It’s helpful to start from the very beginning.
Bitcoin’s pseudoanonymous creator(s), Satoshi Nakamoto, sought to create “trustless” money - a P2P payment system and store of value that could replace trust in central banks and financial institutions with cryptographic proof and game theory. Satoshi combined three elements:
- “Proof of work” mining – an economic and cryptographic system that incentivizes rational actors to participate productively in a network.
- Public key cryptography – asymmetric encryption that enables secure digital signatures.
- The blockchain – a new type of database, a distributed public ledger.
This combination allowed for trustless digital scarcity for the first time in human history. Prior to Bitcoin, transferring a digital asset meant producing a copy. If your friend emails you a picture, he or she still has the original picture. In the context of money, an electronic transfer previously required a trusted third party (e.g., a central bank) to ensure that the same electronic money wasn’t sent over and over. The central bank ensures that when Citibank sends money electronically to JP Morgan, Citibank’s account is debited by the same amount with which JP Morgan’s is credited. The introduction of the blockchain eliminated the need for a central bank or other trusted third party to ensure scarcity. Within the Bitcoin network, every transfer is recorded publicly, verified with “proof of work,” and secured with cryptography.
The Bitcoin network went live in January 2009 at the height of the financial crisis. Bitcoin didn’t have a market price until March of 2010, when it achieved a price of $0.08 per BTC (total Bitcoin market cap of $430,000) on the now defunct “Bitcoin Market” exchange. Over the next three years, Bitcoin faced exchange failures, thefts, and a serious protocol bug, all in the midst of ongoing development of the code and a steadily growing ecosystem. Litecoin (a spin-off fork of the Bitcoin protocol with some meaningful changes) was launched in 2011. The first Initial Coin Offering (ICO) was Mastercoin in July of 2013. As Bitcoin gained in price and attention, many more cryptocurrencies were launched, some hoping to replace Bitcoin and others aiming to be complementary offerings with unique value propositions.
In November of 2013, Bitcoin price reached a high of $1240, an increase of over 9400% for the year (likely facilitated by phantom buying on the Mt. Gox exchange in which BTC was purchased with non-existent US dollars). Bitcoin and cryptocurrency as a whole then faced a 13-month bear market, in which bitcoin lost 86% of its value and fell to $160. The current bull market began in March of 2015 and has seen total cryptocurrency market cap grow from $3.5 billion to $170 billion. During this rally, Bitcoin’s “dominance” slid to about 50% of the total market cap.
The biggest disruption to Bitcoin during this time came from the Ethereum network with its associated Ether (ETH) token. Whereas Bitcoin was viewed as a store of value and payment channel, Ethereum sought to become a global virtual computer and platform for decentralized applications. It inspired a new wave of adoption by engineers enticed by the possibility of coding “smart contracts” and tackling an almost unlimited series of potential new use cases. Ethereum broadened the scope of cryptocurrency from money to “internet 3.0.” 3
At the start of 2017, Ether (ETH) was trading at $8, and had a total market cap of about $700 million. Over the next 6 months, ETH rallied to over $230, exceeding a market cap of $20 billion. This massive wealth creation was supported by a wave of grassroots engineering interest in building on top of the network, as well as interest from established companies like Microsoft that joined the nascent “Enterprise Ethereum Alliance.” A seemingly minor innovation catalyzed the explosion of fundraising via ICOs: Ethereum introduced a standardized smart contract known as “ERC20,” an easily deployable feature allowing developers to easily launch their own tokens on top of the Ethereum network. Rather than having to recreate the underlying machinery of a blockchain network from scratch, they could borrow the security, development tools, and user-base of Ethereum to launch their own projects. Many of these new projects raised money by accepting ETH, prompting even more buying of ETH by speculators eager to fund ICOs.
It’s helpful to use the 1990s tech boom as a parallel for what came next. In 1990, raising money for a tech oriented company was difficult. In that environment, it was primarily dedicated engineers with credible business plans that first launched companies. Investments in these relatively high quality early projects produced great returns for investors and this led to high demand from venture capitalists to fund further projects. The resulting ease of fundraising spurred increased supply, where less credible entrepreneurs met the rising interest by raising capital for fundamentally weaker projects. This produced a bubble as low quality projects were valued exorbitantly as investors chased the returns of the earlier vintage companies.
We saw the same phenomenon in 2017’s ICO market. The incredible returns produced by Ethereum (itself a 2014 vintage ICO), led novice investors to re-invest their Ethereum profits into new ICOs. The ICOs of Q1 2017 were relatively high quality and reasonably priced. But as ICOs began being seen as a way to “get rich quick” by both entrepreneurs and investors, the quality of projects deteriorated and valuations for early stage projects rose precipitously.
The general rise in the cryptocurrency market capitalization brought increased interest and attention from all angles. At $5 billion total market capitalization, this asset class was uninteresting to Wall Street. At $100 billion, many large trading firms, hedge funds, and big banks began taking a serious look. Demand for service providers of all types surged, and entrepreneurs raced to meet the demand – trading and analytics tools, security solutions, OTC trading desks, arbitrageurs, and new exchanges burst onto the scene seemingly overnight across the globe.
Cryptocurrency was international almost immediately after its birth in 2009, with the most development and investment occurring first in the US, Europe, and Japan. In 2013, China became a major player in the mining and trading of Bitcoin. In 2017 Korea surged onto the scene and Japan’s participation grew dramatically. While accurate numbers are impossible to come by (exchanges don’t necessarily report accurate trading volume), we roughly estimate that the US is now 35% of the global market in terms of economic significance, with Japan, China, Korea, and Europe making up most of the remainder. Development on existing protocols and the creation of new credible cryptocurrencies remains mostly a US and European phenomenon, but that too is changing rapidly as credible development is now occurring throughout Asia (and other parts of the world).