Cryptocurrencies, 1: What Exactly Is Bitcoin?

Everybody knows that Bitcoin is a “digital currency”. But what does that really mean, and what is Bitcoin really good for? Who developed it? Turns out, oddly, that we don’t actually know. Can you buy a pizza with it? Turns out that perhaps the most famous pizza purchase of all time was made with Bitcoin.

This post is the first of a series of Tuesday posts here on cryptocurrencies, which are a subset of digital currencies. In general, “money” is something that serves as a medium of exchange, a means of payment, and a store of value. Common currencies of major countries or groups of countries, such as the U.S. dollar or the euro, clearly serve these functions today. For many centuries, in many parts of the world, gold has widely accepted as money, even though of itself it is just a soft, shiny metal.

As we noted in Money as a Social Construct – Economist Writing Every Day , for any system of money to work, the key players all have to believe in its value. Thus, “money” is a mainly a social construct, an article of mutual faith.  So why do people see a digital currency like Bitcoin as “money”? The short answer is that they do…because lots of other people do. That’s it.  For reasons that we will discuss, Bitcoin has obtained buy-in from enough parties in the economy that it has become in many ways the digital equivalent of gold.

What can you do with Bitcoin? You can store, and send and receive any amount of money to anybody without relying on financial intermediaries. In theory, and usually in practice, this avoids issues of high transaction fees, delays, and identity fraud that are often associated with moving money around.

Some key features of Bitcoin are:

•             Decentralized: no single party (no government or corporation) controls or ‘owns’ the Bitcoin network, and transactions can never be altered or censored.

•             Peer-to-peer: secure payments go directly from one person or business to another, so there’s no need for any ‘trusted third party’ to process payments.

•             Fixed supply: only 21 million coins will ever be created, making Bitcoin less subject to the devaluation-through-inflation that traditional currencies are prone to.

•             Low fees: it’s typically much cheaper to move money through Bitcoin’s peer-to-peer network, and transactions are also very fast.

•             Bitcoin’s value in dollar (or euro, etc.) terms can fluctuate dramatically. You can make or lose a lot of money with holding and trading. However, it makes your “store of value” less predictable; if what you mainly want to do is buy and sell real stuff, you may want to fairly quickly convert dollars to Bitcoin, make your Bitcoin purchase or sale, then convert back to dollars. (There is a different class of cryptocurrencies whose value is pegged to the dollar or euro, which we will discuss in later posts in this series.)

The 450 Million Dollar Pizzas

Let’s get the pizza out of the way first. Yes, you can buy pizza using Bitcoin. See here for ordering from Domino’s, Pizza Hut, or Papa John’s. Back when Bitcoin was only a year old, before it was much of a thing, a developer named Laszlo Hanyecz paid a colleague 10,000 BTC (bitcoins) to buy him two large pizzas, then costing a total of about $25. This was on May 22, 2010. For Hanyecz, this was a throwaway, since he was generating (“mining”) thousands of bitcoins a day at the time. At the current pricing of bitcoin (~$45,000 apiece), this would now be $450,000,000, which can buy you a whole island or a jumbo jet plane. Because this was one of the first actual purchases of stuff using Bitcoin, and because the $450,000,000 figure showcases how much value Bitcoin has grown to today, May 22, 2010 is now known as Bitcoin Pizza Day.

A list of other businesses which accept Bitcoin for payment is here.  Microsoft and AT&T accept bitcoins, as do a growing list of eateries and other smaller businesses. Reportedly, there are workarounds to use Bitcoin to purchase stuff on eBay and (using Purse.io ) to buy at a discount on Amazon. Yet more stuff you can purchase with Bitcoin (plastic surgery, funeral caskets, etc.) is listed here.

All that said, these consumer payments are largely something which could be done about as well or better with a regular credit or debit card. Bitcoin purchases have the downside (for U.S. residents, at least) that each purchase must be reported at tax time to Internal Revenue Service in as part of capital gains and losses.  

 Bitcoin’s capabilities really shine with non-consumer transactions, such as a worker sending money to his family back home in a different continent (with just a few keystrokes instead of wiring money between two banks), or various business transactions, especially involving parties operating in less developed countries. And, obviously, shady dealings by criminals and terrorists.

But the main “use” of Bitcoin is not to use it at all, but simply to hold it for the very long term, expecting that its value will go up and up and up. Here is a plot of the price of one bitcoin in U.S. dollars since near its inception:

Source

There are substantial swings up and down, but a general upward trend. So the True Believers hold and hold. The price has spiked up to more than $50,000/Bitcoin in recent months, partly on news of lots of big players on and off Wall Street who are piling into Bitcoin. It now seems like classic FOMO has set in. Those who bought in before 2017 have multiplied their investments more than ten-fold. Even buyers from six months ago have more than tripled their money. This is pretty intoxicating. I jumped in, in a tiny way, in November, and am already up by over 50% in three months. (Bitcoin price has dropped about 20% in the past few days, as the swings continue).

The total value of all 18.6 million bitcoins produced to date is over 600 billion dollars. For perspective, that is about size of the entire GDP of countries like Sweden or Taiwan or Poland. So this thing has gotten huge.

Who Started Bitcoin?

Who started Bitcoin? Well, Satoshi Nakamoto did. He pretty much thought up the concept, authored the key white paper describing it all, and helped write the actual software (code) that implements it. The software concept behind Bitcoin is truly ingenious, and will be described in subsequent posts. It is estimated Nakamoto personally holds about a million bitcoins. If the price of Bitcoin triples from its recent high of $42,000, which is likely at some point, he will be the richest man on the planet.

But who is Satoshi Nakamoto? It seems that nobody knows. Nakamoto collaborated with the Bitcoin startup team by remote messaging in 2009-2010, then dropped out of sight. Wikipedia has collected some of the speculations on his identity (e.g. maybe “Satoshi Nakamoto” never existed, but was a cover for a group of developers), but this is just one more spicy aspect of the world of digital currency. Apparently the guy smart enough to dream up and implement Bitcoin, and to set himself up to be perhaps the richest person in the world, was also smart enough to figure out how to stay anonymous.

This has been an overview of some of the capabilities of Bitcoin. How it actually works as a “cryptocurrency” is somewhat complicated. We will cover that in the next Tuesday post.

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