Introduction

The topic of digital assets, and Bitcoin in particular, continues to receive increasing investor interest and adoption, particularly given Bitcoin’s historically strong performance, low correlation to traditional asset classes over time1 and viability as a digital store of value competitive with traditional alternatives. Yet investor education about Bitcoin needs to be significantly simplified to demystify the asset class, in our view.

What is Bitcoin? Bitcoin is a form of digital cash

Bitcoin (BTC) is a digital currency that does not require an intermediary for people to use and distribute electronically. Bitcoin was the first successful attempt to compile code in such a way that reduces risks of fraud and hacks. However, it is important to note that Bitcoin transactions and transaction platforms are still subject to fraud and theft. As the world’s first functional digital currency, Bitcoin remains the largest and most developed one to date, with a market-cap that has grown to ~$200 billion2 since its origin 12 years ago.

In 2008, the anonymous founder of Bitcoin, assumed to be Satoshi Nakamoto, released a white paper describing a “purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.”3 This digital cash is a collection of computers, or nodes, that rely on a novel technology called “blockchain,” which combines accounting with cryptography.

A blockchain is a ledger of transaction records that is digitally hosted on millions of computers. This ledger records transactions such as ownership of an asset (e.g., Bitcoin) and a history of its transfers. Blockchain is an application of distributed ledger technology (“DLT”),4 where governance is based on the consensus of network participants, rather than on a central authority.

Distributed ledgers are intended to be trustless; meaning they minimize the amount of trust between participants by distributing trust among a network participants. Since the current version of the ledger is independently hosted in millions of locations at any one time, the network is expected to reject fraudulent attempts to modify ledger history; this feature of DLTs is referred to as immutability. Distributed ledgers are also referred to as decentralized networks. A network can be publicly accessible, or it can be operated privately in a closed ecosystem.

Hierarchy of technologies underlying Bitcoin

Image: Hierarchy of technologies underlying Bitcoin

Source: Emles Advisors LLC

What issues did Bitcoin solve? Technological Innovation

Bitcoin is considered the first “cryptocurrency” because it was the first form of digital cash designed to operate in a fully decentralized manner, without a central authority. Prior to Bitcoin, all attempts at creating digital currencies failed because of issues such as double spending,5 which is the risk that a digital currency can be spent twice. It was also not possible to create a digital currency with Bitcoin’s capabilities using the technology of the 1990s.6

The technological innovation behind Bitcoin was creating the first operational blockchain in the world. As discussed, a blockchain uses a combination of accounting and cryptography to create a payment network with no intermediary. Bitcoin’s cryptography is provable and easy to audit.7

The introduction of Bitcoin also showed that value can be created and transferred digitally. Before Bitcoin, if one sent a digital contract to another person, both parties held valid copies, yet each party could have changed their version with no consequences. After the creation of Bitcoin, if one sends a digital contract, the receiver possesses the only valid copy that cannot be changed. Bitcoin removed the transaction intermediary, while maintaining both the convenience of cash and the security of using a trusted intermediary.8

Economic innovation

While the technological innovation of Bitcoin has received much airtime, its economic innovation is arguably just as important. Bitcoin is like digital gold. Like gold, the premise behind Bitcoin is that over time, the issuance of new Bitcoin will decrease and become scarcer. Unlike gold, Bitcoin’s software caps supply at 21,000,000 Bitcoin. Its finite supply makes it provably scarce – which allows investors to model its supply and inflation more than a century forward. In fact, the last Bitcoin is likely to be mined in 2140!9

In addition to the economic innovation of its predictable supply, Bitcoin also improves:

Please note that digital currencies such as Bitcoin are not legal tender.

Conclusion

Bitcoin has been the clear front-runner in the realm of digital currencies, with a market-cap that has grown to ~$200 billion2 since its origin 12 years ago. Bitcoin has invoked strong interest from investors as they better understand its place as a store of value within their portfolios. We believe that we are in the early innings of investor adoption of the asset class and over time, Bitcoin will become a vital component of mainstream investor portfolios, similar to gold.

Tags: digital currency, Diversification