Cryptocurrency is a vast asset class and one that's continually expanding. In the essence of “keeping it real”, the stark reality is many of the digital tokens that are here today will be gone tomorrow (or at some point in the future) and simply are too risky for most clients.
With those disclaimers in mind, bitcoin is the focal point of what follows, but it's worth noting there are some other valid digital assets to consider. For adivor purposes, however, bitcoin is a good place to start because that's the crypto clients are most familiar and in a landscape full of volatile, fly-by-night fare, bitcoin exudes credibility relative to the vast majority of its peers.
In part, that credibility stokes client interest, but the digital/technological element of this new fangled payment system – bitcoin is just 13 years and one month old – stirs client questions. Many even want to know what bitcoin's history is.
That's a relevant query. Interestingly, the white paper penned by Satoshi Nakamoto – pen name of the individual or group that launched what's now the world's largest digital currency – was authored in October 2008 during the darkest days of the global financial crisis (GFC).
Bitcoin History, Evolution
Several months later, the bitcoin network debuted, marking the first test of blockchain technology. That explains why crypto and blockchain are so often joined at the hip, but the latter itself is a fast-growing, investable asset class with or without bitcoin. Back to history. Bitcoin had some good timing, something so many new assets long for but lack.
“Bitcoin arrived at an opportune time. Its launch coincided with the peak of the Global Financial Crisis (GFC), when many individuals lost trust in the large banks that held their money and the governments that set monetary policy,” writes Global X analyst Matt Kunke. “Bitcoin represented a new form of 'hard money' that could not be adjusted or controlled by any centralized entity. This feature, and bitcoin’s scarcity, resonated in the aftermath of the financial crisis as governments around the world implemented large quantitative easing programs that increased the supply of fiat currencies.”
Since it's intended to be an alternative to fiat currencies, there's no physical bitcoin tender. Rather, the currency is entirely digital, but bitcoin can be moved around like standard money. Better still – and this is something many clients don't yet realize – is that bitcoin can be transferred and transacted in without a middle man (a bank) or a platform like Mastercard or Visa.
“The Bitcoin network allows for the transfer of bitcoins on a peer-to-peer basis without an intermediary like a financial institution,” adds Kunke. “The network utilizes fully transparent blockchain technology to facilitate the recording of transactions and the tracking of bitcoins. Network participants can find a consensus state, where they agree on the blockchain’s distributed ledger, by following the protocol rules and independently validating transactions and blocks against the rules.”
Where Mining Fits In
Bitcoin is often referred to as “digital gold” and while that remains a source of debate and a point of consternation for gold bugs, one similarity between the two assets is that both are mined, but as is expected, bitcoin mining is an entirely digital endeavor.
For advisors, one of the primary reasons bitcoin mining is relevant is that many miners are publicly traded companies and represent an alternative avenue to crypto for many clients. Knowing how these companies function and grow profits can be a value add for clients.
“Miners are financially incentivized to be the first to solve this puzzle. The miner who sends a new block with a valid Proof-of-Work first can claim the block reward and all the transaction fees inside that block,” notes Kunke. “The block reward is a special transaction that allows the miner to send themself a fixed amount of newly created bitcoin. This process is referred to as mining because the block reward represents new bitcoin being generated for the first time, similar to new gold being mined from the ground.”
To be sure, there's much more to bitcoin plumbing, but with the digital currency classified as a scarce asset and one that's gaining legitimacy as it becomes more familiar, knowing some of the basics can help advisors prepare clients for what to expect in the crypto and crypto-based equities arenas.
Related: Getting a Handle on Valuing Bitcoin