Last December we launched a project to track the progress and evolution of Bitcoin. The project is not intended as a recommendation for Bitcoin, but more of a public learning experiment. I have no idea if the future price of Bitcoin will be worthless or extremely valuable (I still think both are possible). Bitcoin is a cryptocurrency that was unveiled to the world back in the fall of 2008. We do not know exactly who was behind the creation of Bitcoin, but due to its complex nature, it seems unlikely that it was the work of a lone individual. Since we first introduced the project, Bitcoin has produced its typical wild ride. After soaring roughly 70% from early December into mid-March, Bitcoin was pushed back to around $900. In April, the price steadily advanced and now trades at all-time highs around $1,450. The March decline occurred after the Securities and Exchange Commission (“SEC”) shot down the approval of an ETF that would track the price of Bitcoin. The SEC cited the lack of regulation as a key driver in not approving the investment, which in a lot of ways serves to further validate a key aspect of Bitcoin. No group controls or can completely regulate Bitcoin. I suspect that may be the most important foundational truth to remember.
The more I have studied and thought about Bitcoin, one of my “watershed” moments occurred when I stopped to think about virtual currency in the perspective of history. Money is a store of value that can be exchanged. Throughout history, money has taken on many forms ranging from sea shells, livestock, gold, and paper currency. If the form of money has changed over time, shouldn’t we assume it will change again?
I was in Nashville, Tennessee recently and noticed a couple of things related to cash. First, most of the vending machines I saw had credit card readers on them. I have seen those before, but the occurrence rate seems to be growing rapidly. Second, at a gas station I noticed the air compressor across the parking lot had a credit card reader on it. I can remember digging around my car for $0.50 to air up my tires many years ago. Now, no change required, just swipe it! Cash seems to be slowly going by the wayside.
Vendors such as PayPal, Global Payments, Apple Pay, etc. are beginning to make a dent in how money moves around society. I have a good friend who recently turned me onto the ease of sending cash through PayPal. I’ve used PayPal for years when making purchases to online vendors who do not accept direct credit card payments. By establishing a link between PayPal and my bank account, I can quickly email money to anyone with a PayPal account. It doesn’t cost me (or them) anything if the money comes from my bank account and is not processed through a credit card network. However, that only works if I have a bank account. The World Bank Group estimates that roughly 2 billion people globally are “unbanked.” What would the impact be of opening up basic money transferability to billions of additional people? Some forecasters think Bitcoin might play a role in this process over the coming 10 years. The jury is certainly still out on the issue. Bitcoin remains a very unproven yet full of potential concept.
In our first issue on Bitcoin, I introduced three key details. Below we will start to develop these concepts:
- Bitcoin is a digital currency. It is purchased, sold, and exchanged for goods and services on a “de-centralized” network, meaning that no one entity or authority controls it. Here in the US, we operate under a central bank (US Federal Reserve Bank). There are 12 regional banks that assist in controlling the money supply and implementing policy decisions. These regional banks help distribute currency to US banks, make loans to banks, and oversee the regulation of the banks within their geographic area. This is a centralized network. Likewise, the payment networks of credit card companies are owned and controlled by centralized entities (Visa, MasterCard, American Express, etc.). No one entity or government controls Bitcoin.
- Bitcoin supply is limited to 21 million Bitcoins. Unlike most of the world’s currencies, the supply cannot be increased (or decreased). One of the greatest risks to currency is that it becomes diluted over time. Over the past 10 years we have seen trillions of US dollars, Japanese Yen, and Euros created to purchase sovereign bonds in the effort to lower global interest rates and create additional liquidity into the global financial system. By code, Bitcoin is limited to a finite supply. Today around 15 million bitcoins have been created or “mined.” There is some debate in the bitcoin industry about the future scalability of the network and whether it can really handle mass adoption on a global scale. Most likely there will need to be enhancements made to the network to allow that type of scalability. You’ll see the term “hard fork” thrown around related to bitcoin and the blockchain. We’ll discuss that at some future point, as it could be a major variable in the long-term health of the network.
- Transactions involving Bitcoin are recorded and verified on what is referred to as the “blockchain.” Think of the blockchain as a global peer-to-peer network. As previously discussed, there is no one organization who maintains the records, rather those records are documented on thousands of computers around the globe. In other words, you have lots of people who are keeping track of the same thing at the same time.
Let’s use a poker game to illustrate. Let’s assume you sit down to play poker only no one brings any money or has any chips. Instead, all players keep a paper ledger by writing down who makes what bets, and the outcome of each hand. You don’t have to individually trust everyone at the table because everyone is recording every card, bet, and hand that is played. At the end of each hand, everyone shares their transaction record and compares them for accuracy. The next hand cannot begin until all participants agree on a unified record of the game. This prevents an innocent mistake along with efforts to cheat the game. If you continue to play the game eventually you will fill up an entire sheet of paper with transactions. Let’s consider each sheet a block of information. Over time you will have multiple sheets of paper that together will form a chain of transactions that anyone can review at any time. No one can alter the records after they have been approved. The longer the transaction log continues, the more secure it becomes, as there is a permanent record of all activity since the game began. If a player tries to use money that they do not have, the ledger will know that they have exhausted their resources and tell them they cannot continue to play. This prevents one player from losing money they do not have, and thus protects another player from having an unpaid purse.
Since our project began in late 2016, the price of Bitcoin has risen roughly 88%. Bitcoin stands today at a new all-time high. Continued price appreciation will grant the concept greater visibility, but further investment will be required to build out the Bitcoin/blockchain concepts before we see practical applications developed. Note that Facebook wasn’t developed until years after the internet went mainstream. We remain in the “pioneer” days where both risk and reward are exceptionally high.
In our next update, I plan on delving into cryptography and the overall security of the Bitcoin network. I will also try to explain the role of bitcoin mining on the blockchain.