Circa 2020, a friend of mine heard about an investment opportunity in bitcoin. She knew I was deeply into tech and owned some bitcoin [which I recently sold] but she knew nothing about it except that people were making money from it. I wrote a quick explainer about cryptocurrencies in general. I’ve lost touch with her; I know she did invest in some and I hope she made a mint, though I think people speculating in cryptocurrencies are a big part of the reason that they’ve never fulfilled their promise as a decentralized payment system.
I ran across this same document today, and thought it might be of interest.
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TL;DR: Bitcoin is a digital currency. Though I believe the real strength of digital currencies is as a payment system (digital money), many people have made money investing in bitcoin and other digital currencies. Such investments should be considered highly speculative.
There are quite a few “what is bitcoin?” screeds on the internet, but I didn’t find one I liked well enough to prevent me from writing my own.
What is money?
Money is a marker of value that we use so that we don’t have to work out some sort of complicated barter arrangement every time we want to buy or sell goods and services. In order for money to work, it must have perceived value which generally implies that it must be a scarce resource — there cannot be a limitless supply available to everyone. Using air or dirt for money probably wouldn’t work out so well.
What is Digital Currency?
It would be great if we could store money on computers and move it around using email, text messages, websites, and the like. Credit cards are awful for this, because they put a bank (or three or four) in the middle of every transaction. They might not be visible, but they’re there, taking a bite out of every transaction. Fees can be huge if, for example, you’re wanting to charge someone a nickel to read an article or other kinds of micro-transactions. Banks also absolutely destroy your privacy, are a major pain in the butt for merchants to deal with, and will gladly freeze your assets and cancel your accounts if they decide (with no opportunity for appeal) that you’re operating an undesirable business. There are many perfectly legal (and many more not-so-legal) businesses that are effectively excluded from doing business online because banks have decided that they’re undesirable.
double spending
So couldn’t we just make some really complicated patterns of numbers just as we do with paper money so that it’s hard to counterfeit? No, because computers are made to copy numbers perfectly, no matter how complex. So we lose the scarcity property. It’s also known as the “double spend” problem. So how do you keep people from simply making a copy of their digital money and spending it over and over again?
blockchain
Most digital currencies, including bitcoin, use a public ledger. Your money is stored in digital wallets that are just a collection of numbers. You can move money from your wallet to someone else’s by recording a transaction on a public ledger. “At 12:52 pm PDT on 28October2020 I transferred 0.02 bitcoin from my wallet to Fred’s.” I post that transaction to a copy of the public ledger using cryptographic math to insure that I actually own the wallet I’m transferring from, and the ledger itself will verify what coins have been transferred into and out of the wallet in the past, making sure the wallet actually has the coins to transfer. Now, anyone who looks up your wallet will know it has 0.02 bitcoin less in it, and anyone who looks up Fred’s wallet will know it has 0.02 bitcoin more in it. (Oh, and there are fees associated with the transfer, though generally much less than a bank or credit card company would charge — see below.)
anonymity?
Many people have touted bitcoin’s anonymity and refer to digital currencies as “digital cash.” But didn’t I just say that every single bitcoin transaction that has ever been made, and every one that will be made, are all available in a public ledger? Yes. Yes I did. And people who believe that bitcoin is anonymous really need to take that into account. The provenance and current home of every single bitcoin or fraction that has ever been is public knowledge. What can be anonymous is who owns which wallets, but keeping a wallet’s owner’s identity a secret requires a lot of expertise and care. You only have to make one mistake and an adversary can link you to your wallet and every transaction in the universe that has been associated with that wallet. There are other digital currencies that have some anonymity features built in, but if you’re looking for anonymity then bitcoin isn’t your friend. Don’t try to hide bitcoin transactions from the IRS or the Sopranos or the police or your spouse. Sooner or later, your scheme will fail. If anyone starts telling you about “mixers” and other anonymizing technology, they’ve already drunk the Kool-Aid and it’s too late for them. Get your advice elsewhere.
Who owns/runs this bitcoin racket, anyway?
Nobody. Everybody. One day out of the blue, a detailed description of the bitcoin protocol and sample computer code to implement it appeared online. It was signed by “Satoshi Nakamoto,” though nobody knows who the mysterious Nakamoto actually is. It’s pretty much a certainty that anybody who claims to be Nakamoto isn’t.
Copies of the blockchain are hosted by volunteers (I’ve been one for ages) who run software that implements the protocols with changes that have been approved by consensus. Anybody can, and many people have, create their own digital currency based on the bitcoin model or even fork the original blockchain to create a new currency but implementing variations on the protocols. Which is the “true vision of Satoshi”? Nobody knows. Nobody should care but, like religious schisms, people care deeply and passionately.
Where do bitcoins come from?
Remember scarcity? Obviously, you can’t let just anybody with a Dell create their own bitcoins instantly, because the resulting numbers would have no value. Instead, bitcoins have to be mined by solving complex mathematical problems that change (and become more difficult) with each entry on the blockchain. In the beginning, a garden-variety home computer could mine bitcoins, though it took some time. Now, mining requires rooms full of custom designed chips dedicated to the task, and lots of electricity. There is also an absolute limit to the number of bitcoins that can ever be mined. So scarcity is guaranteed as long as the protocol is sound.
This might sound strange but think, for a moment, of gold. Gold has value because it’s scarce. We can’t really create new gold (well, at least not gold that isn’t radioactive, but that’s another story). You can only get gold by the tedious process of getting it out of the earth and refining it. Point of fact, there are tons of gold dissolved in ocean water as gold chloride [millions of tons, apparently], so the amount of gold on planet Earth isn’t as limited as people think. Refining gold from ocean water, however, is hugely expensive and time consuming, and you’d spend far more “mining” it than the resulting gold is worth. So what makes gold intrinsically valuable is that it takes a lot of money to mine it. It helps that it has some industrial uses, but the scarcity — defined as the effort it takes to accumulate more — is the real defining value. So it is with bitcoin. It takes time, equipment, and money to mine it, and it gets more expensive all the time (just as the days that you could find gold nuggets washing down Sutter’s creek are long gone).
my bitcoin story
I’ve been fascinated by digital currency since before there was an internet (and, thus, no practical way to implement a concept like blockchain). I followed the bitcoin story from the early 2000’s, but only out of theoretical interest.
the one that got away
Then [my son] M got interested in the concept and we talked about it a bit. One day, I said “hey, I have a thousand dollars we could use to buy bitcoin.” It would have involved a walk of about half a mile to the Walgreens on the corner to buy a voucher that I could use to buy bitcoins from an exchange. At the time, bitcoins were going for about $20 each, so we would have had roughly 50 of them. At the current price (20201028@13:49), they would be worth about $660,000. [and about five million dollars now in late 2025]
M decided he didn’t want to take the walk. We didn’t buy the bitcoins.
the one that didn’t get away
The price started going up in what (at the time) was a rather dramatic fashion. M decided he would like to try mining bitcoin, and together we built a computer system with a high-end graphics coprocessor card to do the mining. I ran it for about a month when the graphics card blew up (dramatically, with smoke and all). The company replaced the card, and the new one also ran for a few weeks before going up in smoke. The company said that they had stopped making the card because of those problems, and refunded my purchase price (about $1,000). The rest of the system was made of scavenged parts, so my out-of-pocket cost was only electricity (I’d guess about $500) and we mined just over one bitcoin, by then worth about a thousand dollars. So… profit. I still have that bitcoin, and right now it’s worth $13,210. [~$110,000 now in 2025, but we sold it earlier this year]
But Does it Spend?
I started using bitcoin in day-to-day transactions, but it was a bit of a hassle. Most of the frustration in the bitcoin community centered around the difficulty actually using bitcoin, and the increasing difficulty converting bitcoin to and from what they call “fiat currency,” or real money. The aformentioned banks and credit card companies had decided that any business related to bitcoin was “undesirable” — most likely because they saw it as a threat to their business — and blocked most avenues of exchange and made it very difficult for businesses to implement bitcoin payment methods.
Investment
About the time that the price of bitcoin headed north of $1,000, it started attracting a lot of press. Suddenly, this thing that I had to explain to everybody became a household word. The price of bitcoin started fluctuating wildly, which made it very difficult to actually use bitcoin in place of cash or credit cards. I once bought a software license with bitcoin, and the value of the coin dropped in the moments between when they quoted me the price and they received the coin (transactions have to be verified by at least a few of the blockchain hosts before the transaction can be trusted) and so they rejected it but took two weeks to return my coin. The fluctuations made for a lively market, and people were getting rich and going bust frequently. There were major scams, and what seemed the largest and most stable exchange (Mt. Gox) pulled an exit scam (disappearing at the moment a lot of people had trusted them to hold their coins during a transaction) and folks lost millions. Wild and crazy days. [Things have only got wilder since, and I wouldn’t dream of being any kind of small, retail investor in cryptocurriencies these days. The profits are going to big market manipulators and the US First Family. Those profits are being paid for by the small suckers investors.]
transaction fees
Another side effect of all this trading is that transaction fees went up. Part of the process of putting a transaction on the blockchain involves the owner of a mined block (who also got some bitcoins when the block was mined) agreeing to add the transaction to their block. You generally encourage them to do this by including a few satoshis (hundred-millionths of a bitcoin) as a transaction fee. As usual, people began messing with the system and trying to clear hundreds of thousands of extremely small transactions just to gum up the works (a denial-of-service attack). Previously, you could often get transactions through with no fees, though you’d have to wait a few days for them to clear. With all the so-called dust transactions going on, you had to offer fees higher than credit card fees just to get a block owner to notice you.
belief
Remember back in the first paragraph when I said money “must have perceived value” to work? Gold has perceived value because it has some industrial uses and thousands of years of mining activity have shown that it’s a scarce commodity. The US dollar has perceived value because there are a lot of folks in uniforms with guns who actively enforce its value. (Don’t believe me? Just start printing your own and see what happens.) Why do people believe in bitcoin? They believe because other people believe. It’s a house of cards, and any number of things could be the gust of breeze that topples it. Someone might discover a flaw in the protocols that manage the blockchain. Someone might discover (or just claim to have discovered) a flaw in the underlying cryptographic math. Major governments might try to outlaw the use of bitcoin (though that might just increase value and uptake, if we’ve learned anything from the War on Drugs). Or it might just fall out of fashion.
At the end of the day, there is nothing to guarantee the intrinsic value of bitcoin and it could all be worthless tomorrow. The potential upside, though, is still huge so I haven’t made any move to sell my bitcoin. [until this year] Crazy people say that a single bitcoin could be worth half a million dollars soon. I scoff: it seems really unlikely. But I scoffed when somebody said that $20 bitcoins could someday be worth One Thousand Dollars, and they’re thirteen [110] times that now.
How do I Play?
Oh, drat, you wanted practical advice? Honestly, I stopped following the ins-and-outs of bitcoin trading when the online communities turned hyper-toxic as investors sought to manipulate the value by sowing uncertainty and division. I suspect you could visit a big exchange such as Coinbase (reputable? who knows?) and they’ll tell you all about it.
Hope this was somewhat helpful. Helen thought bitcoin was “silly” and kept telling me I should sell mine back when it was worth about 10% of what it is now. She may yet prove correct.
I just want it to get back to the point where it could be an effective, inexpensive, bank-free way to move money on the internet. [I’m not holding my breath.]
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—2p