Unveiling Bitcoin: Global Currency Potential, and Superiority over Fiat and Gold

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Coinmonks

14 min readMar 9, 2024

Bitcoin is a decentralized, digital currency that operates without the need for intermediaries like banks or governments. It is the world’s first and most popular cryptocurrency, using blockchain technology to secure and verify transactions.

In this article, we will delve into the fundamentals of Bitcoin and its economic implications. We will elucidate the workings of Bitcoin, including its transactional processes and the mechanism behind the creation of new bitcoins.

Furthermore, we will explore the economic dimensions of Bitcoin, particularly in comparison to other forms of money, such as fiat currencies and gold. We will analyze what makes Bitcoin resistant to inflationary pressures, its superior reliability compared to traditional banking systems’ fractional reserve lending, and why the upcoming halving event in April 2024 will render it the scarcest asset on the planet. We will also examine its potential to serve as a global currency, surpassing even gold in this regard.

Additionally, we will address the challenges facing Bitcoin, including scalability and transaction fees, and explore how the Lightning Network could offer solutions to these issues.

It is essential to emphasize that this discussion does not constitute investment advice for Bitcoin. Instead, it represents an endeavor to deepen our understanding of Bitcoin as a multidisciplinary subject encompassing economics, technology, and other fields.

I have also created this video in which are discussed the topics of this story:

· Table of Contents
· How Bitcoin Works
∘ The Bitcoin Blockchain
∘ Transactions
∘ Mining
∘ Halving
· The Economics of Bitcoin
∘ Immunity to inflation
∘ Consistent availability of funds
∘ The scarcest asset on the planet
∘ The Benefits of Bitcoin for International Transactions
∘ Bitcoin the new world currency?
∘ Bitcoin vs Gold
· Bitcoin Limitations
· Lightening Network
· Further Exploration
· Conclusions
· Resources

How Bitcoin Works

Bitcoin is a decentralized digital currency, operating independently of traditional financial systems and governmental oversight. Its transactions occur through peer-to-peer transfers on a digital network, which records all cryptocurrency transactions. This network is underpinned by blockchain technology, an open-source code designed to secure transaction histories and deter tampering.

Due to the direct confirmation of transfers between users and their presence on a shared public ledger, Bitcoin removes the necessity for centralized entities such as governments and banks to authenticate currency transactions.

The Bitcoin Blockchain

The blockchain is the backbone of Bitcoin. It is a distributed ledger that records all the transactions that have ever occurred on the network. It is not stored in one place: it is distributed across a network of multiple computers called nodes. The nodes run the Bitcoin software and validate transactions. Every node has a copy of the blockchain, and every copy is updated whenever there is a validated change to the blockchain.

The blockchain is divided into blocks, which are batches of transactions that are linked together by cryptographic hashes. The blockchain ensures that the history of transactions is transparent, immutable, and verifiable by anyone.

If you’re interested in learning more about blockchain, I recommend taking a look at this story: Blockchain 101: How Decentralization Is Changing the Game

Transactions

Traditional banking vs Bitcoin transaction

Transactions are the basic units of Bitcoin. A transaction is a transfer of value between Bitcoin addresses, which are alphanumeric strings that identify the owners of bitcoins. A transaction consists of inputs and outputs, which specify the source and destination of the value transfer. A transaction also includes a signature, which is a proof that the sender has the right to spend the bitcoins. Transactions are broadcasted to the network and confirmed by the nodes in the blockchain.

The principal distinction in Bitcoin compared to the traditional system lies in the fact that the network validates transactions through a consensus mechanism known as proof-of-work, eliminating the necessity for reliance on a trusted third party.

Mining

Mining, also known as proof-of-work, is the process of creating new blocks and adding them to the blockchain. Mining requires a lot of computational power and electricity, as miners have to solve a difficult mathematical puzzle to find a valid block. The first miner who finds a valid block gets rewarded with newly created bitcoins and transaction fees. Mining secures the network and ensures that the blockchain is consistent and up-to-date.

Halving

The BTC rewards for miners halves every 210,000 blocks or every 4 years

The reward granted to miners for solving mathematical problems and adding new blocks to the blockchain diminishes over time, a concept known as halving.

Initially set at 50 BTC when Bitcoin was created in 2008, the reward halves approximately every four years, or every 210,000 blocks. As a result, rewards decreased to 25 BTC in 2012, 12.5 BTC in 2016, and 6.25 BTC in 2020. The upcoming halving, expected in April 2024, will further reduce the reward to 3.125 BTC, followed by an additional halving to 1.5625 BTC around 2028.

It is anticipated that the final bitcoin will be mined around 2140, marking the culmination of the process with a total of 21 million bitcoins in circulation. Beyond this point, miners will rely solely on transaction fees to sustain the network.

The Economics of Bitcoin

Immunity to inflation

Purchasing Power of the US Dollar 1913–2016

The US dollar has devaluated significantly since 1913. According to the United States Federal Reserve Bank data, as of April 2020, the US dollar lost approximately 96.2% of its value since 1913.

This devaluation has been primarily attributed to persistent money printing by the US Federal Reserve bank and the federal government, leading to a decrease in the purchasing power of the currency over time. The devaluation accelerated notably after the ‘Nixon Shock’ in 1971 when the US dollar was taken off the gold standard, and the dollar became a fiat currency.

Before 1971, the U.S. operated under a gold standard system where the value of each country’s currency was defined in terms of a fixed weight of gold. This system ensured convertibility and limited the money supply based on gold reserves.

In contrast, fiat money, is currency without intrinsic value, backed by government regulation and trust rather than a physical commodity like gold. Fiat money allows governments to issue currency without limitations, enabling unlimited loans and government spending.

How the FED increases the money supply

As the government prints more money, the currency becomes inflated due to the increased supply, leading to a decrease in purchasing power. This phenomenon is not exclusive to the U.S. dollar but applies to all major fiat currencies, including the Euro, Pound, Yen, and others.

If our purchasing power decreases, it indicates that we can afford fewer goods and services with the same amount of money. Consequently, to maintain the same standard of living or afford the same quantity of goods and services, we may need to work more or receive a raise from our company.

If the printing of money becomes excessive, a country can end up experiencing hyperinflation, where the currency loses its value, as seen in Germany during the Weimar Republic in 1933, which eventually led to the rise of Nazism.

Hyperinflation was not confined to Germany; indeed, as illustrated in Ray Dalio’s video “Principles for Dealing with the Changing World Order” it has been a recurring historical phenomenon across various civilizations since the dawn of humanity. Examples include the Romans, French, Dutch, English, and others, where currencies have consistently devalued until becoming worthless.

Satoshi Nakamoto, the creator of Bitcoin, was well aware of this issue, as he wrote:

The root problem with conventional currency is all the trust that's
required to make it work. The central bank must be trusted not to
debase the currency, but the history of fiat currencies is full of
breaches of that trust.

That’s why the supply of Bitcoin is capped at 21 million, making it immune to inflation since there is no central bank or authority capable of debasing the currency. Bitcoin stands out as the only asset that is fully decentralized and trustless, relying solely on its own algorithm rather than a third party.

Moreover, Bitcoin can serve as the sole means for individuals residing in countries with high inflation rates, such as Venezuela, Zimbabwe, or Argentina, to safeguard their purchasing power.

Consistent availability of funds

In the traditional banking system, banks engage in a practice called fractional reserve lending, where they retain only a portion of their total deposits in reserve and lend out the rest. Here is how it works:

Initial Deposit: When a customer deposits money into a bank, the bank is required to hold only a fraction of that deposit in reserve, typically a percentage set by the central bank.
Reserve Requirement: Central banks, like the Federal Reserve in the United States, set the reserve requirement, which determines the minimum amount of reserves that banks must hold. For example, if the reserve requirement is 10%, a bank must hold $10 of reserves for every $100 deposited.
Lending: Banks are then able to lend out the excess reserves to borrowers in the form of loans or credit. This process effectively creates new money in the economy because the borrower now has access to funds that did not previously exist in the form of deposits. For example, if the reserve requirement is 10%, banks can lend out the 90% of the deposited money. In other words, if we deposit $100, the bank retains $10 and can lend out $90.
Interest Rates: Banks charge interest on the loans they make, generating income for the bank. The interest rates charged on loans are typically higher than the interest paid on deposits, allowing banks to earn a profit on the difference, known as the interest rate spread.
Money Creation: Through fractional reserve lending, banks effectively create money by expanding the money supply beyond the initial deposits. This process can lead to increased economic activity and investment but also poses risks, such as potential bank runs if depositors lose confidence in the bank’s ability to repay their deposits.

Satoshi was also aware of this issue, as indicated in his writing:

Banks must be trusted to hold our money and
transfer it electronically, but they lend it out in waves of credit
bubbles with barely a fraction in reserve.

In Bitcoin, fractional reserve lending does not exist, and the funds are always available to the owner. This is because only the owner of the private key associated with the funds has the ability to move them.

The scarcest asset on the planet

The stock-to-flow model is a way to measure the scarcity of an asset. It’s calculated by dividing the total stock (amount of the asset currently available) by the flow (annual production rate).

After the halving in April 2024, Bitcoin is projected to become the scarcest asset class in the world, surpassing even gold in terms of scarcity. Here is a comparison of the stock flow dynamics between gold and Bitcoin post-halving:

Gold: Gold’s stock-to-flow ratio has remained relatively stable over the last 50 years, indicating its enduring status as a store of value. Approximately 187,000 metric tonnes of gold have been mined in history and around 3,000 tonnes of gold is mined each year.
In other words the annual increase in gold supply has been around 1% to 1.5% of the existing stock, maintaining a stock-to-flow ratio of approximately 65–70.
Bitcoin: Bitcoin’s tock to flow increases with each halving. In particular with the halving of April 2024 the block reward will be of 3.125 BTC and since one block is mined every 10 minutes we can expect 144 blocks mined per day. If we consider the total stock to be around 19 million Bitcoins and the annual production to be halved from the current rate, the new flow would be approximately 164,250 BTC per year, leading to a stock flow of about 115.

After the halving in April 2024, Bitcoin will become the scarcest asset in the world. This scarcity could potentially increase Bitcoin’s value. Scarcity has the ability to drive up demand, and since the supply is limited, it can result in higher value or prices.

The Benefits of Bitcoin for International Transactions

Unlike banks, which are closed during the weekend, Bitcoin enables secure transactions at any time of the day or night. Additionally, traditional bank transfers may encounter limitations when sending money to individuals in certain countries, whereas Bitcoin facilitates transactions across the globe.

In contrast to traditional bank transfers, which can take 3 to 5 days to process and may encounter delays or restrictions, Bitcoin transactions have no such limitations. Given that each block is mined approximately every 10 minutes, Bitcoin transactions can be confirmed within minutes, offering unparalleled speed and accessibility.

Bitcoin the new world currency?

A currency is a medium of exchange that facilitates trade and economic activity. A currency should have some properties to be effective and widely accepted, such as:

Scarcity: There should be a limited supply of the currency to prevent inflation and maintain its value.
Divisibility: The currency should be divisible into smaller units to allow for transactions of different sizes and prices.
Durability: The currency should be resistant to physical damage and deterioration over time.
Portability: The currency should be easy to carry and transfer across borders and regions.
Fungibility: The currency should be interchangeable and indistinguishable, meaning that each unit has the same value and quality.
Recognizability: The currency should be easily identifiable and verifiable by its users and authorities.

Bitcoin can potentially acquire the role of world currency because it has all the properties mentioned above:

Scarcity: Bitcoin has a fixed supply of 21 million coins that will ever be created, making it immune to inflation and manipulation by central authorities.
Divisibility: Bitcoin can be divided into 100 million smaller units called satoshis, allowing for precise and flexible payments.
Durability: Bitcoin is stored in digital wallets that are protected by encryption and backup mechanisms, making it resilient to physical damage or loss.
Portability: Bitcoin can be transferred across the internet in minutes, regardless of geographic location or political boundaries.
Fungibility: Bitcoin is theoretically fungible, meaning that each coin has the same value and quality.
Recognizability: Bitcoin is recognizable by its users and supporters, who trust its underlying technology and network.

Bitcoin vs Gold

Gold is a world currency because it has several properties that make it suitable for international trade. Gold is durable, scarce, divisible, fungible, portable and universally accepted. These properties mean that gold can retain its value over time, be easily exchanged for goods and services, and be recognized as a medium of exchange in any country.

Gold also has a long history of being used as money, dating back to ancient civilizations. Gold is often seen as a safe haven asset, meaning that people tend to buy it when there is economic or political uncertainty. Gold is also independent of any government or central bank, which gives it an advantage over fiat currencies that can be manipulated or devalued.

However Bitcoin has several advantages over gold as a world currency, such as:

Bitcoin is scarcer than gold, with a fixed supply of 21 million coins that will ever be created. In contrast, gold experiences an increase in supply of around 1% to 1.5% of the existing stock.
Bitcoin is more divisible than gold, with each coin being divisible into 100 million units called satoshis. Gold, on the other hand, is difficult and costly to divide into smaller units, especially for everyday transactions.
Bitcoin is more portable than gold, with each coin being easily transferable across the internet, regardless of physical location or borders. Gold, on the other hand, is heavy and bulky, requiring storage and transportation costs and risks.
Bitcoin is more verifiable than gold, with each transaction being recorded and validated by a network of nodes, using cryptography and consensus algorithms. Gold, on the other hand, is prone to counterfeiting and fraud, requiring testing and certification by third parties.

Bitcoin Limitations

Bitcoin aspires to become the world currency, but in order to achieve this goal, it must overcome some major issues:

Scalability: Bitcoin can process a maximum of 7 transactions per second (tps), which is significantly lower than traditional payment systems like Visa which handles around 1736 tps.
Fees: since one block is created every 10 minutes with a size of about 4 MB, the number of transactions that can be processed is limited. Consequently, to include your transactions in the next block, users must bid against others by raising the fees attached to their transactions. When the network experiences low usage, this isn’t a problem as transactions can be included in the next block with very low fees. However, when the network becomes congested, fees can rise significantly, sometimes exceeding $5. For instance,during the peak of the 2017 bull market, fees even surpassed $50.

Lightening Network

To address the limitations of Bitcoin and enable it to function as a viable currency, the Lightning Network has been developed. This is a layer two solution that enables fast, cheap, and scalable transactions on top of the Bitcoin blockchain. The Lightning Network allows individuals to transact without having to record every transaction on the Bitcoin blockchain.

It works by creating bidirectional payment channels between two parties, who can exchange value without broadcasting every transaction to the main chain. The payment channels are secured by smart contracts that enforce the atomicity and finality of the payments. The lightning network also allows for cross-chain atomic swaps, which enable users to exchange different cryptocurrencies without intermediaries.

The lightning network is a feasible solution to use Bitcoin in everyday life because it reduces the congestion and fees on the main chain, and allows for instant micropayments and peer-to-peer transactions.

Further Exploration

If you’ve found the subject intriguing and wish to expand your understanding, I recommend exploring the following insightful pieces to enhance your knowledge:

Web3 101: How to Use Blockchain, Cryptocurrency, and NFTs in the New Web. This article delves into the revolutionary concept of web3 and its primary applications.
Blockchain 101: How Decentralization Is Changing the Game. This article delves into the inner workings of blockchain technology and explores its primary use cases.

Conclusions

I trust this article has proven informative and enriched your understanding of Bitcoin. We’ve delved into its operational mechanics, economic implications, and its potential as a global currency. However, there remains significant groundwork to address its limitations, with the Lightning Network paving the way forward. I’m keen to hear your thoughts and address any queries you may have, so please feel free to share your opinions and questions in the comments section below.