What is Bitcoin?

16 January 2022

This post is part of The Crypto Series. A Glossary for Me.

In 2008 a pseudonymous figure on the Internet named Satoshi Nakamoto wrote the Bitcoin paper — A peer-to-peer electronic cash system.

The Bitcoin network was launched in 2009, although it was ready in some form even before the publication of the paper. This was a crucial step in order to prove that everything works as expected and that Bitcoin holds as a concept.

But why bother?

What Bitcoin actually solved is for a group of people who don’t know each other and don’t trust each other, to agree on something. This is a known computer science problem named the Byzantine Generals Problem which Bitcoin solves by putting trust outside of the equation — when coming to some agreement — using mathematics and cryptography instead.

With that being said, the implications of solving this problem have great reach. It allows individual entities to store value across time with no maintenance cost and transact value outside of the current financial system. Doing so from anywhere in the world, instantly, and in a decentralized and permissionless way. Essentially Satoshi created the native digital currency of the Internet and a set of protocols and rules on how the network operates. And to a further extend once it solved the coming to consensus in a decentralized way problem it can be used for fairness of elections, asset ownership, and many more. Decentralization is ensured by storing data in the blockchain where new entries are being added based on a consensus mechanism.

In order to understand Bitcoin and why it matters, it is helpful to understand what money is and its role throughout history. Sure a complex topic but here is a quick overview.

Intuitively when we think of pre-historic times we think of people engaging in direct exchange. You have a fire, I have killed a deer, let’s exchange. This could have happened in very small groups and in very specific circumstances, but quickly this would turn out to be problematic. Once you have a fire you don’t need another one and one day you weren’t able to hunt down a deer to exchange it for something. Inevitably this would lead to some sort of keeping track of debts. You gave me fire today but I don’t have anything to give you. Tomorrow I’ll give you a piece of my deer. So we ended up keeping track of debts in our heads, remembering who owns us what. Not a solid system but it survived thousands of years. And we kind of keep doing this today in a loose way, keeping track of who is honest or dishonest in our lives. Who is funny or not and so on. Keeping track of debts and accounts is human nature.

Later in history, a new way of doing things came about. Instead of keeping track of debt in our heads, we start using objects like seashells, precious stones, beads, or minerals like salt as a way to hold accounts. In order for something to suffice as a public ledger(a.k.a. money) where debts and accounts are stored, it had to meet some properties in order to make the system more solid and fairer.

When money is resistant to change and unpredictable fluctuations, thus making the system stable, it is called hard money whereas the opposite behavior is called soft money. The hardness of money and the properties it fulfills is where money gets its value from. The more properties it has and to what degree it fulfills them, the better.

Probably the most important property is for it to be scarce. If it is something trivial like a regular rock it would be easy to add debt to the ledger and benefit yourself because rocks are everywhere.

Since different things are more scarce than the other depending on location, tribes would have different things as money. One tribe would use sea salt while another tribe would use precious stones and so on. Once trading across tribes started, this got increasingly difficult since there wasn’t a unified and agreed-upon object that was used as money. We eventually found gold which is universally scarce and used it as a universal ledger.

Gold was not adopted purely for its scarcity property. It was also more portable, durable, fungible, and divisible than what came before. So it makes sense if we find something that fulfills all these properties better than gold to be more suitable as money. Which in essence is keeping track of debt only in a more sophisticated way. Bitcoin is considered to do just that. And it claims to be superior — or same — in all the aforementioned properties. It even shows us how gold is problematic in many ways.

It is quite incredible that the best ledger we have ever found is such a primitive thing that takes billions of dollars to dig it from the ground and then we lock it in vaults underground again - Wences Casares

But in what way — and if — is Bitcoin superior to gold or anything else for that matter when it comes to the properties mentioned earlier?

  • Bitcoin is more scarce - There will never be more than 21 million bitcoin ever in circulation. Period. This is built into the protocol so you can be sure it will stay like that indefinitely. Gold on the other hand continues to be mined every year. Approximately 2,500-3,000 tonnes are being extracted from the earth.
  • Bitcoin is more divisible - Each bitcoin is divisible in smaller units with the smallest being a satoshi. One satoshi is equal to one-hundred-millionth of a bitcoin. This gives us a tremendous amount of precision when doing transactions. It is difficult to break a gold bar into pieces.
  • Bitcoin is more portable - If you want to give someone a gold coin or cash is a pretty straightforward process. You just hand it over to them and the transaction is done. Whereas if we want to transfer money via distance — let’s say across the world — is impossible to do without trusting a middle man to do the job with fees and working day delays. With bitcoin either you want to transfer 1 dollar worth of value or a million, it will be an instant action, with the same fees which are tiny compared to what you would pay if wanted to send 1 dollar from Greece to Chile.
  • Bitcoin is more durable - Although gold is pretty hard to destroy and it can survive centuries without damage or corrosion, it still can be stolen or lost while transporting it or if a natural disaster occurs. With bitcoin, you only need to remember a 12 or 24 word phrase and you are fine.
  • Bitcoin is fungible - Units are interchangeable and indistinguishable from one another. The way one-dollar bill is the same as any other one-dollar bill in circulation, likewise, any bitcoin is the same as any other bitcoin. Although this is true, a bitcoin leaves a trace on the blockchain whenever it is transferred between wallets. So-called “clean bitcoins” might be worth more in terms of price since they have no history linking them to any particular wallet or activity. Some crypto exchanges have frozen accounts making transactions to wallets addresses on their blacklist, meaning being used for illicit activities. This fact might make certain bitcoins less desirable though their value is actually the same as any other bitcoin.

Satoshi didn’t invent everything Bitcoin uses. He mostly used what was already out there. You can somewhat compare it with the iPhone. Steve Jobs didn’t invent the screen, the internet communication protocols, or anything of that matter. He just packaged what already existed, scattered, and created something new. There were improvements in various technologies but nothing from the ground up. Touch screens - though primitive and clunky - were around for years. The iPhone merely improved them to be more useable. The same goes for Bitcoin. Proof-of-Work was already invented, Merkel trees as well and cryptographic techniques that were developed even from the ’80s.

Bitcoin uses a process called “mining” in order to validate transactions so they can be added to the blockchain and create new units of bitcoin. The ones who do this are called miners and are rewarded for their efforts. Every 4 years the protocol halves the reward so it limits the total number of bitcoin that will ever be created which marks the 21 million coin limit in the year 2140.

You store bitcoin in a wallet that only you have the keys to. In order to do anything you want with your bitcoin — like sell, pay or exchange — you only need your private key. This gives you, the individual total control. In essence, you have become your own bank.

Of course, dealing with digital money one must ask.

Since I’m dealing with digital cash how can the network be sure that I can’t spend the same bitcoin two or as many times as I like in the same way I can copy a png image?

This is called the “double-spend” problem and Satoshi solved this with the Proof-of-Work algorithm that takes place in mining.

The current system has some serious flaws. People not strictly from the Bitcoin world recognize these problems. Even people being critical of Bitcoin too agree with the Bitcoiners when it comes to inflation and government control for example. But let’s take a closer look at some of these flaws.

Inflation

One such flaw is inflation which is a feature of our existing economy and its biggest bug at the same time. We don’t think about it much but it is astonishing how we go about our everyday life acting like it doesn’t exist where entire countries have been destroyed cause of it. Inflation is the depreciation of money due to not having something to back it up. Not having our currency bind to something tangible or stable, like gold used to be for centuries you can print all the money you want and that is what has happened. The more currency that is not backed by something is dumped into circulation, the more its value is debased.

But the problem here is deeper. If you think of it, gold is not backed by anything either. Bitcoin is anti-inflationary owning to limited units in circulation(bitcoin production will stop in the year 2140). Having money being backed by gold gives us the illusion of stability, due to the difficulty of mining it. We feel safe(r).

Zimbabwe and Venezuela are classic examples of inflations on steroids where you were a billionaire in paper but dead broke in reality.

Eliminate the Middle Men

There is no way today to send money through the Internet without trusting a third party or middle man. We have technology that enables us to see and talk to each other across the world but ironically we still use monetary systems that are insufficient. It seems like a problem that we should be able to solve by now.

This is only possible by having a native digital currency of the Internet where we can send money as easily as we can send an email.

Bitcoin might do to money what TCP/IP did to information. - Wences Casares

A way to transfer value over the Internet fast, secure, and not constrained by borders.

Provides Transparency

A common fallacy about Bitcoin is that it is anonymous. Probably the word cryptocurrency adds to the confusion. The main thing Bitcoin is known for is the transparency it provides, due to the fact that everything is open, decentralized, and peer-to-peer. This fallacy was perpetuated possibly because Bitcoin was associated with Silk Road and the Dark web in its early days. It was assumed to be a great fit for criminal activity and because it was anonymous that is why it was used. Of course, this is all nonsense. Regular dollars are being used for criminal activity as well. With Bitcoin, everything is open. We can see all transactions ever made in the network dating back to the very first block(Genesis Block). Although no identity is shown in the blockchain, there are addresses of wallets. There are many de-anonymization techniques that can associate certain addresses with some kind of activity. So no, Bitcoin transactions are not anonymous or hidden which is a feature, not a bug. This is how transparency is ensured.

Separate Money from State

Money was around long before we had governments. Saying that the government creates it and gives it value is wrong. They do control it to a large degree though and that is the problem. We all remember capital controls in Greece or in Argentina where the government confiscated all bank deposits. There are many more examples of this so separating money from state seems like a good idea.

Bank the Unbanked

There are millions of people around the world where they don’t have any kind of financial identity. Controlling your money and having even the ability to have an option to have financial independence is crucial for a person’s freedom. Financial systems are extremely costly in terms of infrastructure and many countries around the world don’t have that ability due to the country’s economy or political situation.

Many people are split between bitcoin replacing the role of gold which is a store of value that is not used for actual transactions, whereas others believe that it was meant to be a medium of exchange, serving actual cash utility. This is what actually triggered the block size wars in 2017 leading to the division of some portion of the Bitcoin community leading to the creation of BitcoinCash. Some people though think it can be both but in different time spans in Bitcoin’s lifecycle. The third stage will be to have a unit of account utility, meaning we will start thinking about the value of something in bitcoin and not in dollars.

Fun fact:

The largest transaction processed so far by the network was $1.1 billion US dollars, transmitted instantly and processed for a fee of only $0.68.

No matter the end result, there is no doubt that this is one of the most fascinating social experiments of the century and beyond. Even if it doesn’t live up to its promise it will sure spark several breakthroughs.


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