Bitcoin, Explained

You’ve heard of Bitcoin. It’s the digital asset, protocol, and network* that kickstarted an entire industry. 

This revolutionary idea combined three traits that had never existed in a single asset before. It was digital, it wasn’t backed by a government, and it had a scarcity factor built in. This trifecta made it unique among existing financial assets like stocks, bonds, or commodities. 

This explainer will walk through what Bitcoin is, the system that underpins it and what investors need to consider when approaching it as an investable asset. 

Bitcoin is a digital asset. It exists solely as entries on a shared public ledger*. There is no physical Bitcoin, nor is it a claim on any company. It doesn’t have earnings, it doesn’t pay dividends, and there is no management team. The only method of valuation for Bitcoin is driven by market price discovery. Whatever buyers are willing to pay sets the price.

Although Bitcoin is a cryptocurrency*, it is not a currency in the traditional sense like the dollar or euro. It isn’t issued by a central bank, and no government enforces its use. It can be used for transactions, but it is used almost entirely as an investable asset. The shared ledger for Bitcoin is called the blockchain*. The system underpinning the blockchain enables Bitcoin to remain independent and scarce.

The first Bitcoin block* was mined by Satoshi Nakamoto, its enigmatic and still anonymous founder, on January 3rd, 2009. This transaction was recorded on the blockchain. The blockchain is a shared digital record of every Bitcoin transaction that has ever happened, maintained simultaneously by more than ten thousand computers (or nodes*) around the world. 

Bitcoin is peer-to-peer. There is no centralized hub controlling the system. Sets of transactions, usually between fifteen hundred and two thousand, are grouped into a block every 10 minutes and added to the end of the ledger. 

All of the nodes verify the additional block, and it becomes part of the ledger forever. The system doesn’t require trust in one party, instead relying on the mathematical impracticability of being able to recalculate and adjust the entire ledger. The rules are all public as is the software used to function as a node. 

How the transactions are grouped and added is where the scarcity value of Bitcoin comes from.

The total supply of Bitcoin is 21 million coins. This cap has been in the software since the first block was mined. What’s novel is that coins are only given as rewards to users who solve a cryptographic problem. Whenever a problem is solved, the solver gets to add the next block to the ledger and earn newly minted Bitcoin, hence the participants are called miners*.

These problems began relatively simply but became increasingly complex over time. The initial difficulty was low enough that people could mine with their home computers to solve them. This was meant to encourage hobbyists to mine and propagate the idea until adoption increased. Nowadays, there are companies whose business model is running mining operations that utilize bespoke processing units called ASICs* to power through calculations as fast as possible. 

The initial reward for a successful solve in 2009 was 50 Bitcoin per block. Now, it’s 3.125 per block. This is due to a built-in mechanism called halving*. As the name would imply, roughly every four years the mining reward is cut in half. This slowdown in supply ensures scarcity. Over 19.5 million Bitcoin have already been mined, but the cap isn’t expected to be hit until 2140. 99% of all Bitcoin will be mined by 2040 with the remainder trickling out over the next 100 years.

Spot Bitcoin trades 24/7 on exchanges across the world. The market never closes, and price only depends on supply and demand. There are no earnings to track nor any other time-driven influences besides the halving which happens in a predictable pattern.

This means the market is almost entirely sentiment-driven, and it can react to an enormous array of external inputs. This wide swath of inputs means that Bitcoin has higher structural volatility* than equities. Most investors view this as a benefit, encouraging trading and positioning as it phases in and out of c with other assets. These trends can be very short-lived or endure through a cycle. 

Adding to the variable correlation effects is the short overall history of trading for Bitcoin. Though there was measurable trading from 2009, volumes only started hitting the tens of billions in 2017. This means long-term trend patterns don’t fully exist yet, and Bitcoin has had limited interaction with various market cycles, especially credit cycles, which tend to play out over longer time horizons than equity cycles.

Bitcoin ownership is handled with a pair of public* and private keys* held in a digital wallet*. A public key is an address other wallets can use to send Bitcoin to. A private key is the owner’s key that authorizes transactions.  

Whoever holds the private key controls the Bitcoin. This is binary. There is no recourse if you lose your key. Any Bitcoin stored in that wallet will be inaccessible forever unless the key is retrieved.

There is a very public example of this type of risk playing out. In 2013, Welsh computer engineer James Howells mistakenly threw out a laptop containing the private key for a wallet containing 8,000 Bitcoin. This laptop ended up in a landfill and he has failed in all attempts to recover it.¹

Human error is just one of the risk factors associated with key storage. There are myriad scams and schemes that have popped up to take advantage of unwary wallet holders. Fake wallet apps, fake support agents, and transaction scams. Any transaction signed by the key holder is final. That holds even if the holder of the key was tricked into agreeing to the transaction.

A third major risk is hardware failure. Hard drives can fail and become unrecoverable. Cloud solutions can have sync issues and lose data. Wallet holders not only need to ensure they have backups of their keys but also that those backup locations are secure and reliable. 

Controlling your own keys is a core part of Bitcoin's appeal. Self-custody keeps your assets separate from governments and traditional financial institutions, which was the original draw for many early investors. Over time, that appeal has evolved. Investors uncomfortable with the key risks have utilized a variety of structures to offset those risks. 

An early solution was having keys be managed or custodied* by the exchanges facilitating the transactions. This exchange custody came with its own set of risks. There were a number of very public thefts, both internal and external, associated with early exchanges including Mt. Gox, originally a trading venue for Magic: The Gathering cards, and the Bitfinex hack in 2016. In both cases, tens (Bitfinex) to hundreds of millions (Mt. Gox) of dollars' worth of Bitcoin were stolen due to poor controls.

These highlighted the natural tension that exists between the current traditional finance rails that operate on a trust-based system and decentralized finance that are designed to be trustless. Bridging the gap between those systems has been a challenge.

Investors can still custody their own keys, but most have moved to utilizing TradFi/DeFi custodians that operate in the space. They provide the rails for investors to convert their fiat currency into Bitcoin. These providers have the technology, security, and backup coverage liability to provide more reliable service than the early exchange system.

This system of rails has enabled Bitcoin to move from being an asset outside of traditional finance to being a part of the investment landscape. 

Bitcoin entered the public fund space in 2015 via closed-end trust. Bitcoin trusts gaining exposure from future contracts* debuted in 2021, but the first Securities Act of 1933 compliant spot Bitcoin ETFs* only gained approval from regulators in 2024. In the short time since approval, investors have shown a clear preference for traditional finance entry points. Net inflows into US spot Bitcoin ETFs passed $36 billion in the first year of trading, even as the previously dominant Grayscale Bitcoin Trust lost over $21 billion to lower-fee competitors.²

Spot Bitcoin access for retail investors with standard fund reporting and no key management has been the largest inflection point for adoption since the protocol launched.

Understanding Bitcoin is table stakes for investors now. These assets are becoming embedded as part of the financial framework around the globe. Whether it belongs in a portfolio is no longer about practical risk and more about financial risks. Volatility, time horizon, and investor goals are the most important risk factors now.