I’ve had innumerable conversations about bitcoin and Blockchain. I can’t think of another topic in my business career to date that has stimulated such broad and deep curiosity. I am intrigued. It is hard to pinpoint what the buzz is really about and why there are so many approaches to the subject, so I have attempted to capture it here.
Technology has permeated every aspect of our lives, sometimes explicitly and sometimes in ways we don’t readily perceive. We have been down a road that started with a green screen and a hard drive isolated from the outside world. Then we started networking our computers with dial-up modems to connect across phone lines. Next came high-speed connections and mobile. “Sharing” was the next leap. Sharing our social profiles, our information and work in the cloud, our thoughts through blogs, our careers on LinkedIn, our real-time lives on Periscope. Sharing has gone as far as to create a new paradigm – “The Sharing Economy”, where we even go so far as to share our homes.
In 2009, Satoshi Nakamoto. Satoshi created bitcoin – in his own words “a peer-to-peer electronic cash system”. Satoshi, like many great inventors, didn’t start from scratch. He built on a number of recent technologies and developments. Some had failed, like Hash Cash and e-Gold. Some had recently become part of the math and science lexicon, like SHA 256 (a secure hashing algorithm which can create a tiny, unique identifier for any amount of digital data) and Elliptic Curve Digital Signature Algorithms (ECDSA – which creates public addresses and private keys to permission changes to what is held at those addresses).
He didn’t know what he had unleashed. One wonders how far Tim Berners-Lee might have imagined the influence of his work would spread at the moment he first managed to connect two computers and gave birth to the Internet.
So what was so significant about Satoshi’s creation? Satoshi created the World’s first permanent and public memory – and this has profound implications.
Let’s work backwards, starting with bitcoin. Why? Because if one tried to explain TCP/IP to the uninitiated the complexity would be a downer. However, show someone how they can instantaneously send data in text, video, numeric or pictorial form across the World you have their attention.
Bitcoin has a value. At any given moment, 70-odd exchange venues bring together willing buyers and sellers of this digital currency. You can exchange Euro, Sterling, Dollars, Yuan, Krone and even Nigerian naira for bitcoin. To all intents and purposes trading proceeds in bitcoin just like in any other currency pair. Rather than record your balance on a bank statement or in physical cash though, bitcoin only exists as a ledger entry. You pay over your ‘fiat’ money in order to increase your personal balance on that ledger. The ledger in question is the Blockchain. Thousands of copies of this ledger are maintained on servers distributed globally. Those servers can be as small as an individual computer or as large as a massive data centre. The ledger is “distributed” – so the perfect inverse of the legacy bank system where one central authority controls the ledger and changes to it. I can tell you easily who runs HSBC’s ledger. It’s hard to make that determination for the Blockchain, but in short, it is everyone – and no-one. Satoshi’s brilliance imparted on the Blockchain magical characteristics: distributed, unforgeable, synchronized, locked, immutable, time-stamped and ordered are just some. The Blockchain protocol delivers all these things in the absence of any centralised authority. The Blockchain is in the order of 40GB of data and if you have a copy (which is publicly available) sitting on your laptop, you have a precisely accurate version and account of every bitcoin transaction that has ever been done. An immutable Public record. As technologist Jeff Garzik put it “Blockchain is an audit log, a difficult to censor history”.
So what is a block? It is just a file. There are over 386,000 blocks in the Blockchain at the time of writing, with a new one created approximately every 10 minutes. Each file contains information that, once locked at the end of the ten-minute cycle, becomes a definitive record of all bitcoin transactions that took place in precise order. Each block contains changes to the ledger that occurred in the preceding 10-minute window. There are 10 to the power 48 addresses available on the Blockchain. 10 to the power 48 “pages in the ledger”. Each address has a unique private key. Anyone with the private key – usually a 32-byte hexadecimal number – can make changes to the unique address which that key controls. Most commonly, the ledger functions much like a bank ledger would. Bob has a page on the ledger on which is written his balance of 1 bitcoin. Bob want to send Alice that bitcoin so the balance in his account must go to zero and the balance in Alice’s account must increment by 1. If it were dollars you would call Citibank and ask them to make that change. With bitcoin Bob would apply his key to an instruction – using a digital wallet – whereby his private key “signs” the instruction and creates the transfer. Once signed the instruction is broadcast over the Internet, is recorded by all the computers that form the bitcoin network and — once the latest 10-minute cycle expires — that block, that data file, that next iteration of the ledger, becomes locked, agreed, published and distributed – never again to be altered.
This facilitates a ledger, better than the legacy version, perfectly aligned with the internet, offering all the functionality that a bank ledger would offer but so much more and all in the absence of a central authority or controlling third party.
The “Eureka!” moment here is that ANY data can be stored in the blocks of the blockchain.
Now we can look past bitcoin as a currency and view it as a disruptive technology.
For the rest of this article I will describe use cases where the world businesses may be remodelled using bitcoin and blockchain, as well as some comment on bitcoin valuation.
A key concept in taking this forward is the “Smart Contract”, using one of bitcoin’s most powerful characteristic: bitcoin is not just money; it is programmable money.
A Smart Contract comprises an IF THEN statement and an “Oracle”. An Oracle can be any internet-based, accessible data source or sources. An example of an Oracle would be the settlement price for Heating oil as published on the CME website, or the temperature in Chicago at a given moment as published on Weather.com.
Two counterparties could deposit an amount of bitcoin into an address on the Blockchain and IF the Oracle reads a given result THEN the bitcoin would be sent to one of the contract parties as determined by the code.
Bringing in more features, IF your dog’s GPS chip shows a circumnavigation of Central Park, THEN pay your dog walker $25 in bitcoin.
IF your electricity meter shoes 50Kw of energy consumed THEN pay your electricity company. IF General Motors receives $25,000 from your wallet for the car you are standing next to on the showroom floor THEN a) Issue an unlock code for the car to your phone, b) update your Blockchain based insurance to cover the new vehicle, c) update your Blockchain based DVLA or DMV records to reflect ownership – then just drive off.
What bitcoin and Blockchain can do is to merge your financial assets with your digital life. You no longer send discrete instructions to your bank, broker or credit card company to make payment for goods or services. The goods and services pull money, with your permission, as you consume them. In each case you deal peer-to-peer with the counterparty or provider.
So now we can list other potential use cases:
Satoshi did not conceive these examples when he created bitcoin it was, in some ways, an accident.
Valuation – Bitcoin $4400
These considerations lead to my investment thesis in bitcoin itself. Bitcoin is a currency, currency as a content type, programmable money and real estate on the Blockchain. It will not replace Fiat money, it will form part of the product of a migration away from a narrow, monotonic, Fiat currency system we now know to a rich, multi-currency, user-friendly ecosystem of payment mechanisms – all tailored to purpose. The utility that bitcoin brings in doing things that consumers want yet Fiat money will never be able to do is the dominant factor. The promise of distributed ledger technology is so great and the currency that laid the foundations of this revolution will surely be a big part of the financial future that it brings.
I believe strongly in the price appreciation potential of bitcoin. The investment thesis centers on the idea that bitcoin is a cheaper, faster and more global form of currency payment than can be seen in any other form. It also takes tremendous strength from being fully aligned with the internet. Continuing with our theme “money as a content type” we know that today we send email, post on Instagram, Facebook, blog sites, YouTube etc. You can embed text, video, pictures and sound in such communications. Well with bitcoin you can embed money too.
In terms of replacing traditional money the math gets very interesting. Look at a model available online at: http://worldbitcoinnetwork.com/BitcoinPriceModel-Alpha.html. This model theorizes that as money moves out of traditional forms into bitcoin the price of bitcoin would increase to reflect a change in exchange rate. Now it is not necessarily true that if you sell a dollar and buy bitcoin the price of bitcoin goes up by a fixed amount – there is some elasticity in that relationship. But none the less one can expect modest flows out of traditional money into bitcoin to create some relative change in price. You would expect the value of traditionally money to go down and bitcoin up. This model makes the assumption that if you sell $1 of, say, gold, then the total market capitalization of all bitcoin rises by $1. Currently at a price of around $400 you can assume bitcoin has replaced 01% of the $1,000 billion E-commerce market and 0.2% of the $500 billion remittances market. You can explore scenarios online but if bitcoin replaces 1% of gold, 2% of E-Commerce, 2% of the remittance market and 0.2% of the Global Money Supply the price would, by this math, rise to $4400.
This math is what makes investing in bitcoin so strange. Bitcoin is a massively volatile asset on any given day. But long term our view is that only one of two things happens; prices go to zero or $4400 plus. In other words, opportunity is skewed dramatically to the upside on a 10 to 1 ratio.
Therefore, there is little to be gained by trying to time the market when the price is $400. The short term catalysts for bitcoin are clear; a resolution of Global regulations, the so-called bit-license promulgated by the New York Department of Financial Services, Laws created by the Jersey Financial regulator, the emergence of regulated exchanges (by companies such as ItBit, coinbase, and coinsetter) and the emergence of other exchange traded products such as ETFs on bitcoin. The risk in our view is not that you buy at 300, 400 or 500.
One risk is that prices go to zero. The main risk in my view, is that one misses a large appreciation in value though under-investment and hesitation.