I haven't written about Bitcoin on WSO for a long time, and I've seen a lot of questions about it on the site over the past few weeks due to the recent price movements. There's a lot to cover so this might stretch into two posts. We'll see how it goes.
First, the recent price action:
If you follow cryptocurrencies or alternative asset classes at all, it was probably impossible to miss seeing Bitcoin hit an all time high several days ago ($1,141). Then, in typical Bitcoin fashion, it crashed over 20% in a day when officials from the Chinese government paid a visit to the Bitcoin exchanges domiciled in China. It was not a social call.
The digital currency is drifting around $900 at the time of this writing.
It finished 2016 up 122%.
To the untrained eye, that might look like a solid investment. And for the folks who got in at the right price, it certainly is. But you can't afford to sleep on Bitcoin, because its volatility will bite you in the ass. And that's the voice of experience.
I could spend a lot of time explaining what Bitcoin is and how the whole thing works, but I don't think that would be particularly helpful. There is plenty of info available online and, despite what many people would tell you, it really isn't all that complicated. I would start with YouTube, particularly with the Bitcoin 101 Series.
If you're looking to get up to speed on the concept and players very quickly, it's hard to do better than Nathaniel Popper's Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money. It's a real page turner (not being sarcastic) and at the very least you'll come away with a sense for what's at stake (and what would prompt the Chinese government to pay the exchanges a visit).
Ideology and Evolution
While I won't bore you with the technology, I do think it's helpful to understand how Bitcoin came into being, especially the ideology behind it.
Try to imagine the early internet. I don't mean the World Wide Web, I'm talking about way before that. I got my first modem around 1985. Back then everything was dial-up, and you had to know what phone number to call. We had the early version of ISPs like Compuserve, but they weren't good for much.
Now try to imagine what level of misfit you had to be in order to be accessing the internet at this stage. Pretty much the only people on there were sex workers (always early adopters), uber nerds, and extremists (I ran into what seemed like a lot of neo Nazi and Klan stuff back then).
When you combine the uber nerds with the extremists (both desperately seeking a means to transact with the sex workers), you get the chemical precursor for today's anarcho-capitalists. That was the genesis of Bitcoin.
Alternative currencies were hot almost from day one. Certainly by the 1990s there were entire Usenet groups devoted to unseating the US dollar. Most were whackadoo fever dreams, but some got some legs. One in particular I remember was the NORFED Liberty Dollar, and I remember it mostly because it was a great idea that ended with government jackboots kicking down doors and confiscating all the gold and silver backing the currency.
A lot of the alt currency crowd crossed over with the crypto crowd online. The cryptos were giving the feds their own kinds of headaches. What started out as a ragtag group of phone phreaks eventually became an army of online privacy advocates. Out of this consortium came PGP (Pretty Good Privacy), an encryption program that made the government apoplectic. For a time (and it might still be, I don't know), it was illegal to leave the US with a computer that had PGP installed on it.
Naturally the two groups set about creating an encrypted currency that could give the dollar a run for its money, so to speak. They got close in the late 90s, but couldn't solve for the double spend issue. What I mean by double spend is that they couldn't figure out how to stop someone from using a digital "coin" for a transaction, and then turning around and spending that same spent coin on something else.
On Halloween 2008, a bomb went off in the cryptocurrency community. A short, 9-page document was published by someone named Satoshi Nakamoto which finally solved the double spend problem. He called his invention Bitcoin, and the world would never be the same.
Here's where it gets interesting. It's widely believed that Satoshi is not actually one person, but a group of crypto folks who found the digital holy grail. If they had gone to the government or a university with it, things would be very different.
But they didn't. They released it on the internet and walked away. And the internet saw it for what it truly was: a way out from under the control of the government.
The early adopters of Bitcoin are some of the most virulent anti-government folks you're ever likely to encounter. For them Bitcoin is a crusade; a crusade against the prying eyes of Big Brother, a crusade against capital controls, a crusade against the banks who make ridiculous profits for nothing more than middling the transfer of funds from one party to another.
Believe me when I say that it's a holy war for many of these guys.
But that's not what put Bitcoin on the map. Ideology only gets you so far. Beyond that you need utility, for which there was none. That is, until Ross Ulbricht came along.
Ross either set up or purchased a dark web site called The Silk Road (the origin details are sketchy and it's hard to know who's telling the truth). The Silk Road was an online drug emporium. Well, mostly. You could allegedly buy anything there, including arranging for a hitman, but I only ever heard of anyone buying drugs.
If you're going to buy cocaine or ecstasy or ketamine online, you're not going to use yourcard. That's where Bitcoin came in. Suddenly there was an overnight need for a currency that couldn't be counterfeited, was totally anonymous, and couldn't be tracked. It was a match made in heaven. What's more, the service worked.
The Silk Road was so successful it eventually earned Ross a life sentence (the only case in history where someone got life for building a website). Before it all went down, though, it drove the demand for Bitcoin and caused the price to rise exponentially. All of a sudden everyone was talking about this cryptocurrency that was doubling and tripling in value.
And that's where evolution took over.
Around late 2012, a whole new class of Bitcoin owners came to the fore: the investors. These were guys who couldn't give a shit about the politics, weren't interested in supplanting the dollar, and were only in it to make a buck.
Naturally, the fire breathers from the early days weren't crazy about the new guys. But they couldn't complain too loudly, because the thousands of Bitcoins they'd mined at seven cents apiece were now worth $100 each. You started reading stories in the paper about guys digging through landfills hoping to find old hard drives with Bitcoin stored on them.
In 2014 the IRS issued guidance saying that Bitcoin was not a currency, but an asset class, and would be taxed as such (capital gains). Which was really kind of a wonky decision, because it's impossible to know who mined Bitcoins or at what basis to assign them. It's even possible to pay cash for Bitcoin, so it's still relatively impossible to track.
If I had to guess at the ratio of investors to radicals in the Bitcoin mix today (based on ownership position), I'd say the radicals still have a healthy edge but it's eroding. Every time Bitcoin jumps or drops 20% in a day, more people get curious about it. And buying it is so much easier and safer these days.
And it's definitely a currency. It's practically anonymous, and you can even print your own Bitcoin cash (I'll go into that next week).
So the question is, should you buy it? The answer is probably.
There are two positions that make a disruptive technology sticky: primacy and recency. Bitcoin owns primacy. Several other alt coins (some arguably even better than Bitcoin) have come and gone, and that's because recency is dynamic and not static. But Bitcoin is the first, and likely the one that will stand the test of time. That means some day in the not too distant future it'll be worth $10,000 or more per coin.
I'll get into some more strategy next week, but if you have any questions or comments about what I've said so far, fire away!
Mod Note (Andy): Throwback Thursday - this was originally posted Jan 2017