What is Bitcoin?

There have been various attempts to launch a digital currency over the years, but Bitcoin was the first to gain significant traction. After publishing a whitepaper in October 2008 outlining the concept of a peer-to-peer electronic cash- at the height of the financial crisis- pseudonymous founder Satoshi Nakamoto processed the initial batch of Bitcoin transactions in early 2009. The following message, engraved into block zero, the ‘genesis’ block, alluded to his motive:

"The Times 03/Jan/2009 Chancellor on brink of second bailout for banks."

The first transaction involving physical goods took place in May 2010, when programmer Laszlo Hanyecz famously bought two pizzas for 10,000 btc (worth $TBC million as of [date]). The crypto community still celebrates Bitcoin Pizza day fourteen years later.

While Satsohi designed Bitcoin as a medium of exchange, it has also become widely adopted as an asset class. A basic understanding of how the network operates helps to illustrate why the investment case is so compelling.

Bitcoin 101

Unlike fiat currencies, Bitcoin is decentralized. Satoshi designed the underlying blockchain technology as a distributed ledger hosted by thousands of computers around the world. These computers are ‘nodes’ which run the Bitcoin software and maintain a record of every transaction. According to the mapping website Bitnodes, as of October 2024 the network consisted of over 18,000 nodes.

As Bitcoin is decentralized, it doesn’t rely on a central authority, such as the Federal Reserve, which controls the flow of dollars through the US financial system. This means anyone with an internet connection can buy Bitcoin and transfer it to a digital wallet anywhere in the world, a degree of financial freedom unimaginable before 2009. Decentralization also makes the network more resilient because even if a majority of nodes go offline, it can still function.

Bitcoin relies on a ‘proof of work’ consensus mechanism to validate transactions and secure the network. Nodes called miners compete to solve complex mathematical problems, requiring significant amounts of computing power, for the right to process transactions and add the next block to the chain. In return, they receive freshly minted Bitcoin, known as block rewards, the main way new coins come into circulation. The reward currently stands at 3.125 btc, although Satoshi built a mechanism into the network that cuts it by 50% roughly every four years, events the crypto community refers to as ‘halvings’. The latest halving took place in April 2024.

Bitcoin transactions are immutable, which means once recorded, they can’t be altered. If a malicious party wanted to modify a transaction, it would need to accumulate more than half of the computing power (or ‘hash rate’) required to run the Bitcoin network. However, the consensus mechanism guards against a ‘51% attack’ because launching one costs $2.06 million per hour (as of 22 December).

Why invest in Bitcoin?

Investors mainly seek exposure to Bitcoin because it’s uncorrelated with other risky asset classes like shares, so it serves as a valuable source of portfolio diversification. Research by CoinShares shows that Bitcoin only moves in the same direction as the S&P 500 index, composed of the 500 largest publicly listed companies in the US, just over a third of the time.

CoinShares tracks several model portfolios to demonstrate the impact of a relatively small Bitcoin allocation. While the performance of a standard portfolio (60% shares and 40% bonds) improves, returns more than double in other portfolios designed by some <of the world’s most successful fund managers. Furthermore, the Bitcoin holding has a limited effect on volatility (the degree to which performance fluctuates) and maximum drawdown (the biggest single drop in value between peak and trough).   

Bitcoin’s scarcity also appeals to investors. Satoshi capped the total circulation at 21 million, with the supply of new coins controlled by the halving mechanism described earlier. The last Bitcoin is expected to be mined in the year 2140, and then miners will generate income through transaction fees alone. This cap prevents the implementation of inflationary policies, such as quantitative easing used by the Federal Reserve to stimulate the US economy, which typically devalue currencies.

Bitcoin’s scarcity reinforces the ‘digital gold’ narrative. It shares several properties in common with gold- others include divisibility, portability and durability–making it an effective store of value. Some analysts, like  Zach Pandl at Goldman Sachs, believe Bitcoin will erode gold’s market share as it continues to gain traction. This thought is also shared by CoinShares’ Head of Research, James Butterfill who noticed that Bitcoin’s market cap reached 10% of gold market share.

Finally, since it is a decentralized asset, Bitcoin has the green light in most jurisdictions around the world. In the U.S., for instance, although the Securities and Exchange Commission (SEC) claims jurisdiction over some cryptocurrencies, the Commodity Futures Trading Commission (CFTC) classifies Bitcoin as a commodity under the Commodity Exchange Act due to its decentralization, scarcity, and fungibility, meaning each unit is interchangeable. As a commodity, Bitcoin investment products can trade on traditional exchanges and are subject to the same regulations as mainstream products.

How to get Bitcoin exposure?

Until recently, Bitcoin was relatively difficult to access. Most investors could only buy it on unregulated or underregulated crypto exchanges. Moreover, storing Bitcoin in a digital wallet is complex in the case of self-custody and risky when relying on third parties due to the threat of cybercrime and counterparty failure (as FTX customers experienced). Some investment products were available, but they mostly tracked Bitcoin futures, a financial instrument that pays a return based on the price of the underlying asset at an agreed point in the future.     

Investors finally got the opportunity to gain exposure to Bitcoin’s current market price after the SEC approved 11 spot exchange-traded funds (ETFs) in January 2024 issued by some of the biggest players in the finance industry including BlackRock, Fidelity and Invesco. ETFs track the performance of an underlying asset, for instance an index, commodity or cryptocurrency, so the investor doesn’t have to purchase it directly. As they trade on mainstream exchanges, investors can buy and sell ETFs like shares and hold them in a portfolio alongside traditional assets. Demand for these products was huge- inflows hit nearly $2 billion within the first three days of trading.

Investor takeaway

Satoshi Nakamoto designed Bitcoin as a medium of exchange, unlike fiat currencies because it’s decentralized- it bypasses intermediaries like banks, instead relying on a consensus mechanism called proof of work to process transactions and secure the network.

However, Bitcoin has become recognized as an asset class, primarily due to its lack of correlation with other assets and scarcity. The CFTC classifies Bitcoin as a commodity based on its decentralization, scarcity and fungibility.

The easiest way to gain exposure to Bitcoin is through ETFs, which track the performance of an underlying asset. The SEC approved 11 products tracking the spot price of Bitcoin at the start of 2024, which investors can trade on mainstream exchanges and hold in a portfolio alongside traditional assets.