I put this together for a client of mine to give him a basic introduction to Bitcoins. Since it was not published anywhere else, I thought I would post it here for all those who are interested!

On the Island of Yap, giant limestones roughly in the shape of doughnuts served as a form of currency. How could giant doughnut-shaped limestones be money? For one, the Island does not have any limestone quarries. So all the stones have to be quarried from elsewhere and transported to the island. As a result, the limestone doughnuts of Yap are rare, difficult to obtain and therefore, suitable placeholders for value. Bitcoins and other cryptocurrencies are similar to the limestones of Yap.

Cryptocurrencies are something that can only exist because of the internet. Bitcoins are the fully digital currency for an age when many of us conduct the majority of our financial transaction completely digitally. They are a decentralised currency, generated by solving complex math problems. The nature of the maths places a hard cap on any given cryptocurrency. The action of solving mathematical problems to generate bitcoins is commonly known as “bitcoin mining”. The mining process is computationally expensive and requires significant investment in both computer hardware and ongoing electricity costs. Significantly, the “Bitcoin mine” is set to run out by 2140.

The decentralised nature of bitcoins means that every Bitcoin miner maintains their ledger of every bitcoin transaction ever. This distributed ledger system also acts as a check against fraud and ultimately, trust in this distributed ledger system is what has allowed Bitcoins to rise in value from a few cents to $5755 per bitcoin.

The major appeal of bitcoins come from its completely digital nature. Also, it is “statelessness”. With public trust in government at a low point, national currencies are often seen as too volatile and not offering a good enough return on investment. Also, the statelessness of cryptocurrencies holds their special appeal for those who believe the digital world should be borderless. All of these factors have led to the increased desirability of bitcoins. Indeed, the desirability of bitcoins has resulted in many Australians choosing to invest in the coins as part of superannuation strategies.

Bitcoins and other cryptocurrencies are very much a product of our times. At the same time, they are an echo of what currencies have always been. Rare items to which people and societies are willing to assign value.