What is Bitcoin?
Exceptional returns; and strong CAGR predictions; 45% annually for the next 9 years, Bitcoin instantly diversifies investment portfolios and SMSFs. But what is Bitcoin? Einstein said, “The definition of genius is taking the complex and making it simple.” Here’s how to understand Bitcoin, explain it to others and look like a genius at your next dinner party.
According to the Reserve Bank of Australia, Bitcoin is defined as a “digital representation of value that may be accepted by some parties as a means of payment and can be transferred, stored or traded electronically.” It’s also an algorithm; a digital / virtual / crypto / currency; a chain of digital signatures and a blockchain. These labels describe the characteristics of Bitcoin. But definitions don’t provide meaning.
BITCOIN IN SUPER
The Australian Government classifies Bitcoin as an “asset” and legislation allows Bitcoin investment in Self-Managed Super Funds (SMSFs). Due to its low correlation across standard asset classes, it instantly diversifies investment portfolios whilst increasing the funds standard return by 1.65 to 7.69%.
The Bitcoin network is based on a distributed system where everyone agrees on its value and the protocol evolves by consensus. Unlike fiat currency or standard assets, it is not controlled by a central government, bank or authority, thus it cannot be devalued, seized or stolen.
The physical outcome of Bitcoin investment may appear simply as high returns and long-term growth, yet financial security isn’t about forecasted figures. It doesn’t matter what the numbers say if they can’t be trusted.
Nor is financial security only relevant at retirement. Knowing tomorrow is secure affects how you feel today; it creates confidence, comfort and safety. These feelings are priceless.
Yet the current geo-political climate is far from stable, secure or comforting. History has proven fiat currencies decline in value due to their expanding monetary bases, “Over the past 20 years the United States dollar has lost 53% of its value, the British Pound 47%, the Euro 40% and the Australian dollar has lost 64%.”
In our current economic system, the origin and provenance of our money is hidden; we don’t know how much the government prints, but we know they lend a significant more than the fraction they hold in reserve. We’re not sure how bankers hedge funds, create derivatives, derivatives of derivatives or Collateralised Debt Obligations (CDO’s). There is zero transparency; collusion is rife, short-term gains are rewarded and there are no consequences. The $700 billion financial-sector rescue plan of 2008 marked the fourth time the government interceded to prevent the ruin of a private enterprise or the entire financial sector. Further, Forbes reports the original $700 Billion bailout has continued into a “$16.6 Trillion” commitment by the government (tax payer = you).
The U.S. Financial Crisis Inquiry Commission into the 2009 GFC reported its findings in January 2011. It concluded that the crisis was “avoidable; caused by widespread failures in financial regulation; the Federal Reserve’s failure to stem the tide of toxic mortgages; dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; an explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; key policy makers were ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels.”
Famed Swiss financial advisor and fund manager, Marc Faber, also known as “Dr. Doom” in the investment world, told CNBC and Bloomberg “the US is most likely in a recession…when you talk about doom and gloom for 2016, I have to point out… with the exception of people that held bitcoins, the performance of all asset classes has been poor.”
Why buy Bitcoin?
In 2009 a digital currency was launched by “Satoshi Nakamoto” – the name is merely a pseudonym – the creators choose to remain anonymous. The Bitcoin community capped the total supply of Bitcoin at 21 million with a pre-defined, known distribution schedule. Why?
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.” Satoshi Nakamoto
Accordingly, as financial crises ripple the world, Bitcoin’s value continues to rise.
BITCOIN’S GEO-POLITICAL RISE
$US Bitcoin price at each fiat currency crisis
How Bitcoin works
There’s a lot of information, mostly confusing, about how Bitcoin works. Cryptographic algorithms, mining, chunks, blocks, hashes, what?
Worse, people will tell you not to worry about understanding the algorithm, just understand mining – which is like describing the egg without the chicken.
Try this: a class of seven-year-old children are studying Maths. Their teacher, Miss Robertson, writes an equation on the board: ? + ? = 10. There are numerous correct combinations, yet Miss Robertson has decided the answer is 1+9. The challenge for the children is to be the first to guess the chosen combination; the winner gets a big, gold, sparkly sticker.
Milly guesses: “5+5”.
Georgia says: “1+9”.
Correct! She wins the sparkly sticker.
What is the sticker worth? It has no intrinsic value, but to the kids in the class it does. Perhaps Milly says to Georgia, “I’ll swap you my new pencil for that sticker.” Now Tara wants the sticker from Milly – and trades a sparkly pen. Chloe trades a new set of textas for the sticker. Max gives Chloe his entire pencil case.
A sparkly sticker that originally had no inherent value is now worth a pencil case full of assets – because of the agreed value created by the children. Chloe can now go into the playground and trade the contents of the pencil case with other children – for lollies, a ball, whatever she wants.
Let’s imagine all the children throughout the process kept a record of these transactions on a ledger they could all see and verify. Everybody knows what the sticker was last traded for – and that Max now owns it. This is like the “Blockchain” of Bitcoin – a transparent, distributed ledger that everyone can view in real time.
Where does Max keep the sticker? Does he give it back to Miss Robertson to look after? No need; he keeps it in his own little wallet. Miss Robertson cannot seize the sticker – nor can she devalue it – the children each have a copy of their ledger recording the provenance and rising value.
This is how Bitcoin began – but with pizza. In 2010 programmer Laszlo Hanyecz solved an equation generated by the Bitcoin algorithm and was awarded 10,000 Bitcoins – the process referred to as “mining”. Hanyecz went to his local pizza place in Florida and offered the owner 10,000 Bitcoins in exchange for two pizzas. The owner agreed. Together they established the first value of Bitcoin. Today, at approximately $1,600 per Bitcoin, the pizza transaction equates to 16 million dollars. Is Hanyecz bitter? “It wasn’t like Bitcoins had any value back then, so the idea of trading them for a pizza was incredibly cool.”
When to buy Bitcoin