In 2009, the mysterious Satoshi Nakamoto published the now famous white paper that introduced Bitcoin (BTC 0.10%). In its pages, the unknown individual (or individuals) proposed a new type of financial system built on blockchain, an innovative record-keeping technology. And Bitcoin was created as the currency for this new system.
Since then, both Bitcoin and blockchain have changed the world. Bitcoin especially has captured the interest of investors and the mainstream media, as its value has soared roughly 10,000% in the past five years alone. Moreover, Bitcoin is built on blockchain, a platform that promises to make financial transactions more efficient. But does that mean investors should buy Bitcoin? Let's take a look.
The benefits of blockchain
Blockchain transactions work more like cash than payment cards. In fact, when Nakamoto published the white paper, he/she/they referred to Bitcoin as a "peer-to-peer electronic cash system."
Image source: Getty Images.
Consider the complexity of a typical credit or debit card transaction. When a consumer swipes (or taps, inserts, etc.) a payment card, the merchant's acquirer sends an authorization request through the card network to the consumer's bank. If the bank authenticates the transaction, it sends approval back to the merchant. Then the merchant's acquirer sends the approved transaction through the card network to the consumer's bank, and the bank transfers funds through the card network to the merchant's bank.
While this is happening, everyone takes a cut: The consumer's bank charges an interchange fee, the merchant's acquirer charges a processing fee, the merchant's bank collects a discount rate, and the card network charges assessment, clearing, and settlement fees.
Now consider a cash transaction: Money moves from the consumer's wallet to the merchant's register -- no fees are charged in the process. However, cash is less secure and less convenient, and that's where Bitcoin, and blockchain, offer a solution.
In a typical Bitcoin transaction, digital funds travel through the open internet, moving from the consumer's digital wallet to the merchant's digital wallet. Blockchain makes this system possible. Blockchain is a self-governing and highly secure database that eliminates the need for a central authority to create, manage, and keep records regarding a currency. In other words, blockchain transactions involve fewer parties, meaning there are fewer fees.
That efficiency could significantly change the financial industry. In fact, a study by Santander FinTech suggests that distributed ledger technology could cut financial infrastructure costs by $15 billion to $20 billion per year.
The benefits beyond cryptocurrency
Blockchain is not limited to financial transactions. It is an efficient means of storing and distributing many different types of information.
For instance, blockchain can be used to power smart contracts. In this case, the conditions of a contract are written in computer code, and once the terms have been met, the contract automatically executes. For example, Microsoft uses blockchain-powered smart contracts to simplify and expedite the payment of gaming royalties between itself, publishers, and developers.
Blockchain can also be used to monitor supply networks and track supplies. For instance, the IBM Food Trust is a blockchain system that connects farmers, wholesalers, and retailers, improving visibility and accountability in the food supply chain.
Blockchain is also a highly secure means of storing data. That means healthcare providers could keep patient records in blockchain-powered databases, ensuring they remain confidential and unaltered. Insurance companies could do the same thing, but in this case it would facilitate the distribution of verified consumer information (e.g., past accidents, insurance claims, etc.), which could help prevent fraud. And the list goes on.
The case for Bitcoin
Bitcoin was the first widely adopted cryptocurrency, and it has a few qualities that could make it good long-term investment.
First, like gold, Bitcoin benefits from scarcity. The computer code in which Bitcoin is written imposes a limit of 21 million tokens. Yes, code can be changed -- but in order for that to happen, 95% of miners must vote to accept the alterations. And in this instance, I believe that's highly unlikely. Why remove one of the attributes that make Bitcoin valuable?
Second, Bitcoin is still the most popular, most widely adopted, and most valuable cryptocurrency. That's a significant advantage. For perspective, over 4,000 different digital currencies exist, making it unlikely that all of them will gain mainstream traction -- can you imagine the complexity that would ensue if merchants had to accept thousands of different currencies? It would create chaos. It's much more likely that merchants will choose to accept only the most popular tokens. That positions Bitcoin for success.
A final word
To tie everything together, blockchain has the potential to revolutionize numerous industries, improving efficiency and security. Bitcoin, on the other hand, is simply a digital currency powered by blockchain. That doesn't mean it's a bad investment -- as I discussed, Bitcoin has qualities that could make it a good long-term holding.
However, if I could choose between investing directly in blockchain or buying Bitcoin, I would be buying blockchain hand over fist. Unfortunately, it's not possible to invest in the idea of blockchain. Instead, the best strategy is to look for companies that benefit from blockchain.
