Higher and Higher: Will the Bitcoin Rise Ever Stop?

There is a Jackie Wilson song from 1967 called “(Your Love Keeps Lifting Me) Higher and Higher.” I wonder if the financial world’s love affair with the cryptocurrency based on blockchain will ever stop lifting Bitcoin higher and higher. Bitcoin, the first of the major cryptocurrencies, is at the time of this writing trading at over $14K per single Bitcoin. Not bad for a currency that has only existed for a little under nine years.

I think the real questions are why is it trading so high, and how did this love affair start?

1 Bitcoin equals $15,264.95

Before we begin to investigate this phenomenon, a brief history of Bitcoin is in order. Bitcoin is not the first cryptocurrency. Prior to Bitcoin, there were hashcash, developed by Adam Back; ecash, based on proposals by David Chaum and Stefan Brands; and Nick Szabo’s bit gold. Although not as successful as those that came later, these currencies laid the groundwork for later entrants’ acceptability with concepts like Hal Finney’s resuable proof of work concept and Nick Szabo’s Byantine fault-tolerant asset registry. I am not going to delve into the theories as to the identity of Satoshi Nakamoto, the creator of Bitcoin, but will simply mention that he is credited with its conception in 2008.

The basic premise of Bitcoin is the value given for work that is undertaken. However, rather than the digging of a ditch or painting of a wall, this work comprises transactions undertaken by a computer program. These transactions are given a value, and when they are completed, the nominal value is stored in your wallet. That part is understandable, but how is that value enforced and trusted? It is the trust part that is the most interesting part of Bitcoin.

Blockchain is the underpinning trust mechanism of Bitcoin. This algorithm provides a forward- and backward-verifiable trust chain of transactions. It is similar in concept to the end-to-end data integrity in ZFS. This chain needs to be trusted; however, in August 2010, a vulnerability was found that allowed users to bypass it and create an indefinite number of Bitcoins (BTC). The vulnerability was exploited to create over 187 billion BTC. This was obviously noticed and the transaction erased, and a new updated version of the Bitcoin protocol was created with a fork of the program. To date, this has been the only significant security flaw found and known to have been exploited.

What makes this a currency in the true sense of the word? Transactions for real objects. The very first transactions were negotiated between individuals, one notable transaction being the purchase of two Papa John’s pizzas for 10,000 BTC (at today’s exchange rate, this would mean the pizzas cost almost $1.417 million—I wonder if the Papa John’s franchisee still has those coins).

By 2011, the Electronic Frontier Foundation (EFF) and Wikileaks started accepting BTC as payment (the EFF rescinded this decision later in the year and then reversed again in 2013). By 2012, the currency was starting to gain visibility outside the world of tech. CBS ran an episode of The Good Wife titled “Bitcoin for Dummies” in which characters argued that due to its not having a central bank to back it up, Bitcoin could not be considered a real currency. In the fall of this 2012, the Bitcoin Foundation was founded.

By 2013, the legal status of Bitcoin was starting to codify. It was not yet a currency but was legally considered a security (US) or a unit of account (Germany). All of this does not explain the current dramatic increase in value of the fledgling cryptocurrency. In January of this year, a single BTC cost $800, but by December 8, 2017, it had risen to over $18,000 before dropping to $14,000.

According to the site Bitcoinblockhalf.com, the market capitalization of Bitcoin is circa $215.3 billion, with over 16.7 million Bitcoins in circulation. Here is the crux: the value is related to the number of people wanting the item, the number of people wanting to sell the item, and the relative availability, or a person’s capability of gaining more of the item. Originally, it took a small amount of compute effort to generate a Bitcoin. Further, BTC could be created on relatively low-end hardware, which resulted in a flooding of the market against perceived value and ability to sell. At that time, a single block of work created 50 BTC. This halves every 210,000 block, meaning the 210,001th block would only award 25 BTC. Currently there are over 16 million BTC, which means that the block generation/reward rate has been halved approximately 80 times. As a result, a block reward is no more than a single BTC. However, this is only half the story. The difficulty of mining increases roughly every 2,000 blocks generated, making the creation of subsequent blocks harder. This obviously slows down the generation time or increases the amount of compute needed to generate.

This subsequently leads to a shortage of the BTC needed to sate demand, prompting an increase in price, which again makes the generation of said block financially viable. It is almost a self-fulfilling prophesy, but not quite. The compute needed to generate BTC is now far beyond the ability of home miners in the first world, as the power costs alone would incapacitate the vast majority of homes. Most BTC work is now carried out at industrial scale in countries that have lower costs. It is those BTC that are growing the market. The story of BTC is similar to the story of the Gold Rush. It resonates with people. Some have been made very rich; others have lost access to the BTC wallet or sent the HDD that was holding their BTC wallet to the landfill site. BTC is now a fairly mature financial entity. Personally, I still err on the side of caution when it comes to calling it a currency. I think it should be more correctly be considered a commodity or possibly a derivative. Regardless, there is little doubt that it has reached maturity in the market.

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