Everything you’ve heard about Bitcoin is wrong
By now you’ve probably heard a lot about Bitcoin. It’s a Ponzi scheme, a tulip mania, a bubble, a scam, but also somehow it’s supposed to be the digital gold and the future of money. It’s supposedly used by thieves and criminals, but also helps unfortunate people in hyperinflation countries like Venezuela survive the tragedy of a currency collapse. It’s been declared dead by the mainstream media over 300 times over the past decade, yet it still exists and refuses to disappear. Some people say they use it to pay for things, but you’ve probably never seen it accepted anywhere. This is all extremely confusing and intriguing at the same time and just googling the topic seems to make the confusion even worse. So what the hell is going on?
There’s no simple answer to this question (otherwise there wouldn’t be so much confusion), but it’s also not as complicated as it seems to be. See, Bitcoin is simply a network protocol. So first, let’s break down what a network protocol is.
Network protocols in a nutshell
Whenever you use a browser to access a website, your browser needs to somehow figure out where to find that website and how to ask for its content so that it can display it on your screen. This is being done under the hood using a set of so called network protocols. These protocols are simply an agreed upon rules on how computers talk to each other to exchange information. A gross oversimplification of this process in human language would look like this:
Browser: Hello, server at somedomain.com! I’m Firefox and and would like to see the cute-cat-752.jpeg file that you host, please!
Server: Hello, there! Here’s the content of the cute-cat-752.jpeg file that I have. It’s a JPEG file that is 841235 bytes large! It won’t change for at least an hour, so please don’t ask again during that period.
The above is actually an approximation of how the HTTPS protocol works at its core. It’s the same HTTPS that you see in front of every website address. The Internet as we know it works because every browser, every web server and every app follows the exact same rules of the HTTPS protocol, so that every piece of software is guaranteed to be able to talk to every other piece of software. If any browser were to break the protocol and not follow its rules, it would instantly become incompatible with the rest of the Internet. That wouldn’t be a very good browser, would it?
While everyone is familiar with HTTPS because of its ubiquity in today’s world, there are many, many protocols that are absolutely crucial for the Internet to work. HTTPS itself is built on top of TCP and needs it to work. TCP in turn, is built on top of IP protocol, and so on. Every single network protocol has its own unique reason to exist. HTTPS helps securely transfer content over the Internet. DNS helps computers find each other using domain names. SMTP helps transfer our emails from one server to another, etc. There are hundreds of protocols out there and they’re all designed to solve very specific problems. Fortunately, for the average user, this is completely transparent and you don’t need to worry about it at all. You can simply fire up your favorite web browser and enjoy the cuteness of cats on YouTube.
One very important thing about Internet protocols is that they’re not owned by any company. These protocols are established by consensus within the industry, because it is in everyone’s interest to be compatible with each other. There is no single company that has the authority to change how HTTPS works or decide who can or cannot use it. Any person in the world with sufficient skills can create their own web browser or server. Because of this inherent freedom, the Internet has experienced such an incredible growth in recent decades.
To sum up this point, all you really need to know is that a network protocol is an open, predefined set of rules that helps apps talk to and understand each other. It’s their language. That’s it.
Bitcoin as a protocol
I hope you’re still following, because here comes the difficult part. Read this carefully and let it sink for a few minutes.
The Internet made the exchange of information extremely cheap, instant and accessible for everyone in the world, without borders and restrictions. There’s no doubt this has been one of the most important achievements of our civilization. Over the past 2 decades this has transformed almost every industry in the world and made it better. Now what if the Internet could do the same thing with money?
Bitcoin is to money what HTTPS is to information. It’s an Internet protocol that anyone can use, without borders and restrictions. It’s open, it’s not owned by any single entity, it’s based solely on industry consensus. But, instead of information, it transfers value. Because of its open nature and the freedom it inherits from the Internet, over the next decades it will spur an unimaginable amount of innovation in how we deal with money. It will do to banks what email did to post offices, what news portals did to newspapers and what Netflix and YouTube do to broadcast TV. The beast has been unleashed and now it’s only a matter of time before we see the world change in front of our eyes.
But wait… Something doesn’t add up. How come I can buy and sell 1 bitcoin, but I can neither buy nor sell 1 HTTPS? This is the point where technology meets the economics.
Bitcoin as a currency
The economic aspect of Bitcoin is incredibly deep and I recommend you read an actual book on this topic, but again I’ll try to give you a simplified model of what’s going on, just to get you started, and (hopefully) more curious.
Have you ever wondered what money really is? Why is it that the dollar bill in your pocket can be exchanged for a coffee at your local McDonald’s? And why is the coffee worth $1 and not $100 or $0.10?
Turns out money is just another product of our civilization. A dollar has no intrinsic value — it’s just a piece of paper — and is only worth something as long as somebody else is willing to accept it in exchange for some other product or service. While the government-issued currency has become the dominant form of money in today’s world, that’s actually a very recent development. Just under 50 years ago, US dollars were still directly convertible to gold. US dollars have become virtual and not backed by anything physical only in 1971. That’s not that long ago.
Throughout the history people all over the world have used a plethora of different forms of money, from seashells, through salt and animals and, obviously, gold. So what makes money good or bad? Turns out we already know the answer to that question. Any money, to be good, needs to be durable, portable, divisible, fungible and limited in supply. Unfortunately none of the currently used monies tick all the boxes. Gold sort of checks all the boxes except portability. Government currencies sort of check all the boxes except limited supply. So how does Bitcoin approach this issue?
To solve the issue of good money, the Bitcoin protocol introduced its own unit of money, unsurprisingly also called bitcoin (the unit is spelled with a lowercase “b”, while the protocol uses capital “B”). The protocol limits the amount of bitcoins that can ever exist to just 21 million units, and then every bitcoin can be further split into 100 million satoshis — just like a dollar can be split into 100 cents. Because of the digital nature of bitcoin, it’s inherently portable, divisible and fungible. All bitcoin transactions are recorded in a public database called the Blockchain, and any person in the world can keep a full copy of it, giving the whole network an incredible durability. There are tens of thousands of copies of the Blockchain all around the world. While there are some areas in which Bitcoin could still be improved, it’s the first time in human history we have a form of money that covers all the characteristics of good money.
Should you invest in Bitcoin?
Bitcoin is in its early days and it’s incredibly volatile. It went through several market cycles when the price of a bitcoin went up 1500% just to crash by 90% in the months after. Even though every such cycle ended with bitcoin price higher than before the cycle began, there is no guarantee the next cycle will follow this pattern.
Those heavy swings in price attract a lot of attention, which has both good and bad aspects to it. On one hand this helps bring many talented people into the Bitcoin space, which will inevitably result in many great products being built on top of the protocol. On the other it attracts a huge amount of scammers who try to create their own protocols mimicking Bitcoin and trying to convince you it’s the next version of Bitcoin and it’s somehow better (it’s not).
The success of Bitcoin depends not on the Bitcoin itself, but on the success of future products built on top of it. Currently such products are still rare and bitcoin’s price is driven mostly by speculation and psychology of the market, hence the extreme volatility of its market value.
Bitcoin truly is an incredible achievement with huge potential and I highly encourage you to learn about its economic fundamentals and the technology behind it. The ever increasing national debt and government spending, uncontrolled money printing by central banks and national currencies collapsing around the world definitely don’t give an optimistic outlook for the future of the current financial system. The question to ask is not “should you invest in Bitcoin”, but “when the current economic bubble inevitably bursts, what is your plan B?”