Perhaps buoyed by Thanksgiving chatter, bitcoin has been approaching all-time highs, topping $10,000. (Google Trends showed searches for the digital currency spiked after Thanksgiving.) To those who have been monitoring the cryptocurrency, the mainstream moment that people have been waiting for may be arriving.
Thanks to Coinbase and other online exchanges, it’s relatively easy for a person to purchase bitcoin to join the other speculators in the hopes that they catch it on its way up.
In the herd mentality that engenders the “fear of missing out” trade, many people are probably jumping into bitcoin without a firm grasp of what bitcoin is, ignoring Warren Buffett’s maxim to never invest in something you don’t understand.
It’s not clear whether you should buy bitcoin — that’s up to you. (Vanguard’s Jack Bogle just said “avoid bitcoin like the plague,” for what that’s worth.) But if you choose to, you might as well know what bitcoin is and be able to clearly explain it to someone.
The best way to understand bitcoin may be from the original white paper that describes it, authored by the pseudonymous Satoshi Nakamoto and entitled: “Bitcoin: A Peer-to-Peer Electronic Cash System.”
At nine pages long, the paper is written in a simple, explanatory manner that eschews esoteric nomenclature, complex computer jargon, or cryptographic technobabble.
How bitcoin works, in the original language
“We define an electronic coin as a chain of digital signature,” the paper said. “Each owner transfers the coin to the next by digitally signing a hash [making a record] of the previous transaction and the public key [a public-facing identifying key] of the next owner and adding these to the end of the coin.” This digital signature turns into a series of digital signatures, which is known as a “blockchain.”
Since there is no third-party authority, the network works to validate a transaction by consensus. Each transaction involves a bunch of computers on a network doing a ton of work to make a new entry into the blockchain. The longest blockchain by default is the trusted one, since it would have taken the most computing power — a consensus — to create.
Bitcoin’s inherent value
In any discussion about assets, considering any inherent or liquidation value is always important to consider. For a car, it might be scrap metal. For a company, it might its office real estate or some form of passive income. For gold, it might be its useful electronic properties, its anticorrosion, its density, or its bling.
At a glance, bitcoin may not appear to have any “inherent value,” instead it is worth something because many people are treating it as valuable — a sort of fiat by group. But it does have value because it can be completely private, as outlined in the white paper.
Bitcoin not only eschews third-parties, though today people often use third-party exchanges to buy and sell bitcoin, but it can also function in complete anonymity.
“The traditional banking model achieves a level of privacy by limiting access to information to the parties involved and the trusted third party,” writes Nakamoto in the white paper. In bitcoin, all the transactions are public, but instead of names, the owners use a unique public identifying key. “Privacy can still be maintained,” the paper reads, “by keeping public keys anonymous.” So unless a bitcoin owner announces which key is theirs, the privacy remains hidden in the open.
Even if you choose to stay on the sidelines when it comes to bitcoin, reading Nakamoto’s paper and gathering an understanding of how bitcoin works is a sure investment of a few minutes. The underlying technology of blockchain is exciting even the loudest of the bitcoin bears.