A quick primer on how Bitcoin works
We need to start our journey into the crypto world with the most important cryptocurrency – Bitcoin. In October 2008, an anonymous person published the Bitcoin White Paper on the internet under the name Satoshi Nakamoto. You can read it here if you are really curious, but it’s not needed. Here’s the Cliff Notes version. Bitcoin was defined as “peer-to-peer electronic cash” where ownership would be recorded on a network of remote computers. The paper set out a methodology to compensate people for managing the computer records, and it establish a maximum supply of Bitcoins. It also made it possible for Bitcoins to be owned in tiny little fractional amounts.
Let’s get an important point out of the way first. 13 years after the white paper was published, no one knows who Satoshi Nakamoto actually is. It’s not clear if Satoshi is male or female, or a group of people. For simplicity, I’ll refer to Satoshi as “they”. People have tried to claim they are Satoshi, but no one credible has emerged yet. For regular finance people, this is a big stumbling block. How can someone who created something this important not step forward and claim credit? Even more strange is that Satoshi holds a lot of Bitcoin, worth more than $50 Billion today, and this person has never moved or spent any of these Bitcoin. Look, I’ll admit that I don’t understand this part of the story either. Maybe Satoshi is dead, maybe they lost access to their account somehow, I don’t know.
Glad we got that out of the way, moving on. In the beginning, there really wasn’t an easy way to buy or sell Bitcoin, and not a heck of a lot happened. Satoshi didn’t start a broker firm or exchange or anything, they just published the paper and let the world decide what to do next. Eventually people started following the instructions in the white paper and began to “mine” Bitcoin. I’m going to stay away from making this too technical. The basic concept is that you hook a computer up to the Bitcoin network, perform some calculations to prove your value to the network, and then you are a “miner”. In the early days, anyone could do it with a simple desktop or laptop computer, and they would earn some Bitcoin as compensation. The Bitcoin wasn’t worth anything back then, like a few pennies per Bitcoin only, so institutional entities did not get involved. In later posts, I’ll talk about the modern state of mining, hang tight.
In the early 2010s, black market websites for criminals like Silk Road started using Bitcoin as a way to settle transactions for drugs and other illegal activities. The crooks thought that the Bitcoin would make their illicit business untraceable, which didn’t exactly turn out to be the case. This movement of Bitcoin started to give the digital currency value in the real world, so the holders needed a place to exchange Bitcoin for regular old currency like U.S. Dollars. Some poorly run, unregulated exchanges started around this time, and people with Bitcoin were able to cash them out. The process was messy but generally worked OK. The price of Bitcoin rose to over $10 per coin.
In 2012, Brian Armstrong started a company called Coinbase. Initially they launched a wallet to hold Bitcoin, but since it was still really hard to buy back then, they didn’t get much traction. About a year in, Coinbase added a “buy” button and the business started growing fast. By 2014, they had 1 million users and had raised $100MM+ in venture capital funding. Today, the company is publicly traded, has over 50 million customers, and is valued at $67 Billion. A bunch of other places to trade Bitcoin and other cryptocurrencies have sprung up and grown too.
What made Bitcoin grow so quickly? The coin went from $10 in 2012 to over $50,000 today. I think in the simplest terms Bitcoin came to be seen as the dominant cryptocurrency. It achieved something resembling a status as a “store of value” like gold. Why do investors hold gold today? It is not used as a monetary instrument anymore and has only limited intrinsic value. However, whenever there is turmoil in the world, investors rush to buy gold. Investors also buy gold as a hedge against inflation. Bitcoin shed its early image as a currency for criminals and now people are focused on it as “digital gold”. Unlike gold, Bitcoin is easy to store and trade today. Large institutional investors have been adding Bitcoin to their portfolio as a core holding, and large companies are starting to hold Bitcoin on their balance sheets. Technology advances have also allowed Bitcoin to be used to pay for goods and services, and increasingly people are using Bitcoin in this manner. Individuals are also using new Bitcoin tech to send money to friends and family in other countries without expensive fees for money transfer or currency exchange. These use cases have all led to increased buyside demand for Bitcoin, and more are coming.
I’m going to stop here on the topic of Bitcoin Basics. This is a lot to process, even for seasoned finance executives. We will dig into more core topics around Bitcoin and the broader crypto ecosystem in future posts.
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