If you clicked this article, you are probably one of billions of people around the world that is starting to see "investing in Bitcoin" pop up in their daily lives, but you're not quite sure what it is or how it works. Well you've come to the right place! Today, I'm going to break down Bitcoin, starting with how it came to be, moving into what it actually is as well as the technology that powers it, and finally discussing its role in today's society, both from the views of a currency and an investment. So join me today in breaking down one of the stranger parts of personal finance in the 21st century. Welcome to Bitcoin.
Where Did Bitcoin Come From?
In order to understand Bitcoin, you have to understand a little bit about the world back in the late 2000's. The world was teetering on the edge. 2007 and 2008 saw the fall of the United States housing market, taking with it many financial institutions and cratering the stock market almost overnight. Joblessness exploded, retirement accounts were wiped out and banks...well banks were actually fine. Why? Because they received big checks from the federal government in order to stay solvent, meaning the banks went largely unpunished for their greediness in over-leveraging themselves and pouring money into "risk-free" mortgage backed securities. Once the mortgages imploded, so did the banks, prior to getting bailed out.
This bailout, while saving the banks and the money within them, caused a large sense of distrust in the general public. Why do banks get to make huge mistakes with our money, then get bailed out while the average person feels the pain? This type of sentiment drove one anonymous online coder named Satoshi Nakamoto to push back.
In 2008, Nakamoto published a nine-page whitepaper outlining his dream for a future where people can use a digital currency that is decentralized, free from the control of central bodies like governments or banks in a direct, peer-to-peer payment environment. The crux of this paper was built on the concept of cryptography, a concept popularized by former Microsoft engineer Wei Dai in 1998, but more on that in a minute.
Quickly before we move to the meat of what Bitcoin really is, let's close the loop on Nakamoto. It's speculated that Satoshi Nakamoto is an entirely anonymous entity, seemingly created online solely to discuss Bitcoin. While Nakamoto no longer interacts with the Bitcoin community, a wallet attributed to the pseudonym contains one million Bitcoin. Why is this important? Two reasons:
It takes one million Bitcoin out of circulation, further limiting the supply, and
That amount of the currency is currently valued at about $50 billion USD (as of December 6, 2021)
That second point is important because, curiously, there is a court case in Florida occurring at the moment that could finally reveal the identity of Nakamoto to the world, and immediately make him one of the wealthiest people on the planet.
The family of the late computer scientist David Kleiman is suing fellow computer scientist Craig Wright, stating that both men created Bitcoin under one pseudonym: Satoshi Nakamoto.
Wright contests that he is the sole creator of the currency, and that the one million Bitcoins he owns belong to him. However, neither family has ever produced a key to the digital wallet that supposedly belongs to Nakamoto, making the Bitcoin community more than skeptical about the claims from both families. The court case concluded on December 6, with a Florida jury ruling in favor of Wright, but forcing him to pay $100 million in damages out of the $57 billion fortune he has as Nakamoto.
Finally, though Nakamoto is largely removed from the community and seemingly no longer involved, the legacy lives on within the Bitcoin ecosystem. A "Satoshi" is the unit of measurement for one one-millionth of a Bitcoin, and is the smallest available measurement of the currency. Consistently buying Bitcoin? Then congratulations; you're "stacking Sats."
What Is Bitcoin Really? And What Is A Blockchain?
Let's Talk Cryptography
The concept of cryptography isn't new, and it doesn't even necessarily have to be digital. The sterile definition of cryptography is "a method of developing techniques and protocols to prevent a third party from accessing and gaining knowledge of the data from the private messages during a communication process." Simply put, it's the process of developing methods to keep communication secret between two parties. We can largely thank cryptography for giving us the modern day computer, as it was Alan Turing who created a rudimentary cipher to break the "Enigma" cryptography of the Nazi war correspondence in Bletchley Park during World War Two.
However, now that we've moved to a digital-first world, things are a little more...complicated. We now have cryptographic algorithms in both symmetric and asymmetric patterns that have given rise to a new type of technology: blockchain.
If you would like a comprehensive rundown of what symmetric, asymmetric and hashing are, I am ferociously under-qualified to explain it. However, there is a terrific guide at upGrad that's worth checking out at this link.
What Is The Blockchain?
Blockchain is the new-age equivalent of inflation: you hear it a lot, you might even say it once or twice in conversation at Thanksgiving, but you're not quite sure what you're talking about. Well let's clear it up: blockchain is an open-source, distributed ledger used to verify and store transaction data. Not much better, I know, but I'll break it down even further with an example your parents might appreciate.
Think about it like a checkbook: you go to buy something and then note the expenditure in your checkbook (or you used to prior to mobile banking). Now imagine that everyone in the world has a copy of your checkbook ledger. They can all verify how much you had, how much you spent and how much you have left. If you try to alter that amount in any way, it's kicked back because it doesn't verify correctly. And why would someone keep track of your transactions? Because they may get rewarded! Here' a brilliant breakdown of the process:
And while I realize that I am explaining blockchain technology for the purposes of breaking down Bitcoin, it's worth noting that blockchain is starting to find applications...pretty much everywhere. From finance applications to the automotive industry to cellphone networks and even media companies, many different industries are finding new and innovative ways to use this distributed ledger system to make their business more efficient and effective. This chart from upGrad indicates just how many companies are getting into the space by way of their current blockchain-related job openings:
So What Is Bitcoin?
The reason I have waited so long to get here and to explain in annoying detail the concepts of cryptography and blockchain is because Bitcoin is the bastard child of both ideas who has then been coated with a creamsicle paint job and weird logo, along with laser eyes.
Bitcoin is a decentralized currency that allows peer-to-peer payments via the encrypted blockchain network, using cryptography to verify the transaction and issue payments. OK, everyone breathe. You alright? Take a second. OK, now let's get into some of the advantages of Bitcoin and its hyper-complex background.
Bitcoin Is Inflation-Proof
Unlike fiat currency like the U.S Dollar or Great British Pound, Bitcoin has what's called a "controlled supply." Bitcoin was only ever designed to have 21 million total coins in circulation. Once they are all mined, that's it. That makes the token inflation proof. While the Fed can continue printing money and influencing interest rates, Bitcoin doesn't have that, or have to worry about it.
Bitcoin Payments Are Borderless
Shout out to Western Union for this one. Want to work abroad and send money home? Bitcoin can do that. Want to pay your buddy directly for something but they're in a different country? Bitcoin can do that. You don't need an intermediary like Western Union or a bank charging you outrageous wire fees in order to send money to someone abroad. Speaking of fees...
Bitcoin Transaction Fees Are Relatively Low
Thanks to Bitcoin's Lightning Network, it's possible to open peer-to-peer payments without having a direct channel to one another. Without needing to keep a dedicated resource open for you, the fees are quite low.
Bitcoin Is Always-On
Do you want to buy shares of MercadoLibre or Disney at 3am on a Saturday? You can't, because the stock market closes at 4pm on Friday (sort of) and reopens at 9:30am on Monday morning. Cryptocurrency is always-on, meaning there is non-stop liquidity in the market. You can buy or sell whenever you see fit.
How Do I Get Bitcoin?
There are realistically two ways you can acquire Bitcoin: buying on an exchange from someone else, or mining it. Since buying it isn't very interesting, I'm going to dedicate this section to outlining the process of mining Bitcoin. As a note: I'm planning on publishing a piece in the near future fully dedicated to the process of cryptocurrency mining, so this is a quick overview. You've been warned.
Bitcoin Mining and Rewards
Imagine for a second that your boss at work asks you to build a presentation for your company. That presentation takes you about a week to build, which you then shoot to your boss who verifies that it's correct and you get paid. Easy, right? Now imagine that you continue to get asked to build presentations, but they take a little longer each time and you get paid a little bit less. This process continues until you reach a certain number of presentations prepared, when all of a sudden, you start making half as much money for each one. You then decide that you need help, so you bring someone else in to help you make the next presentation. This continues over and over until all the money is gone, getting cut in half over and over again as the years go on.
This process is the exact same concept as mining cryptocurrency. Replace yourself with a computer, and the presentation with a complex math problem on the blockchain, and you all of a sudden now understand the process of mining Bitcoin!
Bitcoin mining used to be extremely profitable. You could fire the laptop up and run it for awhile, after which you would find Bitcoin deposited into your wallet. Now, however, it's a whole different ballgame. So many people with so many mining rigs attempting to mine cryptocurrency of all kinds now are leading to the practice not really being that profitable anymore. With Bitcoin specifically, the electricity it costs to run a full mining setup means your power bill could quickly outpace your Bitcoin profits. There's also no guarantee that you'll receive any Bitcoin at all in the process, as the token is only awarded to the computer that solves the problem the fastest. If you're running a mining operation on a 2005 purple iMac, you can likely say goodbye to any sort of passive income.
While mining Bitcoin may not necessarily be that profitable anymore, there are other tokens you can mine that can still achieve quite a bit of value. Take, for example, this sibling duo who made over $160,000 in 2021 by mining Ether, Bitcoin and Raven. I also want to note that they're making this kind of money at 14 and 9 years old, which makes me borderline suicidal. However, that sibling duo is spending $9,000 per month on electricity and rent for a data center to house the nearly 200 computers they have running equations, many of which contain graphics cards that cost around $3,000 each. EACH. So you can definitely see how mining can be a bit...fruitless.
How Can I Use Bitcoin?
So let's assume that you obtained some Bitcoin, either through mining or buying on an exchange. Now that you have it, what do you actually do with it? Well, there are two main uses: currency and store of value. I'll break them down.
As A Currency
Bitcoin was originally created to be a digital currency, so why not use it as such? For instance, that's what El Salvador is doing with the adoption of Bitcoin as a national currency. You can also use it to transfer money directly to an individual, and more companies are beginning to adopt various cryptocurrencies as valid forms of payment. However, there are serious downsides to this, with one being transaction speed.
The Bitcoin network is slow. Like, really slow. Because Nakamoto coded into Bitcoin's blockchain architecture a 1 megabyte maximum block size, this causes transaction verification bottlenecks. As a result, Bitcoin's typical transaction verification speed is between 3-7 transactions per second. While that sounds fast, competitors like Visa and Mastercard clock in at around 1,700 transactions per second, leaving Bitcoin's network in its dust. This leads to what's called "The Bitcoin Scalability Problem," and is what ongoing Bitcoin updates/upgrades are centered around fixing. The recent Lightning Network improvement is purportedly going a long way to fixing this issue, but it's something to consider.
As A Store of Value
The other current use-case for Bitcoin is as an investment, or "store of value" as you may hear it called by old white men in pinstriped suits from the late 80's. A store of value is an asset that can be exchanged for money in the future that will have held its value, and gold is frequently pointed to as the real-world store of value example. However, over the last decade, gold has actually declined 1% in value, so there goes that theory.
What we're starting to see now is Bitcoin being treated like an investment asset, though it's starting to get less speculative. A 2021 report from Gemini, one of the larger cryptocurrency exchanges, found that 14% of U.S adults owned some form of cryptocurrency. The Motley Fool's survey found that 51% of Americans purchased cryptocurrency for the first time over the past 12 months. Now we're seeing companies like Tesla and Microstrategy hold Bitcoin on their corporate balance sheets as an investment. Tesla's $1.5 billion investment into the coin actually netted them $1 billion in profit at the 2021 price peak, though it's fallen since.
Millionaires are also opening their portfolios to Bitcoin. The 2021 edition of CNBC's bi-annual survey of American millionaires found that millennial millionaires have about 25% of their net worth tied up in some sort of cryptocurrency. Asset managers have noticed this trend and are now starting to integrate Bitcoin into their strategies, albeit unwillingly. JP Morgan began putting some wealth clients into cryptocurrency funds in August, right before CEO Jamie Dimon blasted the currency for being "worthless." They've also started giving out NFT's, which is confusing.
Finally, we have the Bitcoin maximalists, or "maxi's." Bitcoin maxi's are those that believe in the power of the product so much that they evangelize it, dedicate their professional lives to it and "orange pill" others into the doctrine. While you'll find plenty of bots and spam Twitter accounts, you'll also find some digital heavyweights throwing their reputations around. MicroStrategy CEO Michael Saylor tweets about essentially nothing but Bitcoin.
Jack Dorsey left the corner office at Twitter and then changed the name of his other publicly traded company from Square to "Block" to better encompass their focus on blockchain technology and Bitcoin.
The Bottom Line
Regardless of if you're a "believer" or not, Bitcoin and the blockchain technology it's built upon seems here to stay. Increasing levels of adoption from not only retail investors, but institutions and even fucking COUNTRIES is driving levels of mass awareness and inflows of cash. Could it one day establish itself as a true currency, replacing the fiat standard? Who knows. Could you treat it as a store of value and one day retire from your Bitcoin investment? Again, who knows! The fact is that Bitcoin, and cryptocurrency as a whole, has already shaken up the global financial system, and it looks like it still has a long way to go.
Do you invest in Bitcoin? Will you now? Let me know in the comments below! And don't forget to sign up for my email list so you can get these in your inbox as soon as they post. Thanks for reading!