What In The Hell Is A Bitcoin?

Today we will discuss Bitcoin, and I am reminded of the quote by the Taoist Zhuangzi         “A frog in a well cannot conceive of the ocean…” I think a lot of folks, myself included, feel that way as they try to wrap their head around Bitcoin…

Paging Satoshi Nakamoto…

Introduced in 2008 in a very simple White Paper, the very first sentence of the Bitcoin edict succinctly states, “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” Ok… simple enough, right?

Since coming online in 2009, Bitcoin has achieved its goal as a peer-to-peer payment system and become the most popular decentralized currency in the world – decentralized meaning there is no central entity that controls or regulates it and there is no institution printing additional funds.

Bitcoin is maintained on a distributed ledger system called the blockchain, which is an absolutely ingenious invention by a person (or more likely a group of people) using the name Satoshi Nakamoto. To date, the true identity of this man (or group) is unknown.

Mining & The Blockchain:

Simply put, the information that is held on the blockchain exists as a shared and continually reconciled database. It is not stored on a single system or in any single location, but it is hosted by millions of computers simultaneously, and the data is accessible to anyone on the internet.

In exchange for connecting your computer onto the blockchain and assisting in maintaining the ledger, you are rewarded fractional shares of bitcoin – this is called “mining” and it is the only way new Bitcoins can be introduced into circulation.

bitcoin mining a rig
When mining, electricity will be your biggest enemy – along with cable management.

By design, there will be a maximum total of 21 million Bitcoins created and it will take until 2140 for that last Bitcoin to come online.  Until this 21st million Bitcoin is mined, anyone can participate in the mining process as it is an open, decentralized ecosystem.

Currently, there are 16.1 million Bitcoins in circulation and there are 11.5 million Bitcoin wallets – digital accounts online where Bitcoins can be “stored”.  A vast majority of these wallets have less than 1 Bitcoin in them. There are only 130,000 wallets with more than 10 coins, 1,628 wallets with more than 1,000 coins, and 110 wallets with more than 10,000 coins. The largest wallet on the blockchain has 124,178 Bitcoins (worth roughly $368M dollars).

Bitcoin Usage:

PayPal was founded with the idea of becoming a new online currency but instead succeeded in becoming a fantastic online payment system. In quite the opposite fashion, Bitcoin has taken the lead in online currency, but has so far been very lacking as a payment system.  I have owned Bitcoins but never once have I used one to purchase anything, though I use PayPal all the time as a middleman / 3rd party for online payments.

The first publicly known Bitcoin transaction for goods or services was in May of 2010 when a guy named “Laszlo” announced on bitcointalk.org that he would pay 10,000 bitcoin (then worth $25) for 2 pizzas. Four days later, a guy named “Jercos” took him up on his offer and delivered him 2 supreme pizzas from Papa Johns in exchange for the bitcoins. I hope Mr. Jercos held onto those bitcoins for posterity – today they would be worth over $20 million dollars!

Bitcoin Believer
You can buy/sell/pay with micro-payments as small as 1/100 of a Bitcoin (around $28 today)

There are over 100,000 merchants today accepting bitcoin as payment, among them are Amazon, Expedia, Home Depot, Subway, and Tesla. Most folks agree, however, that for Bitcoin to remain viable it will have to soon become a common form of payment. Right now it is almost purely a speculative instrument as its transactional value in exchange for goods and services is minuscule (see chart below).

bitcoin transaction disconnect
Bitcoin desperately need to increase its use as a transactional currency (chart by Aswath Damodaran)

The Dollar vs The Bitcoin:

The US Dollar is fiat currency, meaning it is declared currency by the US government but it is not backed by a physical commodity or the material of which it is made. A dollar bill is worthless paper without the fiat of the government declaring it valubale. What determines the dollar’s value? In my opinion it is ultimately backed by military and law enforcement power, but that’s probably a topic for another blog post…

digital dollar bill

Unlike Bitcoin where the supply is limited, at any given time our government can print more dollars and push them into circulation – as demonstrated by the insane policies of Quantatative Easing over the past 8 years. Using QE, our government “manufactured” money and used it to buy assets from banks, loading up the Federal Reserve’s balance sheet with literally trillions of dollars worth of liabilities that would be impossible to value were it not by fiat of our government.

Bitcoin is decentralized, with no governing authority, and it is finite in its creation. These two concepts are very hard to grasp for those us raised on the concept of the mighty USD. We’re like frogs in the well when it comes to a decentralized currency – and the government most likely prefers it this way…

Gold vs The Bitcoin:

Gold and Bitcoin share common traits – rarity and user confidence. In these terms, no alchemist has every counterfeited gold in a laboratory and most folks doubt some huge deposit of gold will be found that might double or triple its supply and knock the pins out from under its price.

In the same terms, Bitcoin’s existence is measured and finite and for someone to give themselves “free” bitcoins or use the same bitcoin twice, they’d have to commandeer over 51% of the competing power on the blockchain and trick those systems into accepting the fake transaction.

bitcoin chart
Bitcoin 2017 price increase versus gold and major stock indices

Gold and Bitcoin also share one other common trait – in September of 2015, the FTC declared Bitcoin a commodity, just as gold is a commodity, and in March of this year, the value of Bitcoin exceeded the value of gold for the first time ever.

So – What In The Hell Is A Bitcoin?

To the frog in the well it is digital currency and nothing more. It is mysterious and forbidding – too complicated to understand, too complex to be a worthwhile endeavor, and too risky to commit one’s resources toward.

To the active investor it is a brand new commodity on the trading desk with vast potential. For now, its value is being driven purely by speculation, but where will digital currency take us? No one knows…

For myself, with Bitcoin and other similar currencies like Etheruem, Litecoin, Ripple, etc. the true value lies in the underlying blockchain / distributed ledger technology and how that can be applied elsewhere. Investment beyond Bitcoin and into blockchain startup companies (like ConsenSys and Slock.it) is very intriguing to me as I see them as very disruptive technologies.

Blockchain Applications (2 Examples):

Wall St. firms have poured over $1billion in investment toward exploring the use of blockchain / distributed ledger technology. These new technologies could transform everything from stock exchanges to commodity & foreign currency trading, with instant trade settlements and better security. They can do so with greatly increased efficiency. The potential savings to financial firms in their reporting, business operations, and compliance requirements could be huge.

blockchain technologies
Some familiar names exploring blockchain techonolgies

I love UjoMusic’s manifesto; “Shouldn’t it be possible in a digital world for the royalties to come directly to you, instead of through a slow, inefficient, and opaque chain of collection societies and publishing administrators?” I do not understand why the music business has not embraced a major push toward blockchain / distributed ledger technology. One “click” to download a song can instantly send the monies directly to the contributors of the project with no middlemen involved (see below). Obviously this puts a lot of major players in the industry out of business, so adaptation may be painfully slow…

Imogene Heap
An example of Imogene Heap’s Ethereum blockchain

Should You Buy A Bitcoin?

It is all the rage, all the talk, and the big new fad. Should you invest in Bitcoin? I do think it is a worthwhile investment. Please know, however, that this is highly speculative investing. If there is a “bubble” in the market today, Bitcoin would definitely be a bubble contender.

Rarely do you hear a cryptocurrency trader speak in terms of any kind of fundamental value – they’ve lost sight of that, if there was ever a way to fundamentally value digital currency in the first place. Mostly you will hear them talk of charts, graphs, and “trading indicators”. Tread very, very carefully.

bitcoin bubble
Bitcoin’s rapid price increase measured against other famous bubbles that have subsequently burst…

What is fueling this skyrocketing value? One, recent news that India and Russia are moving toward legalizing Bitcoin as currency are fueling speculation. Two, a review of a Bitcoin ETF run by the (in)famous Winklevoss twins that was denied approval by the SEC in March but is now being reconsidered – its approval would open Bitcoin trading up to anyone able to buy an ETF and bring a lot of new “owners” into the finite space. Three, China has a love/hate relationship with Bitcoin but seems to be warming to it recently, declaring it can be an “asset” in the country, just not a “currency“. Lastly, I think folks are simply losing faith in government fiat currencies and desperately seeking a long term alternative, for which Bitcoin has become a good fit.

Personally, I would not invest more than 10% of my cash on hand in Bitcoin – that’s not 10% of my investment portfolio –  but a mere 10% of the cash I have to spend, outside of my normal investing allocation. “Vegas Money” I call it…

One note, the Commodity Futures Trading Commission granted a license to LedgerX to serve as a derivative-trading platform for Bitcoin and other cybercurrencies. This means options & derivatives trading for cybercurrencies will be available soon – buckle your seat belts, that will be a fun ride! Funding for LedgerX is led by Google Ventures and Lightspeed Venture Partners – BIG money…

How?

If you do want to take the digital currency ride, I would recommend Coinbase as your “portal”. There you can buy and sell Bitcoin and other digital currencies, as well as store your digital currencies in a digital wallet. If you click on that link we’ll both get $10 in Bitcoin when you buy $100 worth – not a bad way to earn a free 10% on your money…

If you’d like to send me some digital currency, my wallet’s address is: 1Fq9wztXrM3z4b8z1Q4ZAjBoayYrQ4BwGT or you can scan my QR Code below:

Coinbase QR Code

That’s all I’ve got for Bitcoin and the blockchain. I hope it was worth the read and I look forward to re-visting the topic from time to time and seeing where this rapidly developing road will lead us – Cheers!

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