August 22, 2017
Recently, a friend told me he turned $800 into $7,000 in just two weeks! Whenever I hear figures like these it is hard to suppress my skepticism. My friend is a twenty six year old software consultant, with one undergrad finance class under his belt, so his claim still struck me as highly implausible and perilous. I owed it to him and myself to do a little research. As a result, I became familiar with cryptocurrencies and specifically, Bitcoin.
Bitcoin evolved from the quest of a mysterious inventor, Satoshi Nakamoto, to create a digital peer-to-peer electronic cash system back in 2008. Bitcoin’s initial trading history is murky. I can only imagine how early investors felt about stomaching the trading risk in the volatile investment climate of that time. I do not feel too bad for them though. The price, tracked by CoinDesk BPI, was $0.06 on July 18th, 2010, and had reached $4,268 as of last week. So how did these earliest investors gain access to something that would prove so lucrative? Most of them had developed their own similar predecessor products that never took off. These products included “ecash”, “b-money”, and “bit gold”. This pioneering group had an information advantage which enabled them to see an opportunity in an evolving marketplace; the need for a digital money which was convenient, untraceable, and free from government and banking regulation and taxation.
Nakamoto knew his invention needed a network with specific rules to be successful. No payment system can operate without components such as accounts, balances, and transactions. But how was value initially created and assigned and by what forces? Before online merchants adopted Bitcoin, its value came from characteristics such as decentralization, untraceability, and its finite supply. Numerous researchers argue that Nakamoto’s greatest achievement was not the invention of the currency itself but rather the development of a decentralized transaction system where each peer in the network shares responsibility for maintaining consensus. Without this accomplishment, one user’s disagreement about a single balance could crumble the entire system given there is no controlling central authority. The most important characteristic of Bitcoin’s success was probably the fact that regulatory bodies have great difficulty in tracing and taxing its use. Moreover, its limited quantity mitigates devaluation through inflation. The level of trust in the system has now reached the point where familiar merchants, such as Microsoft, Expedia, and Whole Foods, accept payments using this decentralized currency even though it still lacks traditional governance and central control.
While Bitcoin is highly technical and complex, it is really not too different from the balances in our bank accounts. Think about how much of the U.S. dollar supply exists solely as digital account balances rather than as green pieces of paper. The trend for commercial transactions to be completed through ecommerce will only continue, and cryptocurrencies like Bitcoin seem destined to take an increasing share of this market.