It’s hard not to have heard of Bitcoin at this point. The cryptocurrency is up 650% over the past year, hitting new all-time highs last week at $4,300.00, from $0.05 in July 2010. And we’re not messing up our decimal places here; that’s 4 thousand three hundred dollars per Bitcoin today, up from five cents per Bitcoin a few years ago. It’s no wonder names like Fidelity and Goldman Sachs now accept Bitcoin as a viable currency. Put that all together and Wall Street has changed their tune when it comes to gains like this.
(Disclaimer: Past performance is not necessarily indicative of future results)
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But what is Bitcoin? In simplest terms, Bitcoin is a new form of money. Or, as the financial folks like to call it – a new type of currency. And what is money/currency, after all, besides just something that is accepted as a form of payment? Some people call Bitcoin “digital money” but money is already digital. You aren’t squeezing quarters through the phone line when paying with that credit card, right? The part that makes Bitcoin different than just “digital money,” is that it doesn’t need a bank or a government to work. Instead, it uses math and the ability to store all of its transactions on itself (like a huge dollar bill with every payment it was ever used for written down on the bill). From that standpoint, it’s more like digital gold.
So, distilling things down to their simplest terms, and skipping some important details (for now):
Bitcoin is digital money that doesn’t need a bank.
That ‘no bank’ part was why Bitcoin was originally thought of as a cryptocurrency for making illegal purchases on the black market. But it can also mean no intermediary, no bogus ATM fees, and nobody to block your access to money; which are all pretty admirable features. But that “skipping some details” part is where and why things get confusing in the Bitcoin world in a hurry. Because it turns out there’s a lot more going on. Like encryption and something called Blockchain technology. Turns out, a bit more technically correct one-liner would be something like (here’s paraphrasing Wikipedia a little):
Bitcoin is digital money that uses cryptology to ensure trust & fungibility in a theoretically tamper-proof decentralized ledger called a blockchain.
Cryptology, decentralized ledger, theoretically tamper-proof? Before our imaginations run rampant, here’s our best attempt at explaining Bitcoin:
If there’s no bank or government issuing this digital money where does it come from? This is the part where most people’s eyes gloss over. It’s digitally “mined.” We like to think of it like this: When you mine gold, you get a bunch of machines and dig in the ground until you find the gold. With Bitcoin, there is no ground… there is an equation instead. So instead of Gold hidden under tons and tons of dirt and rock, Bitcoin is hidden under tons and tons of math. To mine it, you set your machines (computing power) to “dig” through that equation until it hits the “bottom” and finds the Bitcoin. But there’s not an unlimited supply of Bitcoin out there. In fact, Bitcoin’s volume is determined by an equation – with the limit of the most Bitcoin that can be mined equal to 21 million. The best explanation we found was on Quora – breaking down when and how new Bitcoin are released.
A block ( think of it as transaction data organized in a digital ledger) introduces 50 new coins into the bitcoin ecosystem. This quantity mined halves every 210,000 blocks.
For instance, the reward for mining a block was most recently cut in half on July 9th, 2016 from 25 bitcoins to 12.5 bitcoins as reward for solving the Byzantine general’s problem. The next halving event occurs every four years with the next one slated for 2020 with a block reward amount of 6.25 bitcoins.
We can visualize the limit of coins mathematically as the summation of this geometric series below:
What’s this BlockChain Business?
A Blockchain is essentially the cloud-based hub of Bitcoin. All transactions, Bitcoins being released, and mining goes back to a distributed ledger called a blockchain. Since Bitcoin is decentralized, the blockchain allows for the sharing of vital transactional information that would otherwise be stored at a centralized location. MIT gives a good overview of how it works:
At a high level, blockchain technology allows a network of computers to agree at regular intervals on the true state of a distributed ledger,” says MIT Sloan Assistant Professor Christian Catalini, an expert in blockchain technologies and cryptocurrency. “Such ledgers can contain different types of shared data, such as transaction records, attributes of transactions, credentials, or other pieces of information. The ledger is often secured through a clever mix of cryptography and game theory, and does not require trusted nodes like traditional networks. This is what allows bitcoin to transfer value across the globe without resorting to traditional intermediaries such as banks.”
Each time a new transaction takes place, a Bitcoin is mined, or any piece of information is recorded – it’s referred to as a block that gets added onto the blockchain. So the blockchain is theoretically endless. But don’t get the idea that this is something unique to Bitcoin.
When The Economist put blockchain on the cover in 2015, it wasn’t really about its use to support a digital currency anymore. It was all about the other applications this technology will unleash within the next 5 to 10 years,” Catalini says. “For example, in finance and accounting there is excitement about the ability to settle and reconcile global transactions at a lower cost using the technology. In logistics the attention is all on how you can use the immutable audit trail generated by a blockchain to improve the tracking of goods through the economy. Others are fascinated by the possibility to use this as a better identity and authentication system.”
And It’s not just one of two companies utilizing this technology, the entire financial services ecosystem has bought into the idea – via the World Economic Forum.
Time will only tell how fast this technology gets accepted as mainstram until it becomes integral to everyday life.
What if you don’t own a server farm that can mine Bitcoin all day? Then what? Well, there’s seemingly an infinite amount of crypto exchanges out there setup to facilitate the exchange of one currency or another for different cryptocurrencies like Bitcoin. Do a Google search for “Bitcoin exchange” if you dare and spend a few days of your life reviewing them all at your own peril. Think of it like those little booths at the airport, only all online. These have not been without their share of drama and intrigue, with thefts and bankruptcies and fraud all happening at one point or another:.
And there’s even Bitcoin ATMs, if you want to physically interact with a machine in order to get your virtual asset, or weirder yet, exchange some of your Bitcoin for dollars to spend somewhere, which sort of goes against the whole purpose of the Bitcoin in the first place.
Using Bitcoin (for a Footlong a Subway)
If one Bitcoin is worth roughly $4,300 dollars, one would think it would make transactions for smaller items difficult, right? Not necessarily. Bitcoin is accepted and used in more places than you might think. For instance, Subway! They’ve been doing it since at least 2013!
Once our subs were made the employee took out an iPad and opened Coinbase. She punched our total in the register and then in the iPad, which immediately generated a custom QR code linked to the store’s Coinbase account which was preloaded with our exact total calculated. I took out my iPhone, opened my Coinbase app, and scanned the QR code. Instantly the total popped up on my screen and gave me the option to leave a note about my purchase.”Subway” seemed appropriate.
I hit send and within seconds she received confirmation on the iPad that her account had received the Bitcoin. It took no longer than a credit card transaction, and it didn’t require my signature.
Transferring Bitcoin is a lot like Venmo. With Venmo, we can see when our friends pay each other for brunch or movie tickets and the amount, we just can’t access that money. With Bitcoin, we can see all transactions taking place, but we don’t know who is involved in the transfers. Those transactions are tied to your online wallet or “lockers.”
Paying by a QR code isn’t all that new and it eliminates the how we think about currency. Instead of pennies and nickels, the smallest measurement of a Bitcoin is one-hundred millionth of a token or what’s referred to as a Satoshi’ after its founder. Right about now, a Satoshi is worth $0.00004014. But that doesn’t matter if it’s a transaction that’s all digital. It just might surprise you how many companies already accept Bitcoin. That’s just one way to spend Bitcoin. Here are just a couple from an interesting infographic by WhoisHostingThis:
If there’s no bank, and it’s digital – where do I keep my Bitcoin?
Imagine Bitcoin is your school lunch. You need a locker to put it into to keep it safe. There are unbreakable see through containers on display for you to store them at school. You can access as many locker’s as you want to store your lunch, as there is an endless supply of locks – and each unused locker you can use with its own locker combo. Everyone can see what kind of lunch is in there, but they don’t know it’s yours, and they can’t access it without your combination. This is what people describe as your online wallet.
But, Just like any wallet – a virtual one can be stolen as well. Just last year, “an early Bitcoiner” had millions stolen in Bitcoin using only phone numbers.
He had kept it offline for most of the past several years, but had connected that device in recent weeks to move them somewhere more secure and sell some. Though he had locked it with a 30-character password, the hackers moved the coins off. And unlike a credit card transaction, a transfer of a cryptocurrency is irreversible.
There’s no issue when it comes to using Bitcoin, but the currencies movement is keeping it from becoming more legitimate. Currencies that we’ve come to know move in price all the time, just not as fast or rapidly as Bitcoin. For instance, Bitcoin is worth $3,200 more than it was that at the beginning of 2017. Investors who have Bitcoin might be scared to use it in fear of the cryptocurrency continuing to grow in value (i.e. why spend the Bitcoin you have on groceries if it’s going to double in a couple months?). Early adopters to Bitcoin might be playing the waiting game to sell most of it. So, it’s almost turned into an investment rather than a currency.
Does Bitcoin need to be both for its further acceptance in everyday culture? Does the Bitcoin market need to become more stable in order for more and more people to start using it? Or do we let the market fly free and wait to see how much the market gains before we reach the limit on the amount of Bitcoin in the market? The man who bought Subway using Bitcoin seems to think the answer is Bitcoiners using it for purchases.
Transactions will be the backbone of bitcoin’s future. If you really want to support bitcoin’s longterm success, you need to support bitcoin-accepting businesses by making purchases. Unfortunately, due to the volatility of bitcoin over the past year, many people are choosing to sit on their investment and watch it rise and fall in value.
If the market does look to stabilize, Zerohedge suggests pegging it to Gold, like we used to do with the U.S. Dollar, giving it some “physical legitimacy.”
One potential solution to the Bitcoin volatility problem I find interesting is to link Bitcoin to gold at a fixed rate. This would require consensus in the Bitcoin community and a sponsor willing to make a market in physical gold at the agreed value in Bitcoin. This kind of gold-backed Bitcoin might even give the dollar a run for its money as a reserve currency, especially if it supported by gold powers such as Russia and China.
Investing in Bitcoin
So, maybe you don’t want to actually use Bitcoin, but you’re interested in some of those charts showing it going up and to the right sharply. What to do? Well, there was a much-publicized effort by the Winklevoss twins (yes, those made famous by the Social Network movie) to get SEC approval for a Bitcoin ETF – but it was denied (temporarily sending Bitcoin prices crashing, by the way). Others have looked to $GBTC, the Bitcoin Investment Trust which trades over the counter and is not yet listed on an exchange. There’s just one issue there, the trust is being bid up well above the value of its Bitcoin holdings.
Then there are some penny stocks which provide crypto currency services, but proceed with much caution there. Of course, not everyone believes this is an investable asset. There’s famed hedge fund manager Howard Marks, who called the internet bubble, saying Bitcoin is a pyramid scheme.
As for us in the alternative space, the CBOE recently announced its plan to launch Bitcoin futures to allow those looking to profit another avenue that paying the premium above. It’s like some smart people in the space recommended this years ago….
Here’s FT on this exciting development:
CBOE and Gemini expect the deal to pave the way for the exchange to launch Bitcoin futures contracts by the end of the year, pending regulatory approval. The Bitcoin futures will be cleared via the Options Clearing Corporation, the exchange said.
Gemini, which is regulated by the New York State Department of Financial Services, acts as a gateway for users who want to trade bitcoins but also have it linked with a normal bank account. CBOE will retain exclusive rights to use Gemini market data for the creation of new indices, as well as rights to distribute Gemini market data over the options exchange market’s data feeds.
Bitcoin, and all of the other cryptocurrencies which have followed are exciting because they are at the intersection of finance, technology, equality, anonymity, and independence. It has the potential to dramatically change the way transactions take place, to depower banks in favor of individuals, to drastically lower fees and layers of access to people’s own worth. If nothing else, it will have ushered in the age of Blockchain technology which has applications outside of the digital currency. Time will only tell whether Bitcoin will be a winner take all winner like Google or Amazon, or whether all of the cryptocurrencies can co-exist in some manner. Not to mention what will happen when we’ve reached the upper bounds of limit on the amount of Bitcoin in the world (perhaps that will stabilize the market and make it a real currency). Are we going to 25,000 on Bitcoin, or zero as it’s exposed as a scam? Both sides are passionate about it. But we’ll greedily grab a seat and watch the show, given the launch of futures on Bitcoin, which would benefit from the volatility and pushes one way or the other.
Article by RCM Alternatives