The Bitcoin Big Bang

How Alternative Currencies Are About to Change the World

Brian Kelly

• Publisher: Wiley
• Year: 2014
• Print ISBN: 9781118963661
• eBook ISBN: 9781118963654
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Get a handle on the digital currency revolution, and learn how to get on board

The Bitcoin Big Bang is a guide to navigating the uncharted territory of digital currency. Written by CNBC contributor Brian Kelly, this book goes beyond Bitcoin 101 to explain how this transformative technology is about to change the world. Digital currency is thrown into perspective against the history of payment systems and its own evolution, as readers are invited to explore the ways in which this technology is already changing the way business gets done. Readers gain insight into the mechanisms behind Bitcoin, and an expert perspective on digital currency's effect on the future of money and the economic implications of the Bitcoin revolution.

In the same way that e-mail changed the way we transfer information, the decentralized Bitcoin network is about to revolutionize the business world, the legal profession, and even the role of the government. The Bitcoin Big Bang dives head first into this paradigm shift, allowing readers to:

• Explore the origins of digital currency
• Learn the history and evolution of payment systems
• Discover how the Bitcoin network is facilitating free and instant transfer of value
• Understand the mining of Bitcoin, and how to invest

The digital currency revolution has implications that spread far beyond the finance industry. Anyone who exchanges payment for goods and services is on the cusp of the next big push in societal evolution, and only an understanding of the technology and a clear knowledge of the systems and behaviors at play can fully prepare us for the changes to come. The Bitcoin Big Bang is the go-to guide, helping those who use money use it better.

Chapter 1
Bitcoin Is a Bubble

When I see a bubble, I buy that bubble, because that is how I make money.

—George Soros

Fad, scheme, scam, tulipmania, and bubble are all terms I have used to describe Bitcoin. The majority of my professional money management career has been spent in the currency markets, and as a so-called expert I was convinced Bitcoin was nothing more than a speculative bubble. It seemed impossible that a string of numbers backed by nothing and without an army could ever meet the accepted definition of a currency as a plausible medium of exchange, store of value, or unit of account. More than once, I confidently declared that Bitcoin was nothing more than “Tulipmania 2.0,” a reference to the Dutch tulip bubble of the 1600s. Of course, the only thing I knew about Bitcoin was that people were calling it a digital currency, a term that was new to me. Unfortunately, not even ignorance could stop me from bellowing on national television that Bitcoin would not last.

I had first read about Bitcoin in 2011 while browsing my usual currency websites looking for investment ideas. In the late spring of 2011, the price of bitcoin had reached parity with the U.S. dollar, and by July, one bitcoin was worth $31. Any investment that has a 3,000 percent increase in value will attract a lot of attention, but two decades working on Wall Street has taught me not only to be skeptical but to automatically dismiss these investments as unsustainable bubbles.

Bitcoin appeared to be a quirky little project hallucinated by a cryptic computer programmer who was disillusioned with the post-financial-crisis world. It was interesting, but I did not think there was any money to be made, so I promptly forgot about this diversion and continued blissfully unaware that a revolution was under way. It was not until the autumn of 2013 that Bitcoin would reappear on my radar.

In October 2013, I was consumed with research on the end of quantitative easing by the U.S. Federal Reserve. The so-called taper had roiled financial markets, and I needed a template to guide my investment decisions. Since many believed that Bitcoin was a direct response to quantitative easing, the two concepts had become twinned, especially on the Internet. Through my research, I began to notice the price of bitcoin was once again on the rise. After stagnating below $31, the price of bitcoin had spent the past year climbing to $150.

As the price climbed, the media attention grew, particularly on the business channel CNBC, on which I appeared. If there is one thing I have learned from being on television, it is “if it bleeds, it leads,” and Bitcoin was as close as business news gets to a bleeding headline. Not only was the price rising rapidly, but the clandestine creator made the story fascinating. Most importantly, people were interested. Perhaps we all sensed that something remarkable was happening and we all craved knowledge. Information becomes a valuable commodity during times of uncertainty.

Despite my deep skepticism, I was haunted by a quote from famed investor George Soros. Mr. Soros was talking about gold as the ultimate bubble when he was quoted by The Australian as saying, “When I see a bubble, I buy that bubble, because that's how I make money.” Well, this was my bubble and it had been unknowingly stalking me for two years. I could no longer ignore the palpable euphoria. I wanted in—no, I needed in.

The Quest to Buy Bitcoin

In my day job, I am accustomed to taking risks, but as I contemplated buying into the Bitcoin hype, fear coursed through my veins. This was a different kind of risk; Bitcoin had a bad reputation. The notorious website Silk Road had just been shut down and its hoard of bitcoins seized by the FBI. Characters with monikers like Dread Pirate Roberts ruled this realm, while hackers constantly launched attacks. If I were to stride into this land flashing my Wall Street credentials, I would be an easy target. Caution and anonymity would be my friends on this quest.

Clicking on stealth mode, I typed “how to buy Bitcoin” and Google's algorithm churned out 166,000 results. The first page of results was meaningless to this neophyte, except for one: Mt. Gox. Since Mt. Gox was the largest exchange in the world, I was vaguely familiar with the name. It was comforting that Mt. Gox was the largest bitcoin exchange in the world, and I decided immediately to ascend Mt. Gox to make my purchase. Astonishingly, it did not bother me that only a short time ago Mt. Gox stood for Magic: The Gathering Online Exchange and was a place to trade magical game cards. Bitcoin was cutting edge, it was the Wild West; I needed to take a risk. In a spurt of rapture I convinced myself that since Mt. Gox was located in Japan and the inventor of Bitcoin went by the name Satoshi Nakamoto, then Japan must be the Bitcoin epicenter.

Doing my best impression of James Bond, I created a fictitious Gmail account to remain as nameless as everyone else who dealt in these “coins.” My pulse quickened as I registered under my alias—I was unsure if I was breaking the law or stumbling upon a hidden fortune. I surveyed my new environs, and I decided to make a purchase; this was my first step toward untold riches. But it all came to a screeching halt when I realized that I overlooked one tiny detail—I needed an actual bank account with real money to buy the coins.

I was determined to cash in on my bubble and promptly formulated a plan.

When I signed into Mt. Gox, a message advised that there was a waiting list of people trying to buy bitcoins. The exchange was so busy that they could not process all the requests, and the message indicated it would be five days before my paperwork could be processed. I was thrilled to have an additional five days to open a U.S. bank account for a “person” with only a fake Gmail address. It was not yet clear to me that my judgment had been compromised by visions of planes, autos, and jewelry. Finally, I drifted back to reality and began to hatch a better plan.

Even though Bitcoin was anonymous, I quickly recognized that my dreams of bitcoin billions required my personal information. I immediately began to look for a layer of security. Another Internet search led me to eBay, where sellers of bitcoins were plentiful. It appeared that I could use PayPal, which meant I did not need a bank account and my information would be safeguarded. Alas, I had once again overlooked a small, but important, detail. If I bought bitcoins on eBay, I would be a counterfeiter's dream. This is a currency that lives on the Internet. While I was accustomed to dealing in foreign currencies, buying Mexican pesos from JPMorgan is a long way from purchasing a digital currency from a stranger on EBay. I did not know if I should expect a zip file of computer code or an actual metal coin. Obviously, I needed Plan C.

After an appearance on Fast Money, where I disclosed parts of my Bitcoin buying adventure, a Twitter follower mentioned Coinbase as an alternative to Mt. Gox. I had not heard of Coinbase, so back to Google stealth mode I went. As it turns out, Coinbase is one of the largest digital wallets, and it is a bitcoin broker that could handle my purchase seamlessly. I felt even more comfortable when I learned that Coinbase was based in the United States and backed by one of the largest venture capital firms in Silicon Valley.

Now that I was back on my road to riches, I needed to register, verify a bank account, and wire funds. The entire process would take over a week: three days to verify the bank account, one day to buy the bitcoins, and another five days before the coins would show up in my account. This was unacceptable—I was about to make a fortune and every second counted. Sadly, I was out of options. Since I was technically inept and had absolutely no idea how Bitcoin worked, I was at a severe disadvantage. I just had to wait, which was a monumental task for this attention-challenged trader. For a week I checked my account like a child on the night before Christmas: Were they there yet? How about now? Now? Now? Now?

My anticipation was exceeded only by my excitement when the coins finally arrived. All that remained was relaxation, planning my private jet purchase, and waiting for the world to catch up and buy bitcoins. I was waiting for a greater fool than I, and it did not take long before a whole bunch of fools arrived. The price of bitcoin soared from my purchase at $795 to $1,200 in a matter of days. I quickly calculated the annual return—$400 in 4 days meant $100 a day; multiplied by 365 days meant I had just turned $795 into $36,500, a 4591 percent gain. This was going to be the greatest trade I ever made—drop the mic and walk off stage.

Not so fast, hero.

Within days, the Chinese government banned banks from dealing with bitcoins, effectively shutting down the largest market. The price plummeted to $500 almost overnight. There is a saying on Wall Street about losing positions: they start out as a trade and end up as investments—rationalization at its finest. My “can't miss, surefire” trade had just turned into an investment. I was in for the long haul.

Now that I was an “investor,” I thought I better find out what I actually owned. Typically, I rely on a deep knowledge of the markets I trade before I place money at risk. In the case of Bitcoin, I had succumbed to the powerful emotion of greed. Ironically, I make a living seeking out greed and fear, acting only when other people's emotions have reached their zenith. In the case of Bitcoin, I was a rookie and I had paid the price of inexperience.

In order to supplant my ignorance with knowledge, I began to research Bitcoin as a currency. If Bitcoin was a new type of currency, then the logical place for me to start my journey was from a familiar point of view. Since Bitcoin was designed to have a finite money supply—only 21 million coins will ever exist—it appeared to be akin to digital gold. The process of mining fit with this analogy, and the fact that miners received free coins was intriguing. However, unlike gold, bitcoins were being used to purchase everything from pizza to Tesla automobiles. As a medium of exchange, bitcoins were fulfilling at least one of the three functions of money.

Like many other Bitcoin explorers, I had my “aha” moment when I realized that if people could buy a pizza with bitcoins as easily as a credit card, then Bitcoin was also a payment system. This disruptive technology was a free payment system—no credit card fees for those who indulged in the pizza pie or the pizza shop. Not only was this technology disruptive but it was happening in my industry. I was hooked; I needed to know everything. It did not matter that by now I could sell my bitcoins for a small profit; I was in too deep to turn back.

Bitcoin Enlightenment

My path to Bitcoin Enlightenment careened between cryptographic hash functions and the simple balance sheet that is the beating heart of Bitcoin. Searching for the mysterious creator, Satoshi Nakamoto, made for interesting reading, but it wasn't until I looked at Bitcoin as smart money and a social network that I truly understood the revolution.

Removing the middleman has a long history of disruption in business—the personal computer placed mainframe computing power on the desktop, while the Internet enabled peer-to-peer communication. The collision of personal computers and the Internet spawned companies like Apple, Netflix, Twitter, and Facebook.

The Bitcoin Big Bang is a story of evolution. It is the evolution of currencies, payment systems, how money is used, financial services, and even the way business is organized. It is that moment when you realize the world has changed, permanently and forever. Evolution is a laborious grind, until BANG—everything changes at once.

Even though I knew Bitcoin was game changing, it was still in its infancy. If I became evangelistic about the technology, I risked appearing to be a kook who thought he saw a unicorn. Perhaps it was self-doubt or an innate longing to be part of a crowd, but I would be restless without validation. Then, seemingly out of nowhere, I stumbled on a series of quotes from venture capitalists who were committing big money to Bitcoin. My sanity was restored.

Eventually mainstream products, companies and industries emerge to commercialize it; its effects become profound; and later, many people wonder why its powerful promise wasn't more obvious from the start.

What technology am I talking about? Personal computers in 1975, the Internet in 1993, and—I believe—Bitcoin in 2014.

—Marc Andreessen, inventor of the Web browser and cofounder of Netscape

Marc Andreessen is not only the inventor of the Web browser; he is also a founding partner of the venture capital firm Andreessen Horowitz, which has invested $50 million in Bitcoin-related companies, including my wallet service, Coinbase.

In 2010, BusinessWeek named Chris Dixon the top angel investor in the technology industry. In 2012, Mr. Dixon joined Andreessen Horowitz, and by 2013, he wrote these words:

Like a lot of people I initially dismissed Bitcoin as a speculative bubble (“Internet tulip bulbs”) or a place to stash money for people worried about inflation (“Internet gold”). At some point, I had an “aha!” moment and realized that Bitcoin was best understood as a new software protocol through which you could rebuild the payments industry in ways that are better and cheaper.

And Peter Thiel, the billionaire founder of another “little” payment system called PayPal, had this to say about Bitcoin:

It is worth thinking about money as the bubble that never ends. There is this sort of potential that bitcoin could become this new phenomenon.…

Mr. Thiel has gone on to invest millions in Bitcoin companies like BitPay. If you don't remember Peter Thiel from PayPal, you may remember his business partner, Elon Musk, the founder of Tesla. If that's not enough street cred, you may also recall from the movie The Social Network that Peter Thiel was one of the first outside investors in a promising start-up called The Facebook.

Twitter, Tumblr, Foursquare, Zynga, and Kickstarter are all companies in which Fred Wilson, cofoun...

Table of contents

• Cover
• Title Page
• Copyright
• Dedication
• Preface
• Acknowledgments
• About the Author
• Chapter 1: Bitcoin Is a Bubble
• Chapter 2: Understanding the Digital Gold Rush
• Chapter 3: Bitcoin Is More than Digital Gold
• Chapter 4: Byzantine Generals' Problem
• Chapter 5: A Decentralized Financial System
• Chapter 6: What Do You Call a Bitcoin Miner? A Banker
• Chapter 7: Nautiluscoin—0 to $1 Million in 60 Days
• Chapter 8: Building the Nautiluscoin Economy
• Chapter 9: Investing and Trading in Alternative Currencies
• Chapter 10: Regulation
• Chapter 11: Smart Money: Set It and Forget It
• Chapter 12: Everything You Know about Business Is Wrong
• Appendix 1: Department of the Treasury Financial Crimes Enforcement Network Guidance: FIN-20 13-G00 1 Issued: March 18, 2013 Subject: Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies
• Appendix 2: New York State Department of Financial Services Proposed New York Codes, Rules and Regulations: Title 23. Department of Financial Services Chapter I. Regulations of the Superintendent of Financial Services Part 200. Virtual Currencies
• Index
• End User License Agreement