Financial Education

The Genesis of Bitcoin and a History of Currency

August 3, 2020

Why Bitcoin Matters

Bitcoin can be a bit overwhelming when you first hear about it… money on the internet, a single coin costs thousands of dollars, the price fluctuates dramatically, it’s on a “blockchain,” there are so-called “miners” who support the network, etc. There’s a ton to take in.

Don’t worry! You’re certainly not alone if this all seems a bit confusing. It’s incredibly complicated and even financial professionals often take years to fully understand the intricacies of Bitcoin.

In this article we want to get you familiar with the tip of the Bitcoin iceberg and introduce you to the big picture stuff. We’ll cover why Bitcoin was invented, why it matters, and why more and more people are starting to see Bitcoin as a legitimate store-of-value (hard) currency, like gold.

Setting the Stage — A Brief History of Currencies

To understand why Bitcoin was invented and why it matters, we need to first start with a brief history of money.

Though humans have used many things to barter and trade with since the beginning of time, some of the first real currencies created were coins made of gold, silver and copper (around 5,000 years ago). This was logical because they could easily be melted into a standardized weight and design, and as a bonus, people already knew there was inherent value in these metals due to their rarity (hence the term “precious metals”).

Paper money was first introduced in China during the Song dynasty (11th Century) and then later in Europe to make it easier for merchants to trade without the need to carry around heavy metals. The governments and banks backed the value of this paper money with precious metals held in their treasury, making the paper simply a representation of the gold and silver backing the currency. Importantly, anyone could easily redeem precious metals in exchange for their paper money. This allowed people to enjoy the ease of using a paper currency while still having the financial security of a precious metal with its limited supply and long history of being used as money.

The US Dollar rose to prominence in the early to mid 1900s and became accepted as the global reserve currency because, among other reasons, it was backed by more gold per dollar than other major currencies at the time. Therefore, the international community deemed it a safe and steady currency to use for global trade.

The practice of backing paper currencies with precious metals was common until the 1970s when United States President, Richard Nixon, passed a law saying the US Dollar no longer needed to be backed by gold. This turned the dollar, the world reserve currency, into what is known as a “fiat currency,” a paper money that is not backed by anything, or, has no intrinsic value. You read that right, it has no intrinsic value!

Because fiat currencies aren’t backed by anything intrinsic (i.e. gold) throughout history they have always at some point fallen victim to higher levels of inflation (as there is nothing to limit how much of the currency is created). Your money is not “worthless,” but it is “worth less” over time. You can see this relationship illustrated in the chart below. Inflation is a problem because:

  • The money you work hard to earn does not keep its value in the long run as the supply keeps increasing, and
  • It’s a system that accentuates the rich getting richer as those with limited financial means are less likely to invest their savings in assets, such as stocks, bonds, real estate, etc. (which can negate the effects of inflation with their respective price appreciation).

Governments and central banks are aware of the inflationary nature of fiat currencies and have developed methods for limiting how quickly the currency depreciates. However, as global central banks have begun printing record sums of money in the past decade, first to bail out the global financial system during the 2008 financial crisis, and now again to support the global economy in response to the COVID epidemic in 2020, an increasing number of people around the world have started to question how long this system can continue. How long can the global financial system go on being supported by these fiat currencies, with no intrinsic backing, that can just keep being printed at will.

The Creation of Bitcoin and its Rise as a Store-of-Value

Bitcoin was created in direct response to this excessive central bank printing (or Quantitative Easing as it was called) during the 2008 financial crisis by a developer (or group of developers) operating under one pseudonymous name, Satoshi Nakamoto . At the beginning, Bitcoin was really no more than an online experiment to create a digital currency with a limited supply, like gold, whose value could not be diluted by central banks or governments. A digitally-native “hard” money for the 21st Century that is not susceptible to inflation and therefore holds its value over longer periods of time.

One of the key anti-inflation features the Bitcoin developers implemented was a supply cap of 21 million coins. There can never be any more created, it’s fixed into the Bitcoin code. This makes Bitcoin an ultimate store-of-value, as we know first hand how much will be created. Based on this metric it’s an even better store-of-value asset than gold as Bitcoin’s supply is “finite,” whereas gold’s supply is simply “limited” (we don’t know exactly how much gold there is, we just know it’s rare).

The early days of Bitcoin were very turbulent but then an interesting thing happened, against all odds, Bitcoin worked… and continued to work! People recognized Bitcoin’s potential and the blockchain technology Bitcoin implemented incentivized a decentralized network to form around it. This network protects and preserves the accuracy of all Bitcoin transactions and therefore, Bitcoin itself as a form of currency. The network grew and grew, and continues to expand to this day.

Over the past 10 years, Bitcoin has reached amazing heights, it is now:

  • Backed by the strongest computer network in the world
  • Commonly discussed by central banks and financial institutions around the world as an emerging global currency,
  • Responsible for an explosion of new types of decentralized digital assets and currencies, such as Ethereum
  • And has been profitable to hold for over 95% of its time in existence (see chart below, only if you bought Bitcoin during the brief times indicated in red would you be at a loss currently on your Bitcoin holdings).

The internet placed the power of accessing and sharing information into the hands of the people. Bitcoin, and the blockchain technology it pioneered, are doing the same thing for money — putting the power back into the hands of the people.

In August of 2020, a major tech company, MicroStrategy, decided to allocate $250 million of their company’s treasury reserves to Bitcoin instead of holding that money in US Dollars or another investment vehicle.

Their CEO eloquently explained their rationale for doing so by saying, “We find the global acceptance, brand recognition, ecosystem vitality, network dominance, architectural resilience, technical utility, and community ethos of Bitcoin to be persuasive evidence of its superiority as an asset class for those seeking a long-term store of value. Bitcoin is digital gold — harder, stronger, faster, and smarter than money that has preceded it.”

Having come this far, Bitcoin’s future looks very promising. What will the next decade bring for Bitcoin? Or better yet, what will the next century bring? To those paying attention, it is clear that Bitcoin’s time is just beginning and its timing could not be better given the record levels of central bank printing occurring around the world today.

References:

Image 1: https://long-term-view.com/2020/03/22/5-reasons-to-start-investing-early/

Image 2: https://www.lookintobitcoin.com/charts/bitcoin-profitable-days/

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