An Introduction to Bitcoin for Financial Advisors

An Introduction to Bitcoin for Financial Advisors


Bitcoin

By: Guy Adami, Director, Advisor Advocacy
Published January 3, 2018

Bitcoin has been in the news frequently these days, and a lot of advisors are interested in learning more about it, so we asked Brian Kelly to give us a primer. Kelly is founder and CEO of BKCM LLC, an investment firm focused on digital currencies. He is the portfolio manager of the BKCM Digital Asset Fund and is the author of The Bitcoin Big Bang: How Alternative Currencies Are About to Change the World.

What is Bitcoin, how does it work, and how do we explain it to our clients? The simplest explanation for Bitcoin, says Kelly, is to think of it as software that automates much of what banks do. Financial transactions, like moving money around the world, can be done via this software system without involving a bank. That doesn’t mean it is unregulated or nefarious. It’s just new technology, like an app. Imagine if Google came up with a new app that allows you to send money around the world to anybody and that it was faster, better, and cheaper than the way we do it now. Bitcoin is like that. Where people get confused is in regard to Bitcoin’s economic incentive.

The Bitcoin Basics: How it Works

Bitcoin doesn’t have a salesforce. It is simply software running autonomously. It needs some kind of economic system to get people to run the software. That is where the token Bitcoin that we see being traded comes into place. To understand this better, let’s dive deeper into how Bitcoin works and learn some of the Bitcoin jargon. Every ten minutes, all the transactions made on Bitcoin are bundled together. This is called a block of transactions. Those transactions go out to the network, like a broadcast. When you run the Bitcoin software, you are called a miner. The first miner to solve a really hard math problem gets to verify and process that block of transactions and for that they get 12-1/2 bitcoin. The miner is responsible for verifying that yes, you John Smith did own that Bitcoin and you can transfer it over to Sarah Jones. This is recorded in the underlying ledger. At the end of each block, they put a reference to the block that happened previously, 10 minutes ago. This links blocks together in a chain. That’s how we get the term blockchain. A blockchain is really just a big spreadsheet of every transaction that ever happened on the Bitcoin network. If you want to have a blockchain that is public like Bitcoin is, you have to have the economic incentive, which is the token.

What are the securities in place? At its core Bitcoin is a self-sovereign asset. The individual is responsible for holding onto his or her private key. If you lose your private key, it is like losing the key to your house. You can get your back-up key that you store in a safe place, and you’ll be able to get your data back. If you lose your key and your back-ups, then yes you can lose your assets. The Bitcoin blockchain has never been hacked. Every block is linked to the previous block, going back to the very beginning. To hack it you would need to change every transaction from the beginning, and the longer Bitcoin operates, the harder that is. As for nefarious activities we sometimes hear about, there are some coins called privacy coins, such as Zcash and Monero, where you can obscure who you are and how much you’re sending, and that is being used on the black market.

How will Bitcoin Impact Financial Advisers?

So, what do you need to know as an adviser? Kelly says, “In my opinion, this is going to be a new asset class. It’s going to be more than just a currency. You’re going to start seeing stocks issued on a blockchain with a token.” You might be thinking, but whenever a new space opens up, usually the first ones in are the first ones to die off. Kelly doesn’t disagree. “I consider Bitcoin a proof of concept,” and the biggest issue Bitcoin currently has is how to scale. He also thinks we’re going to have 10 or 20 more foundational coins. “I want to make a bet on the space in general and not on Bitcoin in particular.”

It’s like Jeff Bezos in the mid-1990s. He leaves Wall Street. He goes and starts an online bookstore. There is absolutely no way that he could have predicted that one of his biggest revenue streams would be streaming movies over hand-held computers. Streaming didn’t exist. The iPhone didn’t exist. That’s how Kelly looks at the cryptocurrency space today. We don’t know what is going to be built on top of this software. But we do know that some of the smartest minds in the world are working on this. “And to me that’s something I want to have exposure to.”

If you are considering investing in Bitcoin for your clients, we suggest you call LPL compliance, and they can walk you through how and what to do.