Considerations for Investing in Virtual Currencies Other than Bitcoin

any questions have arisen lately about investing in virtual currencies other than Bitcoin.  This issue can get somewhat complicated and a few risks need to be understood:

Decentralized vs. Centralized.  Bitcoin is decentralized, meaning no central authority or bank, controls the supply.  It is controlled by people who run the software.  Centralized coins, like Amazon coin, are controlled by the central authority or company that operates the coin.  In this case the central authority controls the supply.  For instance, Ripples (XRP), is a centrally controlled currency operated by OpenCoin, Inc.  Currently, the only use of XRP’s to facilitate transactions on the Ripple system.  An investment in XRP is more like an investment in OpenCoin, Inc.

Alt-Coins.  This is the terms given to coins based on the Bitcoin software.  Since Bitcoin is open source anyone can take the code, change some things, and create another coin system.  New coins systems get created all the time (see Coinlist.me).  Generally, these coins depend on the Bitcoin developers to put out new versions of the software and they adapt it to whatever parameters they use.  If any of these coins were to overtake Bitcoin in popularity they would need their own developers.

Proof of Work, Hashing Rate, and Difficulty.  The security of decentralized systems depends on the “proof of work” algorithm and the amount of computer power to “mine” these coins.  Some coins use different proof of work algorithms so their hashing rate cannot be compared one-to-one.  The “difficulty” is a measure of how difficult a problem is to solve.

One scenario that has happened is that many people will start mining a specific coin, the hashing rate will rise and the difficulty goes up.  If the exchange price of the coin drops for some reason they trade their coins and move their mining equipment to another coin.  Now the difficulty is so high it takes weeks to solve the next section and all transactions stay in limbo.  Meanwhile, they sold off many coins and the value goes to essentially zero since it is essentially a non-functioning system.

Another scenario that has happened is a “51% attack” which is where one entity has a majority of the hashing power.  They create their own block chain ledger and create s situation where they can spend the same coins twice.  Or they can simply disrupt the whole system by delaying transactions.

Alt-coins replacing Bitcoin in popularity.  Some other coin could replace Bitcoin as the most popular virtual currency.  However, if one of these Alt-coins does something better than Bitcoin it is possible that Bitcoin users could adopt this change within the Bitcoin system rather than switching to another coin.  It remains to be seen what will happen.

Availability of exchanges.  Being able to exchange these alt-coins also depends on exchanges willing to exchange the coins.  Currently, these coins, if they are exchanged, may depend on one or two exchanges.  Of course Bitcoin was the same way when it started and still is to a certain extent.

Malware.  Some users report being infected with malware from downloaded alt-coin software.  One user reported that one program used a key logger.  This logs every key stroke and sends the information back to the attacker.  The information was used to steal funds from their various wallets.  Do not load this software on a computer where you have Bitcoin stored or do Bitcoin transactions or other important things, such as accessing your bank account.

 

 

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