An Introduction to Bitcoin
It’s been said that when it comes to investing, what is comfortable is rarely profitable.
And when it comes to Bitcoin, nothing could be truer.
If you’re wary of Bitcoin or just haven’t taken the time to understand it, you’re not alone. The cryptocurrency is a major headline-grabber, but it’s still a relative mystery. And investors find it to be a difficult sell (or buy). It is, however, changing the way the world views currency.
Early adopters of Bitcoin who purchased some when the first transactions were made in 2010 could be millionaires today — or even billionaires — if they hung onto it. In fact, it only takes about 66 Bitcoin to reach $1 million. How is that possible? Well, if you think $15,000 for 1 Bitcoin is extreme, just wait until it reaches $1 million.
Bitcoin’s story is quite the saga, and if you continue on, dear reader, you might find out what all the cryptocurrency fuss is about.
Cryptocurrency, in Brief
It sounds more complicated than it is, but the difference between cryptocurrency and regular currency is basically the difference between decentralized and centralized money.
Think about traditional money and how it’s created. We have the Federal Reserve and its notes, or U.S. dollars, that are Americans’ sole legal means of conducting monetary transactions. The Federal Reserve is the lone authority when it comes to setting the value of our money and ordering its creation (printing dollars). It’s the same for every country. That’s a ton of power, and it’s one of the main reasons cryptocurrency came about in the first place.
Cryptocurrency is just like any other currency, only it’s not controlled by a government and, true to its name, is encrypted so it can’t be manipulated. Encryption is the process of creating a cipher, or set of algorithms, to scramble text that you want to keep secret. The same process is easily applied to money.
Until the digital age, encryption was used in confidential communication such as for intelligence gathering and between diplomats or military personnel. Alan Turing is perhaps the most famous cryptologist, or codebreaker, for his work for the British military during World War II deciphering Nazi code.
From the Fringes to the Feasible
The idea of cryptocurrency is as old as the world wide web, having first come about in the 1990s when a group of libertarian cryptographers calling themselves Cypherpunks started exploring the idea of digital cash.
Those early efforts were all failures, however, because they were not true cryptocurrencies in that they relied too heavily on traditional forms of currency exchange.
Cryptocurrency would remain a fringe topic for super-geeks until in the late aughts with the onset of the global economic recession and a mysterious whitepaper from an even more mysterious guy named Satoshi Nakamoto.
Bitcoin is Born
One of the hallmarks of any monetary transaction is the trusted third party. When you use a credit or debit card to buy something, the trusted third party is the financial institution that issued your account. When you use cash, the Federal Reserve that set the value of that cash is your trusted third party. With cryptocurrency like Bitcoin, there is no third party. That’s what makes it special, but it’s not what made it revolutionary.
On Oct. 31, 2008, a whitepaper explainer called “Bitcoin: A Peer-to-Peer Electronic Cash System” was published on a new website called bitcoin.org. The author, Satoshi Nakamoto, claimed to have created “a new electronic cash system that's fully peer-to-peer, with no trusted third party.”
That idea alone was exciting, but the genius game-changer was that Nakamoto had figured out how to eliminate a problem that vexed all previous cryptocurrency efforts: double-spending. Double spending in digital currency is like copying and pasting text; the currency is essentially a set of numbers that can be used over and over again unless someone is policing such numbers — in essence, a trusted third party that prevents fraud.
In Bitcoin’s case, Nakamoto proposed that the public become the third party. A ledger of all transactions of Bitcoin would be made public and called a “blockchain.” Wired in 2011 wrote of the process: “Users willing to devote CPU power to running a special piece of software would be called miners and would form a network to maintain the block chain [sic] collectively. In the process, they would also generate new currency. Transactions would be broadcast to the network, and computers running the software would compete to solve irreversible cryptographic puzzles that contain data from several transactions.”
The blockchain is so indestructible and trustworthy that it largely drives the incredible value of Bitcoin (and, of course, the demand for it and the fact that it’s finite).
As Finite As Gold
Gold is a precious metal that must be mined from the Earth, and Bitcoin is not much different — it just needs to be mined from the digital world. Bitcoin was created with a shelf life. And not only is it difficult to mine Bitcoin, only so much of it can be mined at a time.
When the blockchain was released to the public and people began mining Bitcoin, the cryptographic puzzles had to be solved by computers in order for Bitcoin to be released. It started at 50 Bitcoin for each solved puzzle, with all of the transactions necessary to mine those 50 Bitcoin then added to the blockchain.
Puzzle difficulty would increase as more miners came aboard, thus ensuring that only one block of transactions could be produced every 10 minutes. And block sizes would be halved after every 210,000 mined blocks, with the idea that Bitcoin production would top out at 21 million around the year 2140.
As of late 2017, some 17 million Bitcoin had already been mined. It’s a little bit confusing, but some 99 percent of all Bitcoin will have been mined by 2032, leaving about 100 years to mine the last 1 percent.
Who Is Satoshi Nakamoto?
For everything we do know about Bitcoin, there’s at least one gigantic question mark hanging over every transaction and successful mine: Who is Satoshi Nakamoto?
Not since the days of D.B. Cooper has there been such a frenzy to figure out the identity of someone. The stories are more intriguing than any Lindbergh baby claim. And if you think Elvis is still alive or Bigfoot is real, they’re both probably hanging out with Nakamoto in an ice fishing hut in the Yukon.
Numerous journalists and amateur sleuths have claimed to have solved the mystery, only to be quickly disproven. But the guesses are as fascinating as the mystery itself. There are four people who attract the most scrutiny as the real Nakamoto: Nick Szabo, Dorian Nakamoto, Craig Steven Wright, and Hal Finney. All of them have denied being Satoshi Nakamoto — especially the guy who shares the same last name.
For a while, it seemed like Wright could be the guy. Wired first outed the Australian academic in 2015, although the story then took some bizzare turns before dying.
Finney was definitely involved with Bitcoin from the start, although again he vehemently denied being the creator, despite a pretty good argument to the contrary.
Szabo seems to be the darling of Satoshi Nakamoto conspiracy theories. Many have claimed he’s the one — the first being this blogger — and of course he has denied everything.
Another popular idea is that Satoshi Nakamoto is more than one person. Bitcoin and everything associated with it are so complicated that it would be impossible for a single actor to pull it off. Suggestions include a team at Google or a government agency like the NSA. It might even have been Citibank or another financial institution, seeing the global recession as a warning sign for traditional currency.
How to Acquire Bitcoin
There’s nothing scary about acquiring Bitcoin, although, as with anything, be smart to avoid the scams. One thing that makes it popular is the relative anonymity, although initially you will need some traditional money to acquire it so expect to give out personal information.
Let’s say you want to explore Bitcoin and make a few purchases. There are plenty of sites that sell small amounts of the currency, less than $2,000, and the proper “wallet” for storage. Kraken, CEX.IO, Coinmama, and Bitstamp.net are a few. Coinbase is also a big player in this arena, although they have been plagued by accusations of fraud.
For larger investments, exchanges have the best commission rates. Think of them as stock markets, and again there are numerous options.
Special ATMs also dispense Bitcoins. There are hundreds of them around the U.S. alone, although they charge much higher transaction fees than online sellers.
Other ways to acquire Bitcoin are meeting people in person through sites like Craigslist for a good old fashioned exchange of cash for digital currency, or even getting a job that pays in Bitcoin.
Or, if you’ve got the computer power to do so, you can actually mine for your own Bitcoin, perhaps the most satisfying way to acquire the currency even if it’s not a get-rich-quick scheme by any means. It will, however, heat your home for free.
And there are, of course, ways you can get rich off Bitcoin, they just might not be for everybody.
How to Store and Spend Bitcoin
Now that we have Bitcoin, what do we do with it? The smart thing is to put it in a wallet, of which there are several options, because leaving your Bitcoin in the exchange where you bought it leaves it vulnerable to hackers.
Web- and mobile-based wallets are convenient and good for storing small amounts of Bitcoin, while people with bigger investments might opt for a hardware wallet or physical piece of paper with all their Bitcoin digits. Paper copies are usually stored in vaults as well.
Paying for something is akin to sending an email. If you use one of the wallet services, there will be a link for you to complete the transaction. You can also pay with a QR code or your Bitcoin address.
What Can I Buy With Bitcoin?
Increasingly the question is, what can’t you buy with Bitcoin? From guns to beer to anything on Overstock.com to prime real estate to coffins, Bitcoin will get it for you. It is, however, most cost effective to pay with Bitcoin rather than convert it into cash, since — at least in the U.S. — that will trigger a capital gains tax because the IRS considers Bitcoin personal property and not currency.
Another popular Bitcoin “buy” is a charitable donation. More and more organizations are accepting Bitcoin in lieu of traditional currency. Check out the Bitcoin wiki page for options.
There are also things you can buy with Bitcoin that you shouldn’t be buying with any currency. In fact, when Bitcoin was far less popular than it is now, it was the black market transactions that had financial experts, law enforcement, and investors wary of the future of cryptocurrency.
Bitcoin’s Bad Rap
In 2013, a man was arrested in a San Francisco library on suspicion of operating Silk Road, a dark-web marketplace for contraband and all sorts of other bad stuff. (If you want to deep dive into the story, check out this Wired piece.)
Ross Ulbricht was by all accounts a smart guy and the last person you might think would operate something like Silk Road. That’s probably why he almost got away with it. Ulbricht will, however, spend the rest of his life in prison. And websites like Silk Road will go on, as they did even after Ulbricht’s arrest.
As for Bitcoin, it was the currency of choice for Ulbricht and so it was an immediate scapegoat. The argument went: Rather than a revolutionary method of transacting that could free the world from government oppression, Bitcoin just made life easier for drug lords and assassins.
However, true Bitcoin enthusiasts and believers saw Silk Road as the perfect manifestation of their vision for world currency, despite all the buying and selling of drugs and death. It was, for them, a utopia.
How Volatile Is Bitcoin?
Bitcoin obviously survived the bad press from Silk Road and prospered. But it took its lumps and many people lost millions of dollars. The funny thing is, most of those lumps were not from actual investors but people who were always on the outside and never wanted to come in period.
Silk Road might have actually been a good thing for Bitcoin. It certainly changed the way the cryptocurrency industry looked at itself.
But price fluctuations, or volatility, are a way of life for Bitcoin. There isn’t a lot of information about the currency, so there doesn’t yet exist an index for determining its volatility.
Many factors contribute to the fluctuations, including how it’s categorized for tax purposes, bad press, hacks, and large-volume holders who could really move the needle if they sold big chunks of their Bitcoin.
It’s somewhat scary how many other cryptocurrencies exist — there are at least 1,372 — considering the short amount of time they’ve been around. Bitcoin is still king and probably always will be, but the “altcoin” universe is expanding.
Most of these other currencies are considered much more risky than Bitcoin, as they have less liquidity and acceptance and don’t retain as strong a value as Bitcoin. Still, plenty are worth your while.
What About That Pizza?
It’s true: Someone once spent about $164 million on two pizzas from Papa John’s. (Of course, back in 2010 when the transaction was completed, the Bitcoins used to buy the pizzas were worth about $20.)
The story goes that on May 17, 2010, Laszlo Hanyecz, a programmer from Florida and early adopter of Bitcoin, posted in a Bitcoin forum that he would send someone 10,000 Bitcoin if they could successfully get two large pizzas to his door with lots of savory toppings, either homemade or from somewhere like Papa John’s. On May 22, an 18-year-old British man named Jeremy Sturdivant (screen name, jercos) answered the challenge and placed the order from the U.K. The rest is history.
In a now-legendary post afterward, Hanyecz said, “I just want to report that I successfully traded 10,000 bitcoins for pizza. Thanks jercos!” (For the record, Hanyecz has no regrets about the purchase.)
It also happened to be the first transaction ever using Bitcoin. And it spawned Bitcoin Pizza Day, which naturally occurs on May 22 and rewards Bitcoin users are many pizza places worldwide.
Oh, and in case you’re wondering about Mr. Sturdivant, he is not living the high life on those 10,000 Bitcoin because he sold them off years ago.