What is all the buzz around Bitcoin? Learn more about Bitcoin and other digital currencies — called cryptocurrencies — and get the overview on the issues they potentially solve for in this month’s Financial Fridays!
In today’s Financial Fridays episode we are going to be talking about Bitcoin. What the heck is Bitcoin, why does it exist, what is it for, and what is up with this term “cryptocurrency?”
If you live in a developed country, you’ve probably heard at least a little bit about Bitcoin and cryptocurrencies by this point, and perhaps you’ve heard more buzz lately. If you live in an undeveloped country, chances are probably even higher you’ve heard of Bitcoin. So what exactly IS Bitcoin, and if it matters at all, why should we be paying attention to it?
There’s a ton of history underlying digital currency, but Bitcoin was the first real attempt and success at a decentralized version. It was invented by an anonymous person who goes by the alias Satoshi Nakamoto. Satoshi announced Bitcoin in 2008 alongside a whitepaper titled Bitcoin: A Peer-to-Peer Electronic Cash System. The vision was that any two individuals anywhere in the world can exchange value in the form of digital currency without the use of an intermediary, not requiring a bank or government regulation to do so. In January of 2009, the network went live, and on a very small scale, people were now able to exchange value without the need for a central body. How exactly does this work?
A key detail here — and perhaps a source of confusion for those just learning about Bitcoin — is that Bitcoin is decentralized. All this means, though, is that it’s like the internet in that nobody owns it. Though it is a digital currency, it isn’t so much money for the internet as it is the internet of money. So when Bitcoin gets sent from one person to another, the transaction occurs through a technology called the blockchain, which catalogues these transactions in public ledgers. What this means is that you essentially tell everyone anonymously that you’re transferring value from yourself to someone else. Even though these accounts are anonymous and come with an associated signature unique to each transaction, every transaction still needs to be verified to ensure there’s no fraud taking place, and normally this is the job of a federal government or at the very least some other intermediary like Paypal or a bank. This need for verification from a third party is solved by actually asking people all around the world to handle it. An obvious question here may be, “why would anyone do this voluntarily?” The answer to that question is actually also the answer to the question, “where does Bitcoin come from?” Bitcoin “miners” set up home computing systems that will verify transactions by essentially solving a series of math problems that comes along with each transaction, and for every completed verification, the miner will receive a tiny fraction of a Bitcoin, and pass that verified ledger along to other nodes in the network.
Thus, a fractional amount of Bitcoin is created with every transaction, but not forever. Like gold, bitcoin has a finite supply, capping at 21 million units. This is one reason for Bitcoin’s imputed value, as demand could potentially continue to rise, perhaps significantly, while supply will never increase once it hits 21 million units in circulation. From there, miners will be motivated to continue verifying transactions digitally through transaction fees.
So what exactly can Bitcoin solve for? One important key is that because this decentralization of currency puts more power in the hands of people as a worldwide collective than in the hands of regulatory bodies like governments, people living in countries where they cannot trust their governments may find that a universal currency is life-altering. Countries like Zimbabwe are commonly mentioned case studies in how a government can betray their people by doing something like aggressively printing money until its relative value decreases into complete obscurity. In Venezuela right now as I write this in August of 2017, government-caused hyperinflation has caused their local currency to become almost totally useless, and the populus has begun to turn to Bitcoin mining as a means of procuring a currency that actually has value and can purchase them everything from food and baby diapers to insulin and other medications from overseas.
Bitcoin is also a potentially lucrative investment channel — it’s that point in the show, of course, where I must remind you that I am not a financial advisor and I am not recommending you do or don’t invest in Bitcoin. I personally do, but treat it as a largely speculative gamble because I believe in it and have seen its price action over the past year or so. I only invest in it what I am willing and able to lose completely. That having been said, many people hearing about Bitcoin and perhaps many who are listening to or reading this now have begun to look into it after hearing about its astronomical rise in value. Indeed, this is one huge factor to Bitcoin’s recent increase in buzz and adoption. Just one year ago in September 2016, a single Bitcoin was worth about $600 USD. As I write this, the value per coin is $4,600 USD, meaning a $6,000 investment a year ago would today be worth $46,000. Going further back, a $5 investment in Bitcoin in 2010 would today be worth $4.4 million. In fact, the catalyst for myself looking into and investing in Bitcoin started when I heard a family friend tell a story of a woman he’d actually met at a restaurant who had become a decamillionaire off of Bitcoin investments in the tens of thousands.
Aside from making millionaires already, some even consider Bitcoin to be a potential store of value in recessions, but the reality of that remains to be seen — it’s not a bad theory that a decentralized currency is determined by global climate rather than any single country, but nonetheless the volatility of Bitcoin suggests that for the time being, political powers are likely to affect value. It’s worth noting that Bitcoin, however, is not the only cryptocurrency, and even today we are still very early into its adoption despite its status as the reigning crypto. Apart from low awareness and higher barriers to entry, Bitcoin’s rapid scaling leaves it in a state of being somewhat plagued by higher fees than it was really ever intended to have, and its 30 minute “block” transaction time is notably slower than some alternative coins and tokens today. As of July 2017 there were 900 different cryptocurrencies, so it may be reasonable to assume that there are over 1000 today in September 2017. Not all of these operate like Bitcoin, as many use technologies other than the blockchain, and many serve specific niche purposes. Of course, not all of these are going to succeed in the long term — if any do — and in fact many are potentially even scams meant to money grab and crash or enable large principal investors to pump and dump a new coin. However, several primary alternative or “altcoins” such as Ethereum and Litecoin have seen generally stable lows and generally aggressive positive returns in a short timespan, with Litecoin having already grown in value by 1400% in 2017 alone. Each of these coins has a different development team and a different mission, and some — such as Litecoin — are even being touted as superior value exchange tools to Bitcoin. As with anything, I highly advise you do your own research before determining whether to invest, how much to invest, and in which coins to invest.
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