the world’s oldest profession to encourage more people to send money to me electronically. There are lots of ways to get people to send me money using PayPal, but most of those things — selling stuff, for example — I’m not yet prepared to do. I need money now — as in, yesterday. So I need to begin thinking outside the box and find another digital transactions service that might provide me with a way to make money without having to do much work. Something that bears interest, or something like… the stock market.

PayPal operates more like a bank than a stock market. At one time you could increase the value of your funds through the service’s now-defunct Money Market Fund. These days, there’s no way you can gain a bit of interest using PayPal. But there are digital transactions systems that operate much like the stock market, providing the potential to make a lot of money by turning your dollars into digital coins.

Bitcoin logoOne such service that operates more like the stock market than a bank account is Bitcoin. This service is an entirely different beast than PayPal; it’s considerably more difficult to manage for anyone who is not versed in P2P (peer-to-peer) technology and it involves a bit (no pun intended) more risk than PayPal. Though PayPal is not backed by the Federal Deposit Insurance Corporation (FDIC) and therefore is somewhat risky to use, the service is generally robust and has yet to be hacked to a point of concern. Bitcoin, on the other hand, is not only uninsured by the FDIC but is actually considered illegal in the minds of some congresspersons who recognize that the Bitcoin economy is unable to be taxed at this time.

Proponents of Bitcoin generally view it as a relatively safe and reliable form of transferring funds electronically without having to pay the fees normally charged by services such as Western Union or PayPal. That’s right, Bitcoin is entirely free to use — that is, you need to convert your dollar bills into digital coins (called Bitcoins) in order to participate in the Bitcoin economy, but you do not have to pay fees for your transactions. This is precisely why Bitcoin is so attractive — at least, theoretically. The problem with Bitcoin is that, due to the system operating similarly to a stock market, with the potential for widely fluctuating values of its currency, there is always the risk that the value of the dollars you invest into the Bitcoin economy will lose their value in a dramatic fashion. In fact, this occurred in 2011, and in spectacular fashion.

Heather Schlegel, the American Innovation Leader for Innotribe (the innovation initiative of SWIFT), is currently in the process of researching digital currency transactions systems. She explained to me her view of the participants of the Bitcoin economy, which seems to be generally composed of two categories of participants. One category is composed of users with shared values, including a heavy interest in technology (particularly P2P networking), a libertarian perspective, and a general distrust of the government. These characteristics are in no way absolutes, but they generally describe the type of Bitcoin user who engages in what she refers to as a value-driven economy: they more or less share certain values which drive them toward solutions such as digital currency exchanges. The other category of Bitcoin users (though not entirely distinct from the first) are the speculators: users who aim to use Bitcoin exclusively to generate wealth. They must be able to afford to speculate, so it follows that these are generally wealthy users who have money to “play” with.

I asked Ms. Schlegel what kind of advice she had for anyone interested in investing in digital transaction economies such as Bitcoin. She told me they should experiment with it a bit:

It’s doesn’t have to be a huge amount of money; it could be five dollars, or 10 dollars, or 25 — whatever you can afford to ‘play’ with. You don’t have to move your entire bank account into Bitcoin.

If my bank account wasn’t currently overdrawn, I might take Heather’s advice and speculate in Bitcoin with whatever I could afford to lose. On the other hand, I’ve only invested in the stock market once — just for one day — and came out of that transaction with a bit less money than I started out with. That experience was enough to keep me from avoiding investing in volatile markets again until I know what I’m doing. For now I’m going to keep digging up stuff I can sell via PayPal and look forward to the day when a friend from Virgin Galactic can transmit enough Galactic credits to my Galactic credit account so I’ll be able to take off on a suborbital flight on some future weekend.

Which of these types of digital currencies would (or do) you use? Would you risk your money in the Bitcoin economy or similar digital transaction exchanges?

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  1. Brad Tomlinson says:

    With my debit card, I rarely have any hard cash with me.  Thus I am close to only having digital money.

  2. Good article. I’ve invested a lot of time and money in Bitcoin. And there’s also a secure way to convert your money from PayPal to Bitcoin: (If you’re not registered to SecondLife, insert ‘none’)

  3. Thanks for letting me know about VirWoX, Satoshi. During my research I discovered a similar service (MoneyAlter) but it doesn’t appear to convert to Bitcoin.

  4. runeks says:

    You write that Bitcoin is “similarly to a stock market” (in that it fluctuates).
    What you mean is that Bitcoin is similar to any other *currency* (Bitcoin is – or can at least be considered as – a currency), in that its exchange rate fluctuates relative to other currencies. Bitcoin is a lot more volatile (varies more in value) than other currencies though, because it’s so small at the moment.

  5. runeks says:

    You write that Bitcoin is “similarly to a stock market” (in that it fluctuates).
    What you mean is that Bitcoin is similar to any other *currency* (Bitcoin is – or can at least be considered as – a currency), in that its exchange rate fluctuates relative to other currencies. Bitcoin is a lot more volatile (varies more in value) than other currencies though, because it’s so small at the moment.

  6. Harold says:

    Thanks for your comments, runeks. I agree, Bitcoin is similar to other currency, as all currencies’ values fluctuate. Even some fiat currencies fluctuate in value much more than the citizens of those economies would prefer. But from my (quite) limited experience speculating on stocks it appears that Bitcoin seems closer to the stock market than most of the world’s flat moneys.

  7. runeks says:

    You are right that Bitcoin resembles a stock in a stock market, in that it is freely traded, and that it’s volatile (compared to a currency). Besides that, it seems to me Bitcoin is more like a currency, since – as opposed to a stock – there is no value behind it, ie. it’s not an equity, as a stock is. When you own a stock, you own a part of a company. When you own a Bitcoin you own a commodity that is valuable only because it’s limited in supply, and can be easily transferred to other people. It’s sole purpose is to be used to facilitate trade, like all other currencies.

    The reason Bitcoin is so volatile is because there are only about 8 million in existence, valued at around $4 per coin. That’s around $32m of value in total – equivalent to a nano-cap stock. The dollar currency, in comparison, has a total value of around $2,600bn (80,000 times more). The value of Bitcoins (or rather, their exchange rate to US dollars) fluctuates so wildly because when someone buys for $500k worth of Bitcoins, they buy more than 1% of all the Bitcoins in existence. Buying $500k worth of dollars, and you’re only buying around 0.00001% of all the dollars in existence.

  8. Harold says:

    I’m somewhat concerned about the risk. I know Bitcoin got a lot of bad press last year due to a heavy being taken down (and just a few days ago there was some talk of another large exchange taking themselves out of the Bitcoin economy). Hacking is always going to be a risk with any online currency (and just about any currency worth its salt, since the dollar is essentially online now) but it seems Bitcoin — due to precisely what you’re saying, the heavy players can cause huge waves — is too risky for my tastes at this point in time.

  9. Email says:

    That SWIFT video has a claim I don’t really believe: At 1:03, one of them claims that this sci-fi version of SWIFT is “totally anonymous.” You should ask Heather Schlegel how she thinks SWIFT will ever be allowed to process anonymous transactions in a culture that is obsessed with controlling every detail of people’s financial activities, and brands any resistance to that control as “money laundering.” 

  10. Harold says:

    Thanks for your comment. Actually, even though one of the dinner guests says “It’s totally anonymous” another dinner guest responds, “That’s what they say. I’m not so sure.”

    Still, that’s a good question. I did ask Heather about concerns the government (I’m referring to the U.S. government because I’m not yet aware of how other governments view Bitcoin yet) is having about money being transferred “under the table”. She told me the goverment is mainly concerned with being unable to tax citizens on these transactions at this time. I believe she also mentioned (though I’d have to double-check this) that it is not impossible for the transactions to be tracked back to their sources.

  11. Harold says:

    Thanks for sharing that information, Satoshi. I responded to you earlier but for some reason my comment is not displaying so I’ll repeat: During my research I discovered a similar service (MoneyAlter but it doesn’t appear to convert to Bitcoin. I’m guessing there are probably a number of similar services online. Are you personally associated with the service you linked to? If not, have to used it yourself?

  12. Andrew Fader says:

    I made $1000 on bitcoin by buying $500 worth at 7 and selling at an average of 21

  13. No, I’m not personally associated with this service, but I’ve used it several times. Compared to other exchanges, the fees are high, but it’s easy to get some Bitcoins here, if you have PayPal or Paysafecards. I never had any issues with them and I’m using it since April 2011.

  14. >and just a few days ago there was some talk of another large >exchange taking themselves out of the Bitcoin economy

    TradeHill was a very cheap (low fees), which was good for the users, but they lost some money due to problems with Dwolla and I think they also had some legal things to solve. Now they didn’t have enough money to pay lawyers.

    >Hacking is always going to be a risk with any online currency >(and just
    about any currency worth its salt, since the dollar is >essentially
    online now) but it seems Bitcoin — due to precisely >what you’re saying,
    the heavy players can cause huge waves >– is too risky for my tastes at
    this point in time.

    IMHO hacking is not a problem for the users, but for bitcoin exchanges and services. Mt.Gox has a large trading volume so it’s very likely that hackers are trying a lot of things there. Yesterday Mark Karpeles (head of Tibanne/Mt.Gox) told me, that someone tried to do a Denial-of-Service attack on them. I like Mark and his exchange and he knows lot about security, but his exchange is a big target for criminal hackers and a computer system will never be 100% secure. That’s why I use and support smaller exchanges like Intersango, VirWoX, CryptoXChange and CampBX.

    Talking about stock exchanges:
    There’s a “Bitcoin stock market” too, where you can invest bitcoins in mining and other things and get dividends. They are currently working on a
    new user interface (the current user interface is very difficult to use for non-geeks) and some policies to avoid scamming, but it’s not finished so far.

    Here it is:

  15. Bitcoin isn’t really a risk, but rather it is risky.  Bitcoin has gone from pennies to over $30/bitcoin then back down to ~$4/bitcoin and has sustained these numbers for extended periods of time.  Bitcoin, in itself, is an interesting investment because it is like investing in a foreign currency.  I will agree and say that you should play with it.  You don’t necessarily need any money, just look into a mining pool like…they’ll explain the rest.

  16. Harold says:

    Is that “Bitcoin stock market” actually trading Bitcoins? Or is it trading some other form of digital currency?

  17. Bitcoin^^

  18. runeks says:

    “I’m somewhat concerned about the risk.”That seems like very appropriate attitude. Bitcoin is an *experimental* digital currency (says so right on the front page). I advise anyone who talks about Bitcoin to stress this fact. Bitcoin has been running now for a little over three years, with notable incidents in this time frame (Google “incidents bitcoin” if you’re interested in some of the things that didn’t go as expected, but were fixed quickly enough to not cause problems). If the technology is proven to be sound, it will succeed. There is no reason to rush into buying Bitcoins. The earlier you get involved in Bitcoin, the more risk you assume (and the greater your potential reward is). Those not willing to invest in a first-of-a-kind experimental distributed digital currency should stay away from Bitcoin at this moment, there’s no reason to assume more financial risk than you are comfortable with.

  19. runeks says:

    The Bitcoin stock market is not for trading bitcoins, it’s for trading stocks in bitcoin related companies. You can buy shares in bitcoin-related companies (like you would buy a share in Google or Apple), and hopefully get a return on your investment.

    This is, in essence, giving money to a presumably existent internet company you know very little about, and hoping it will be kind enough to give back the money to you again plus some dividends.If investing in bitcoins is high risk, this is extremely high risk.

  20. Harold says:

    For now I’ll have to observe Bitcoin from a distance, for two reasons:

    1. I don’t have any money to invest. I mean zero money. I’m currently typing this on a ~2004 laptop because I can’t afford to upgrade to a new one.

    2. I might look into something like Zach mentioned but if it requires any mining then that probably won’t work for me either. I need to have money in order to put together a killer system in order to begin mining. So it comes back to reason #1.

  21. Harold says:

    I took a glace at the site. Would I be required to mine coins?