What is Bitcoin Exactly?
If you're like me, you had certainly heard the words "blockchain" and "Bitcoin" before, but until recently had considered it a thing only for tech geeks and anti-government conspiracy theorists. Then suddenly, Bitcoin blows up and returns a whopping 817% over the last 12 months. Congratulations geeks, you have my attention.
Full disclaimer — I am not an expert on this technology nor do I own any myself or recommend their purchase for any clients. What I am is a fiduciary, with an intellectual curiosity about the space, and a belief that I have a responsibility to research and be conversant on new and emerging investment opportunities. So here we go.
Bitcoin was first conceptualized in 2008 by a white paper, "Bitcoin: A Peer-to-Peer Electronic Cash System," written by an anonymous hacker who called himself Satoshi Nakamoto. Nakamoto's opus stemmed from a frustration of relying on third party bank and government intervention; claiming that bank intermediation only increased transaction costs. His hope was to create a government-independent, fraud-proof, peer-to-peer payment system based on cryptographic proof instead of trust. Think Venmo, but without the "transfer to bank" step.
Bitcoin trades on a cryptographically-secure, public database called a blockchain. The best way I can think to explain this is to imagine there is one single shared spreadsheet on a cloud drive where everyone in the world has editing privileges. Blocks made up of hundreds of transactions are reconciled and irreversibly published on the public Bitcoin blockchain continuously. "Miners" provide the necessary cryptographic computing power to reconcile and secure each transaction block. The miner who provides enough "proof of work" the fastest is rewarded with new bitcoins and transaction fees.
The system is therefore secure, or "unhackable" as long as honest participants collectively control more computing power than hackers. All transactions are publicly viewable, but they are not linked to identities. Since Bitcoin owners are anonymous, it was often initially used on Silk Road for illicit payments, a reputation Bitcoin is still struggling to shake off.
Globally, we are already beginning to see a move towards digital currency: Sweden is nearly cashless; African countries, like Kenya, are transacting via mobile phone money accounts; and India radically demonetized 95% of circulating rupee banknotes just last year.
Cryptocurrencies, coins, or protocol tokens as they're often called, have now expanded far beyond Bitcoin, which today encompasses only about 50% of the crypto-coin market. Each protocol token is developed for use within its own network database and can be used to purchase digital assets or services within that network.
Three Types of Assets
- Use assets: investments you buy primarily to use and enjoy such as cash, a car, boat, or engagement ring. They hold value and can be resold, but generally for less.
- Investment assets: assets purchased that you expect to grow in value over time, provide consistent income, or both. Examples: long-term retirement assets, buy-and-hold equity, oil and gas royalties, closely held businesses, rent-houses.
- Trading assets: assets generally purchased because you believe there is an opportunity to resell them at a higher price and make a profit. Shorter-term, not tax efficient: precious metals, foreign currency contracts, derivatives, equity day trading.
From my research, I believe cryptocurrencies may be a hybrid. Many protocol utility tokens, such as Ethereum, can be used to trade for digital assets, storage, or work from other network participants; be held and speculatively traded; and perhaps will soon be used within a new technology platform.
To consider it an investment asset, I'm not yet convinced. Call me old fashioned, but determining an asset's intrinsic value by calculating the discounted present value of its future cash flows is still the way to go. Bitcoin and other protocol tokens don't have any cash flows, there is no way to systematically exponentiate demand growth, it doesn't pay a dividend, you can't eat it, you can't burn it.
That leaves me to conclude that for now, cryptocurrencies remain squarely in the trading asset category. Much like me at the fair, unless you have a use for them, or the technical knowledge to know when the demand will be high and when the demand will be low, it's best to avoid as an investment for now.
I still think the future is bright for blockchain protocol technology and digital money. Even though it's currently overly technical, inefficient, and expensive, it will get better. Only time will tell whether Bitcoin, or another dominant player will emerge the victor.
I hope this has helped to answer some of the questions you were too scared to ask. Sticking your head in the sand and ignoring this revolutionary technology is a mistake, if not downright foolish.
Reach out with questions at amy@radixfinancial.com.
Amy Hubble, CFA, CFP®
Principal, Radix Financial LLC
If you want to learn more, read the original white paper by Satoshi Nakamoto, and listen to Patrick O'Shaughnessy's three part audio documentary, "Hash Power."
