We have all heard about this newfangled computer money called Bitcoin. Whether it is through a college friend advising that you invest in it before it’s too late, or your uncle scoffing at the idea of making any sort of gain off “the world’s biggest scam.” Bitcoin became the new buzzword at the end of 2017 when the cryptocurrency increased by almost $10,000 over the course of 17 days. Coinbase, a cryptocurrency exchange application, became one of the most downloaded apps in the App Store during December when the crypto-market exploded. A cryptocurrency by definition is a digital currency that uses encryption techniques to generate new units and regulate transactions for the currency. Common cryptocurrencies are Bitcoin, Litecoin, Ethereum, and Ripple, but there are hundreds of different cryptocurrencies in circulation. Although many cryptocurrencies saw huge market gains, Bitcoin was the loudest. But what prompted this Bitcoin boom? How did this digital currency mainly used by computer geeks and drug dealers turn into a mainstream investment tool? Before we understand why Bitcoin and other cryptos skyrocketed last month, we should know where Bitcoin came from.
Bitcoin was first introduced in 2008 in a paper titled “Bitcoin – A Peer to Peer Electronic Cash System” by someone using the name Satoshi Nakamoto. In the paper, Nakamoto states that the purpose of Bitcoin is to be a currency that does not have to go through a third party– such as a bank or credit card company– for transactions, thereby reducing the costs of transactions between individuals. Bitcoin is not issued by any single government or organization; rather, it is “mined” by computers. Computers mine Bitcoin through a process of solving computationally difficult mathematical equations, and the result is the generation of new Bitcoin.
However, there is not an infinite supply of Bitcoin; once the number of Bitcoin in circulation hits 21 million, no more units will be able to be mined. As more Bitcoin is mined and circulated, the reward for mining (the amount of Bitcoin generated) gradually decreases until there are no more equations to be solved, which many experts predict will occur in 2040. This settles any worry of inflation having any impact on the Bitcoin market, since no more cryptocurrency will be able to put into circulation after it hits that number. The circulation limit is what makes Bitcoin so unique. Other currencies such as the dollar or euro can be easily added into circulation by printing more mint, thus depreciating the value of each unit in circulation.
In January 2009, the first block (or unit of Bitcoin transaction) was mined, starting the long chain of transactions that are recorded onto a digital list called the blockchain. Every transaction that occurs includes a hash (or a record) of the previous transaction. Thus, every transaction is linked to one another creating a chain that connects back to the first transaction, which is known as the genesis block.
Shortly after, the first indication of Bitcoin’s real-world value was when a Florida programmer offered to trade 10,000 Bitcoin for two pizzas on the Bitcoin Forum. This transaction valued Bitcoin at about .0025 USD. From there, the value of the cryptocurrency increased and eventually was valued at par with the U.S. dollar, which was another big milestone for Bitcoin towards becoming a generally-accepted and legitimate currency. As time went on, more and more Bitcoin exchanges popped up, and Bitcoin was appreciating in value reaching $1,000 in November 2013.
Despite its astonishing growth, there were multiple incidents of hacking, theft, and even Ponzi schemes among multiple Bitcoin exchanges, which resulted in many investors losing a lot of money. One of the largest Bitcoin exchanges was hacked for 24,000 Bitcoin, and approximately $6 billion was lost as a result. Bitcoin was also notorious for being the method of payment for illegal drugs and weapons on sites such as the infamous Silk Road. Since Bitcoin transactions are not traceable, it made for an effective tool for trading illegal goods. In fact, Bitcoin is still used for these purposes, most notably for fake state identification cards.
Throughout most of its life, Bitcoin was still largely unknown and only used by those looking to make transactions with the cryptocurrency; however, 2017 proved to be a revolutionary year for the cryptocurrency market. Bitcoin became more mainstream as an increasing amount of people began to invest their money into it. As a result, Bitcoin grew 1000% throughout 2017. Multiple factors caused this surge; one of the biggest reasons is that investors are buying out of “FOMO,” a colloquial acronym for the fear of missing out. As prices rose, more and more people hopped onto the Bitcoin bandwagon, which in turn fueled the increase in price. Bitcoin received a seal of approval from Japan’s government and it even began to license Bitcoin exchanges earlier in 2017. In fact, part of the appeal that Bitcoin possesses is that many financial regulators are taking hands-off approach towards it. At the end of 2017, Bitcoin was valued at an all-time high at $19,783.06.
But is the Bitcoin craze over? Multiple big-name investors –Warren Buffet and Jamie Dimon who is the CEO of JPMorgan Chase– are quite skeptical of the now-booming cryptocurrency. Many other institutional investors believe that Bitcoin is nothing but a bubble, not unlike the dotcom boom in the early 2000’s or the housing bubble in 2008. Robert Shiller, an economist who won a Nobel Prize for his book Irrational Exuberance, predicted both the dotcom bubble and the housing bubble. He believes that the Bitcoin boom is not a good long-term investment and that those putting money into virtual wallets may very well not see their money again.
Among all the skepticism surrounding Bitcoin, optimists are still outspoken. John McAfee, a cybersecurity pioneer, boldly predicts that Bitcoin will hit $1 million by 2020. Others believe that Bitcoin will catch up to gold in value. The Winklevoss twins, Tyler and Cameron, who are known for their famous lawsuit against Facebook CEO Mark Zuckerberg, are extremely bullish about Bitcoin. They likened Bitcoin’s rise to a social network citing Metcalfe’s law, which states that each additional participant in a network increases the value of that network. As more people begin to use Bitcoin, the value will increase, barring any government regulation.
Now in 2018 the future of Bitcoin is yet to be determined. The highly-volatile cryptocurrency market is one that can either produce huge gains or devastating losses. As the saying goes: high risk, high reward.
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