Well-Being

Financial Well-Being: What the Hell Is Bitcoin?

August 7, 2017

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IS IT AN INVESTMENT or a way to pay for things online?

Bitcoin was created in 2009 by a very smart but secretive person (or persons) who goes by the name “Satoshi Nakamoto.” He invented it as a way for us to make payments and other money transfers without ever having to use banks, credit cards or money wires again.

How? Satoshi Nakamoto invented a “cryptocurrency,” the Bitcoin, a currency with no government backing. Then he cut out the middle man in most transactions (the trusted third party a/k/a the bank).

Then he combined the Internet, a special type of online network called peer-to-peer, a really powerful math program and a shared “ledger” to create a system called the blockchain. This blockchain technology is a new secure way, not only to manage financial transactions but to record and validate records and information, such as a real-estate title, your healthcare records or an insurance document anytime/anywhere. And of course it manages all digital currencies like the Bitcoin—Ethereum, Monero, Litecoin, Stratis and others.

And blockchain technology does all that without any intermediary. (See below for the details of how this works.)*

Forbes magazine recently defined blockchain as  “a digital ledger which both [parties to a transaction] can immediately access,” reducing human error and the risk of the funds being in both accounts simultaneously. “This wire transfer,” Forbes continued, “would be completed almost instantly and the transaction would be added as a new ‘block’ to the ‘chain’ of ledger entries across the network.”

Once the ledger is updated (in seconds), everyone can see the unique ID transaction and direct it where it will ultimately be matched and confirmed. All transactions are tracked and stored in a “digital wallet”; the Bitcoin can be held as an investment or sent to another recipient as a payment for a specific good or service. Bitcoin owners transmit no personal information, and no bank account numbers are required, eliminating the pitfalls of identity theft. Another benefit is that there is no need for fees attached to any transaction, unlike a bank or PayPal payment.

Let me say again, no personal information, no fees, just a generated unique code created by algorithm at the central ledger to authenticate/facilitate the payment to another Bitcoin party. The blockchain, or ledger, becomes the book-entry digital wallet used by the central computers to manage all transactions for Bitcoins.

Certainly PayPal, now in alliance with Venmo, performs a similar function, facilitating online transactions. But there’s one big difference. It does not use a virtual currency but performs a US-dollar-based transaction. And plenty of information is required.

A Bitcoin is not a “fiat“ currency, one backed by a government; it exists in an unregulated marketplace. The Bitcoin’s value floats freely according to basic economic supply-and-demand conventions. In fact, there are currently 800-plus kinds of digital coins in this digital world. Bitcoin just happens to be the most widely traded since its 2009 creation. Some $45 billion worth of Bitcoin is currently traded daily. By contrast, though, $5.3 trillion of government-backed currencies are traded each and every day worldwide. Yes, Bitcoin has a way to go before it reaches that size market valuation.

Even if you’ve ignored all the recent news about Bitcoin’s volatility, you will hear more and more as the blockchain technology expands globally on all industry fronts. Internet experts have forecast that blockchain technology will be the next revolution/disrupter in the financial technology world (FinTech). Harvard research argues that blockchain is most important as a foundational technology that can be used to create new business models and underpin business, economic  and social infrastructures for many decades.

All of us Luddites (and we are many) should know that companies such as IBM, Dell, Microsoft, Overstock.com, and also companies we use daily—Subway, Amazon, Whole Foods, Expedia and Shopify.com—have embraced the blockchain technology, and Bitcoin currency, as an alternative to the PayPal/Venmo and credit-card/bank option because it reduces their bank fees. Also, the innovation wraps their infrastructure around the new shared-data revolution of blockchain processing.

So that’s Bitcoin and blockchain as an alternative Internet payment process. But what about Bitcoin as an investment?

Well, the investment possibility is trickier. Since 2009, the Bitcoin’s value has risen considerably, to one “coin” being worth $2,783 as of July 29, 2017, and can be very volatile day to day, moving as much as 1% to 10% in a day, sometimes more, something that rarely happens with a government-backed fiat currency. So instead of “investing” directly by buying  Bitcoins, with their attendant volatility, you may want to consider two more-conservative investments vehicles in the new world of the Bitcoin exposure and blockchain technology, namely: The Global Bitcoin Investment Trust stock (ticker symbol GBT) and The Global X Fin Tech ETF (ticker symbol FINX).

I am not personally recommending either of these investments, just reminding the reader that with every newly created financial instrument or technology, there comes a new-fangled process that plays out and adoption of either may take some time. And as expected, more people, industries, businesses and governments are considering these alternatives in a very real way to democratize the bank, credit-card and PayPal payment options available currently.

So to answer the original question, the Bitcoin is both a new and improved online digital payment alternative and it is also a possible investment in the dynamic and ever-changing world of blockchain technology. I believe Satoshi Nakamoto would be very proud of his invention.

The final question, How do I buy Bitcoins? There are several companies that make a market in Bitcoins such as Coinbase or Blockchain.info; and a list of digital vendors can be found at this site. Simply pick a vendor, request an amount of Bitcoins in US dollars, enter the credit/debit card and create your very own digital wallet.

But remember, as our good friend David Kotok, chairman of Cumberland Funds, recently cautioned on cryptocurrencies, we should not think of them as money.

Bitcoin “does permit the classic function of money as a medium of exchange,” he writes in his July 26th market commentary. But, he points out, money (at least currency with low or no inflation) also “has a certain ‘store of value’ . . .  and we have price references denominated in dollars or euro or yen. Bitcoin has not yet attained the ubiquity needed to meet those tests.” Kotok sees Bitcoin as a speculative investment, one that will not be in the reserve of any major central bank any time soon.

—Abigail Cook
Cook has been managing director or vice president for foreign exchange sales at BNY Mellon, Westpac Banking Corporation and RBC Capital Markets. She is based in Pittsburgh.

* To make blockchain technology work, Satoshi’s math program essentially generates a unique identifier for each and every transaction, which then gets posted on a decentralized public ledger. The identifier details are then sealed and stored on that ledger with digital versions of keys. This is now a digital receipt known as “block.” Each block is then connected together creating a trail and chain of secured transactions that cannot be altered, and thus the term blockchain! Think of it like a game of Tetris, building those tiles (blocks) into a wall (ledger) through computing power to build, store and keep the histories of those ID records/transactions.

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