Bitcoin 101: Why It's Attracting Wall Street Investment

Despite its infancy, Bitcoins are being called one of the greatest developments of the new financial services landscape. Here's why.

Ten months ago, I set up my digital wallet and bought my first bitcoin. Weeks later, after five years on Wall Street, I decided to leave behind the bulge-bracket banks and their endless rows of gray and navy suits and join the ranks of forward-thinking disruptors who just might transform the financial services industry forever.

Consideringmy conservative finance background, youre probably wondering why I made the jump. More importantly, you would be smart to ask whether the esteemed institutions I left behind would even consider looking at something as nascent as Bitcoin. Its true that Bitcoin and digital currencies are still in their infancy, but what they lack in age, they more than make up for in potential. Bitcoin might radically alter our concepts of money, store of value, and the means by which assets are exchanged the world over, and therein lies the opportunity-- and the risks.

Today I spearhead investor outreach for the broker-dealer providing sales and marketing for the Bitcoin Investment Trust (BIT), a private, open-ended trust that is invested exclusively in Bitcoin and derives its value solely from the price of Bitcoin. I spend my time educating hedge funds, asset managers, family offices, and other investors about the digital currency space. As such, I thought that it would be helpful to provide this audience with a Bitcoin 101. Upon learning about Bitcoin, I think youll come to understand why it has attracted so much attention and investment from the venture capital community and, increasingly, from Wall Street.

So, what is Bitcoin?

First, you need to understand that Bitcoin actually refers to two different things. There is Bitcoin, big B, which refers to the underlying technology and global payment system, and bitcoin, little b, which refers to the digital currency that makes the network and technology work. Id argue that the two cannot be separated.

Bitcoin, the open-source protocol, was released in 2009 by an anonymous programmer who called himself Satoshi Nakamoto. At its core, Bitcoin centers on the concept of the blockchain, a public ledger, which records every transaction on the Bitcoin network. The blockchain employs innovations from cryptography, peer-to-peer technology, and economics to allow two parties who dont know each other to instantly and securely transfer assets -- without a trusted third-party intermediary.

Payments are a good early use case. Jill can send Jack money without a bank clearing the transaction and without Jack ever worrying that Jill has duped him and double spent the same funds with another party. Jill sends funds to Jack by broadcasting a transaction to the Bitcoin network that she wants to transfer funds from her public key (a randomized alpha-numeric address stored on the blockchain) to Jacks public key, and she proves that she is entitled to transfer those funds by providing her corresponding private key. Dont get hung up on the terminology: The public and private keys are just the Bitcoin equivalent of your bank account number and password. The key difference between Bitcoin and banking is that while transactions are public and pseudonymous, the addresses and numbers of bitcoins involved in a given transaction are known to everyone and are recorded on the blockchain.

Bitcoins come into existence through a process called mining, where individuals/institutions who have invested in powerful computers to run the Bitcoin software compete to correctly process transactions on the network. This involves confirming the ownership and movement of Bitcoin between owners. The reward for spending time, energy, and computing processing power? Freshly minted or mined bitcoins.

Mining solves two problems: first, how to fairly distribute the new currency; second, how to incentivize early pioneers to process transactions. The Bitcoin protocol awards miners with new bitcoins according to an algorithm that adjusts predictively over time. There are approximately 13.4 million bitcoins in circulation, which at todays price of US$350 per bitcoin, carries a market capitalization around 4.5 billion dollars. The Bitcoin protocol stipulates that there will only ever be 21 million created, and we can estimate that the 21 millionth bitcoin wont be mined until the year 2140.

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Bitcoin 101: Why It's Attracting Wall Street Investment