Bitcoin: An Introduction To the Most Dominant CryptoAsset

Dec 5, 2017

Bitcoin was developed and launched by Satoshi Nakamoto – a mysterious person or organization – in late 2008, after the publication of a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System. After possibly mining about one million Bitcoins, Nakamoto disappeared from the public eye and the organization was taken over by a team of volunteer open-source developers. The cryptocurrency’s value has since soared from less than $1 to more than $11,000 per bitcoin.

In this post – we take a look at Bitcoin from a high-level. For a deeper-dive please consult the newly released Bitcoin Asset Highlight – we authored it as ‘required reading’ for anyone new to or curious about bitcoin and cryptoassets.

Bitcoin & Its Benefits

Bitcoin was originally designed to enable online payments to be sent from one party to another without going through a financial institution. Trusting financial institutions works well enough for most transactions, but merchants must deal with fraud that costs billions of dollars per year. Permissioned systems like the traditional financial system also excludes billions of people from online commerce by requiring merchants and customers to have bank accounts and/or credit cards. Bitcoin solves these problems by providing an electronic payment system based on cryptographic proof instead of trust, which cuts third party financial institutions out of the equation. Each coin is a chain of digital signatures that is digitally signed and hashed upon transfer. A peer-to-peer network is then used to verify coins and ensure integrity. The result is a technology where transactions are impossible to reverse and double-spending is prevented.

The core benefit of Bitcoin is that non-reversible transactions can occur between two users with no third party financial institution. Transaction fees are flat, regardless of the amount sent, and payments normally clear in a matter of hours. No access to the legacy financial system is required, enabling online commerce between any two computers connected to the Internet.

Another benefit of Bitcoin is that it hides the true identity of users since only a digital signature is recorded in the blockchain. While users must interact with a network to verify coins, the peer-to-peer nature of the network makes it nearly impossible to match IP addresses to transactions. The only exceptions have been when users have used compromised third-party software to transact coins that exposed IP addresses and matched them to transactions.

Finally, Bitcoin is an inflation-resistant store of value since there is an inherent limit to the number of coins that can be produced. In particular, Bitcoin will never suffer from M0 or MB inflation, although it could suffer from M1, M2, M3 or MZM inflation since existing coins could be hoarded and distributed in a fractional reserve banking system. The stability and popularity of Bitcoin has also made it an important ‘reserve currency’ for other cryptocurrencies.

Why Use Bitcoin?

Bitcoin can be used as a currency, an investment, or both, depending on the situation. For example, an investor looking to build a diversified portfolio may use bitcoin given its volatility and lack of correlation to other assets, whereas a merchant looking to reduce costs may choose to use it as a transactional currency in lieu of accepting credit cards. Consumers may also transact in bitcoins while also holding them, as they would in a cash savings account.

Bitcoin As A Currency

Bitcoin has become a popular cryptocurrency that’s accepted in many traditional retailers. For example, Overstock.com famously began accepting Bitcoin in late 2013. Many other retailers followed suit soon after. Traditional payment processing companies, like Stripe, also integrated bitcoin into their payment systems, which made it easier for independent merchants of all sizes to begin accepting bitcoins in their businesses.

In some countries, bitcoin has become a popular alternative to domestic currencies that suffer from mismanagement. The U.S. dollar has been historically used as an alternative in these countries, but dollar scarcity and the ubiquity of telecommunications has made Bitcoin a popular alternative. Governments have tried to crackdown on the use of Bitcoin, but internet censorship has always been challenging, even in autocratic governments.

Bitcoin As An Investment

Speculative traders are drawn to Bitcoin given its extreme volatility compared to equities and other asset classes. Over the past year, bitcoin prices have soared from less than $1,000 to more than $11,000, representing a return of over 1000%. That kind of return is greater than those found in many asset classes.

Long-term investors are drawn to Bitcoin because it provides access to a volatile asset that may be a fit for a risk-appropriate portion of a diversified portfolio. In addition, Bitcoin has a very low correlation with other conventional assets – such as equities, bonds, or currencies – which means that its addition to a portfolio could dramatically increase diversification.

Will Bitcoin Remain Dominant

Bitcoin wasn’t the first digital currency ever developed, but it was the first to reach any significant scale. This first-mover advantage means that it will always have the longest track record among cryptocurrencies. Many large institutions look for established track records before investing in an asset, especially in the finance and investment industry where technologies tend to be slowly adopted.

Despite constant attacks, Bitcoin has also thrived and survived. The only major security vulnerability was discovered in August of 2010 when transactions weren’t properly verified before being included in the blockchain. Criminals exploited the vulnerability, but within hours, the fraudulent transactions were spotted and erased. The Mt. Gox security breach in the following year made headlines, but wasn’t due to a flaw in the currency itself.

Finally, Bitcoin benefits from network effects that have insulated it from a constant stream of competing cryptocurrencies. Just like Facebook, the value of Bitcoin as a network increases by the square of its participants. Each new user that decides to use Bitcoin increases the value for the entire network. New competing cryptocurrencies must work against these effects, which can make it tremendously difficult to get traction.

The Bottom Line

Bitcoin is the leading cryptocurrency with a long track record dating back to 2008. With its non-reversible and anonymous transactions, as well as inflation-resistant characteristics, the currency has become popular among both consumers and investors. The price of bitcoin has soared to more than $11,000 in recent months, and there are few signs that the fundamental factors underlying the trends are changing.

Bitcoin has also become a popular alternative currency in countries where domestic currencies are mismanaged. And, investors have just begun to realize the benefit of using cryptocurrencies as an uncorrelated and inflation-resistant asset to enhance long-term risk-adjusted returns in their portfolios. CoinShares offers investors one of the first regulated exchange-traded products to capitalize on these benefits. To learn more about bitcoin – see below.

care for more depth? read the bitcoin asset highlight:  

care for more depth? read the bitcoin asset highlight:  

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