A Beginner’s Guide to Understanding Bitcoin

A lot of guides have been written to describe the basics of bitcoin. They usually start with an analogy around gold and mining, and something called the blockchain. These guides are great, but they often get into the technical weeds and don’t explain why people are investing in bitcoin or why it can change the future of money. In this guide, you’ll learn what bitcoin is, its pros and cons, and what it means for the future of cryptocurrencies.

What is It?

Bitcoin is a currency. It can be sent digitally. It can also be stored securely, either digitally or on paper. Unlike traditional money, it can’t be easily forged. Unlike traditional currency, bitcoin transactions are both public and largely anonymous.

Why is Bitcoin Valuable?

Bitcoin does a number of things that traditional money, gold, credit cards and checks do, but it does it without a central bank. Bitcoin also does it digitally and in a way that is very difficult and arguably impossible to forge. These characteristics are so desirable that many people are trading traditional currencies for bitcoin. In fact, so much of this is happening that it’s causing the price of bitcoin relative to traditional currencies to skyrocket, creating an investment opportunity for many people coming into the currency.

Like other currencies, bitcoin’s value is driven by supply and demand. Bitcoin has a limited supply (today there are only 16 million bitcoins and the currency will only ever have 21 million coins). This is a limited global supply but an in increasing global demand. Bitcoin is becoming more widely accepted and easily transferable. It’s now possible to send money from person to person and country to country, without it going through a bank.

While this may seem basic (that’s the point), it’s transformative. It’s was previously impractical for people to be their own bank. You could store money in a vault or under your mattress but it was difficult and impractical to do so because ease of transfer and portability are important. This is why centralized digital payment companies like credit cards, PayPal and Venmo took off. They made payment easy and portable. But these methods are centralized. Anyone who has had their credit card stolen or had their PayPal account locked up knows how crippling this can be. The differentiator of bitcoin is that it’s decentralized.

Why Does Society Think Bitcoin is Valuable?

• It can store your money.
• It can protect against forgery.
• It can be used to pay people securely.
• It can be exchanged globally for goods and services.
• It can appreciate in value (investment).
• It is decentralized so that no government or individual bank is in control.

Technological disruption often eliminates middlemen. It allows people to deal directly rather than indirectly. Bitcoin is eliminating the arbitrage of a bank. It allows people to control their own funds directly.

What’s Wrong With Bitcoin?

For all the things that are positive about bitcoin, there are a number of problems worth discussing. These problems are being worked on by teams around the world, and given the decentralized nature of bitcoin, will require consensus to solve.

• Bitcoin is slow. Transactions, sending money and receiving it is slow; currently too slow for real-time purchases. Bitcoin is faster and more secure than sending a check, but it’s often measured in minutes and hours, not milliseconds.
• Bitcoin uses a lot of electricity. Part of the algorithm of bitcoin is designed to make it difficult to create new bitcoins. This process is intentionally inefficient. Because of the rapid scale of the currency, it’s estimated to be using enough energy to power about 2 million homes.
• Bitcoin is currently an unstable currency. It’s so new that it changes price daily in 10 percent swings both positively and negatively. This can equate to even larger weekly fluctuations. I expect it will settle, but it’s hard to tell how long this will take. In the meantime, there will be investment winners, losers and inevitable bubbles.

The Future of Cryptocurrencies

Global wealth is measured in the $100 trillion range and up. Cryptocurrencies, including bitcoin, are in the $200 billion range. I believe that the future will have more cryptocurrencies rather than fewer. My predictions:

• I expect cryptocurrencies such as bitcoin will grow north of 1 percent or $1 trillion in global value in the next year. Over the next few years, I expect it to be 5–10 percent.
• The decentralized encryption technology behind bitcoin (blockchains) will be used for many new things including accounting, medical records, insurance and more.
• New cryptocurrencies may begin to grow even faster than bitcoin as the performance and energy issues with bitcoin become more pronounced.
• When the growth rate stabilizes, we’ll see more personal payment solutions (similar to PayPal) as well as traditional banking solutions built on top of cryptocurrencies.
• Governments and tax agencies will begin to pay a lot more attention. Bitcoin is considered an “intangible property” by the IRS. Expect further regulation and taxes around cryptocurrency to measure and track capital gains.
• Exciting new technologies will become more popular. New currencies and blockchain tools like Ethereum will allow a new breed of apps to be built and run in the cloud. This is still in the experimental phase, but people are already using Ethereum for identity, crowdfunding, voting, and even breeding digital cats (yeah, really.) More complex and sophisticated apps will evolve to use the technology that will further digital currency and decentralized trust.

I believe that many aspects of cryptocurrencies will become inevitable. Not everyone wants to trust banks with their money, but to date, it’s been impractical to do otherwise. The collapse of Lehman Brothers, the fraud at Wells Fargo and others have created new opportunities for bitcoin and beyond. I believe the future is bright for digital currencies.

Warning: Never invest in something you don’t understand and don’t risk money you’re not willing to lose.