On Halloween 2008, in the midst of the financial crisis, a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System was sent to a cryptography mailing list. The paper was written by an anonymous person (or persons) named Satoshi Nakamoto. Nakamoto described Bitcoin as a digital currency that would allow transactions between two parties without a financial institution facilitating the transaction. Three months later, Nakamoto officially launched the Bitcoin network. It took a year for the first known commercial transaction to occur on the network, when two Papa John’s pizzas, worth $25, were purchased for ₿10,000 bitcoin. Today, a single bitcoin is worth around $50,000…
How Does It Work?
So how is a cryptocurrency different from normal currency, say, the Dollar? Well, unlike Dollars, no physical bitcoins exist. And also unlike the Dollar, Bitcoin isn’t controlled by the government. Instead, Bitcoin is controlled by its users on a network called a “blockchain”. Stay with me, we’re going to get a little technical for a minute…
The blockchain is essentially a growing list of public records (“blocks”) that track all Bitcoin transactions. These records help verify how many Bitcoins each user holds, which ensures transactions are valid. The records are continually maintained and verified by participants who use the network in a process called “mining”. For maintaining the network, miners are rewarded with new bitcoins.
The records are also stored across a network of computers (“nodes”), instead of one, centralized database. The decentralized nature of the records makes fraudulent transactions nearly impossible. To engage in a fraudulent transaction, someone would have to control 51% of the nodes.
Why Is It Valuable?
Each Bitcoin was initially worth a fraction of a penny. It has since reached astounding values of over $50,000 per Bitcoin. Why it is worth so much?
A key aspect of Bitcoin that makes it attractive to investors is its limited supply. The total amount of Bitcoin that can be mined is capped at 21 million. (As of March 2021, around 18 million have been mined.) Other currencies, like the Dollar, theoretically have no cap on the amount that can be created. Printing too much of any currency will eventually lead to inflation. We have seen this happen recently in countries such as Venezuela, Argentina, Zimbabwe. Unsurprisingly, Bitcoin has gained heavy traction in those countries.
So, Bitcoin is a hedge against the stability of the current financial system. In fact, this purpose is built into the very first block of Bitcoin’s blockchain. Satoshi Nakamoto embedded it with the title of a news article: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”.
The Future of Cryptocurrencies
While Bitcoin was not the first cryptocurrency, its success has led to a proliferation of digital assets. Cryptocurrencies that are not Bitcoin are collectively known as “Altcoins”, of which there are now thousands. Altcoins all use blockchain technology, but they slightly change the rules of their cryptocurrency to appeal to different users. In the long-run, crypto bulls believe cryptocurrencies, (maybe Bitcoin), will permanently replace physical currency.
Though cryptocurrencies are starting to be adopted more broadly, risks still loom. The values of cryptocurrencies remain highly volatile. This means that a lot of money can be made — and lost — rapidly. This is bad for an asset class that aims to underpin the global financial system. It also remains unclear who should regulate cryptocurrencies and how they should be regulated. Simply put, we are still in the Wild West days of cryptocurrencies. Many changes certainly lie ahead…
Did You Know?
- To this day, nobody knows who Satoshi Nakamoto is. Some suggest it was a team of developers, while others claim it was a single genius. One online theory pointed to Elon Musk, which Elon denied. (See below.)
- Bitcoin is abbreviated as “BTC”.
- According to the Bitcoin Foundation, “Bitcoin” is capitalized when referring to the cryptocurrency as an entity, but written in lowercase (“bitcoin”) when referring to the quantity of currency.
- Read Bitcoin: A Peer-to-Peer Electronic Cash System by Satoshi Nakamoto here
- View an extensive list of Altcoins here
- Read a more thorough introduction to blockchain and crypto here: Introduction to Blockchain and Cryptocurrencies