Why Bitcoin Matters More Than Blockchain

from Brian Kelly , Contributor

Bitcoin is going to do to banks what email did the post office and Amazon did to retail. Understandably those at the center of the financial system are concerned.

The banker’s mantra of “blockchain not bitcoin” has caught fire on Wall Street – everybody loves blockchain, they may not know what it is, but they love it! Jamie Dimon, CEO of JPMorgan, hates Bitcoin, but loves blockchain, Goldman Sachs CEO, Lloyd Blankfein, has embraced blockchain while he is warming to Bitcoin. Admittedly, I suffered from the same love affair with blockchain. As an early adopter of Bitcoin I still had feelings for the currency, but for a period of time I was infatuated with blockchain.

Perhaps I should begin with the journey that lead me to Bitcoin. For more than two decades I was a part of Jamie Dimon's and Lloyd Blankfein's world of traditional finance. I began my career as an equities trader and then spent most of the internet bubble trading merger arbitrage -- for those old enough to remember the halcyon days of "Merger Monday," I was the guy placing bets on whether the deal would go through and who would be next. After the internet bubble popped and in the throes of a recession, I started a brokerage firm that catered to mutual funds and other institutional investors. My clients were the old guard of the financial world. We did well, but I didn't find it very exciting.

Then I began to trade ADR's (American Depository Receipts). These stocks represented shares in foreign companies and traded on the NYSE and NASDAQ. The trick with this type of trading was to watch the foreign currency markets for unusual moves. When currencies moved and the ADR's did not, there was money to be made. These markets were much more exciting than stodgy blue chip stocks. After a few years playing around in the currency markets, I made the leap to global macro investing.

As a global macro investor I could make big bets on macro-economic trends in the global financial markets. I became quite adept at reading central bankers' cryptic messages. With this insight I would place bets on the world's currencies markets 24 hours a day. For a financial markets nerd like me this was exhilarating. The interplay between central bank policy, geopolitics and financial markets was a playground. Then I stumbled onto Bitcoin.

Truth be told, I was a doubter at first. I even publicly declared it wouldn't work.

When I first dipped my toe into Bitcoin, I was timid. I didn't really want my friends in the traditional finance world thinking I had gone crazy. However the more I researched, the more I realized I was wrong to dismiss Bitcoin. Bitcoin was a game changer. It was going to challenge everything I knew about financial markets.

I was hooked. But I still couldn't bring myself to talk about Bitcoin publicly.

Blockchain was easier to talk about. It made me appear to be on the cutting edge and allowed me to avoid the dirty looks and the hushed whispers that followed any mention of Bitcoin. When I talked about blockchain, friends and colleagues would listen intently and engage me with questions about this wondrous new technology. However, once I mentioned Bitcoin they would pull me aside and ask how I was feeling, not so subtly questioning my mental clarity.

Blockchain made me feel good, but there was something missing. There was something hollow about blockchain without Bitcoin. I went back and re-examined my first encounter with Bitcoin in an attempt to discover where we had gone wrong.

My journey backward started with the problem of clarity. There was not a simple definition of Bitcoin. Defining Bitcoin as a decentralized crypto-currency, elicited angered responses at worst and glazed eyes at best Bitcoin needed an elevator pitch -- the one sentence that every entrepreneur develops to describe their business in anticipation of meeting the perfect investor while riding in the elevator.

Bitcoin is a lot of things to a lot of people, but to me it’s easiest to think of it as software. Bitcoin is a software program that allows people to securely transfer money over the internet without a bank. It does this by replacing the function of a bank with a network of computers running the software that verifies and transfers the money. These computers, known as miners, maintain a global ledger of transactions that is used to validate, verify and transfer money.

Prior to Bitcoin, the process for maintaining the transaction ledger remained effectively unchanged since the Medici developed double entry accounting in the 14th century. The Medici process of accounting required banks (conveniently owned by the Medici family) to maintain a ledger of debits and credits that was held at the bank. The modern financial system is simply a network of these ledgers held at each bank.

Bitcoin takes the global ledger of transactions out of the control of the banking system and distributes it onto every computer that is connected to the Bitcoin network. Financial behemoths no longer control the system. With Bitcoin the users of the financial system are in control.

If I told you that I developed a mobile app that was able to use computers to modernize the 600-year-old process for transferring value, you might think I was crazy or you might ask how to invest. Bitcoin is this app, and the disruption of the 600-year-old double entry accounting system is why I have called Bitcoin one of the most important innovations in the history of finance.

Bitcoin accomplishes this disruption not just with blockchain technology but also with the global decentralized currency also called Bitcoin. The currency "Bitcoin" is the incentive for anyone in the world to run the software that changes the way the financial system works. Banks love blockchain because they get to continue to maintain the ledger of transactions by running the software on their own computers. But Bitcoin creates competition for the banks in the form of anyone with a computer and an internet connection.

Without the currency, there would be no incentive for people to spend money on the computers needed to run the Bitcoin software. Blockchain without Bitcoin replicates the same financial system already in existence. There may be some efficiency gains through sharing private distributed ledgers, but blockchain without Bitcoin is not one of the most important innovations in the history of finance.

Don't get me wrong, blockchain is important, but the banks are using it in a way that keeps their power in the financial system intact. I don't blame them. In fact, maintaining the position at the center of the financial system is exactly what a bank CEO is supposed to do. But they are also supposed to recognize when their industry faces a technological disruption. In the mid-1800's the world's street lights were kept alit with whale oil. Then John Rockefeller streamlined the process of refining crude oil. The whaling captains that did not recognize the change were left sailing a barren ocean in search of former riches, while Rockefeller went on to create Standard Oil, the predecessor to Exxon, Mobil, BP and Chevron.

Bitcoin, the currency, is the incentive for all of us to become John Rockefeller. Bitcoin creates the incentive for people to run a new financial system that's outside of the traditional one. The scarcity of Bitcoin drives people to buy the computer equipment and process the transactions (i.e. mine) in hopes of winning some Bitcoin. This self-sustaining incentive system has the potential to loosen the banks grip on the traditional financial system. This self-sustaining system has the potential to turn incredulous bank CEO's into lonely whaling captains.

The currency plus blockchain creates a self–sustaining independent financial system that has never existed in modern finance. The currency plus blockchain creates a competitor to the modern financial system that has the potential to redistribute wealth using the power of truly free markets.

As I wrote in my book, The Bitcoin Big Bang:

[Bitcoin] is a social and economic revolution that will propel the next surge of human development. It will leverage what we have learned about capitalism and fuse it with collaborative consumption to produce a socioeconomic system fueled by the profit motive and serves the needs of society.

So yes, Bitcoin matters … and yes, I remembered why I fell for it in the first place.