A Bitcoin Brief
The terms cryptocurrency and blockchain have become synonymous with the technology behind the 2008 invention Bitcoin. Bitcoin, a project first introduced by Satoshi Nakamoto in a 2008 whitepaper drew on ideas from various earlier projects, developers, and spheres of thought ranging from economics to cryptography — the combination would eventually become the foundational layer of the Bitcoin project. So what is it?
Bitcoin is a piece of software. To illustrate it from the ground up, one must imagine a single computer at first. This computer is mining for bitcoin — how does it do this? A computer can mine bitcoin by attempting to solve an extremely complex math problem. To accomplish its goal, the computer must run through the set of possible answers to find the correct one. Once the computer has found the answer, and satisfied the protocol’s proof of work a block is mined. What is a proof of work? A proof of work system, an idea introduced and formalized by Hal Finney, an early Bitcoin developer and user, is a reusable proof that requires a substantial amount of computational power to solve. By solving the proof the computer is rewarded for its effort in Bitcoin. This is how a computer mines. The solution to each proof is first come first serve, the validity of the answer is checked by the other nodes or computers in the system. Once a solution is found, it is distributed, checked, and laid down in the following block. Checking the solution is easy, as it is just plugging a number in and evaluating it. There is a massive hurdle which, once crossed, is recognized by the entire system right away.
What is a block? The term blockchain comes from the simple idea of a series of data chunks in a line. A block is a chunk of data, containing some key information. Each block in the Bitcoin network contains the latest transactions and dispenses the rewards for each miner. Once a block has been mined and added to the blockchain it becomes incredibly difficult to rewrite. This is where the security of the Bitcoin system comes into play. To corrupt the current ledger of Bitcoin, one would need to somehow gather enough energy to overpower all other systems in the network. By doing this, and only this, the system could rewrite the history of the chain — effectively doing whatever it wanted. Perhaps this was possible in the early years of the project, where a handful of computers controlled the entire network, but now decentralization has run its course. Let’s break it down:
Once a computer has provided a sufficient answer to the proof, it distributes the answer to the other systems who then verify it and the block is placed. One of the genius inventions in Bitcoin is its elegant solution the Byzantine Generals Problem:
A group of generals are besieging a city and are stationed at various points around the outer walls, however, they have no reliable form of communication between them. The messages could be intercepted and there is no single leader calling the shots. If the generals were to combine forces and attack at once, they would easily win, but attacking separately would surely lead to a loss. How can all the generals simultaneously receive the same orders and perform their task without a centralized leader? Bitcoin’s strength comes from its ability to verify a message from a single sender on many systems at the same time. Only through the effort of the verifying nodes is the potential answer to the proof accepted, and through Bitcoin’s decentralized architecture, all the nodes are made aware of the new data at the same moment. This effectively solves the Byzantine Generals Problem.
Getting back to the issue of security, how would one attack this system? Imagine one of the generals was an imposter, and attempted to send a false message to the rest of the group. The message would be checked by all other generals, at the same exact time, and deemed false; only by controlling the majority of the network could the imposter convince the entire system that its message was in fact true. As the Bitcoin network continues to grow, the energy needed to perform such a task grows enormous and is already far too great to reach. According to many statistics, less than 20% of the Bitcoin currently in the world is available on exchanges, meaning, if one entity were to purchase all the available Bitcoin in the world, they would still fall nearly 30% short of taking control of the system. To successfully attack the Bitcoin blockchain, you would need to effectively re-write the previous blocks in the chain. However, with each subsequent block placed, and each generation recognized on the entire distributed ledger, the amount of necessary power to rattle the system increases.
Why should Bitcoin have value? This comes to the term cryptocurrency which is actually quite far from the truth. The word currency denotes that Bitcoin is attempting to supplant the fiat currencies used today, however, this couldn’t be further from the truth. The value of Bitcoin comes from its strength as a system, and its sound ledger. The ledger is essentially the blockchain. It is a distributed ledger because all systems are receiving the same one simultaneously. All parties involved are given the same exact info, the data of the mined block which contains in itself the history of the chain. This robust system is where the value of Bitcoin arises from. Through the 12 or so years that Bitcoin has been actively mined, energy and trust has been injected into the system. Every instance in which one computer mined a block or someone purchased any amount, the value increases. Money is an abstract concept that attempts to determine value. To that end, we must search for the most useful means of denoting value — as that is really what we’re after, isn’t it? Why does Bitcoin have an advantage over the US dollar or gold? Let’s consider gold.
Why is gold a commodity that is used to denote value? Well, many would first say its scarcity. Over the centuries of human civilization gold has always emerged as a primary store of value. From every corner of the Earth are stories of kings and their stores of treasure. Each year, only 1.5% of the world’s total gold population is added to the supply through mining. This has been the case for decades, and perhaps centuries. It has always been hard to gather, however, new veins are always discovered. While this doesn’t suggest there is infinite gold, there may be a lot more to come. Bitcoin, on the other hand, is a completely fixed supply. There will only ever be twenty-one million Bitcoin, no more no less. That is the total number of Bitcoin since the first day, and will be past the last block mined. In the earliest form of Bitcoin, the schedule was laid down by Satoshi, and that schedule is the true leader of the project. Gold’s value comes from its scarcity as well as its necessary use in electronics, however, this makes up a small portion of the total demand for gold. Wouldn’t a more ideal form of storing value be something completely determined on its own supply and demand as a monetary asset? For example, if gold is used as the determining value of a nation’s assets, and the demand for gold increases tenfold because of a chip shortage, the assets will skyrocket in value — not because the nation has increased the total number of assets, but because others are in need of its materials. Bitcoin, on the other hand, is only a store of true value. Therefore, it would not sway with the supply and demand, the ebb and flow of traditional commerce, and could be left alone to be an instrument of stored value.
Another obvious difference between gold and bitcoin are its physical properties. Most of the world’s gold is stored in vaults underground. To successfully tally the weight, quality, and quantity of a nation’s store, it could take enormous amounts of resources, manpower, and computing power to draw together an entire view. Conversely, Bitcoin is stored not in one location, or even ten locations, but on the widely distributed ledger that each node is constantly reading. How could a nation assess its assets? They would just have to look at the latest block and see how much Bitcoin it owns. Whether this be a single wallet or a thousand, it would be a simple scan of addresses and values. It would take a single computer.
Let’s say I wanted to trade with another nation some of my gold for some of their local produce. This could be done in a few ways, one could literally transport the gold but this requires a large amount of energy and manpower. According to some rough calculations one million dollars of gold weighs roughly 50 pounds. This may not sound like a lot, but what if the order costs twelve billion? That would end up being 66000 pounds of gold, or 330 tons. Now consider the energy to even get into a truck, let alone being shipped across the world. Bitcoin is sent through a simple transaction, verified through the distributed ledger, and relatively costless compared to the transport of physical commodities. For the first time in history, humans have a means to transport energy in a virtually costless manner. No wires or pipes are necessary, and because of Bitcoin’s shared value at any location in the world, the energy is equivalent.
Now, a lot of this has been somewhat technical and it may not be immediately obvious why any of this matters. Let’s imagine a few scenarios. Suppose you are the mother of two in a country such as Nigeria, where their currency the Naira is failing. They are experiencing an inflation rate of nearly 16%, debasing the value of their currency each year by a substantial amount. In 1972 you could get 0.658 Naira for every US dollar; in June of 2021 you would get 413.0 Naira per US dollar. This reminds one of the widely known story of the failed Zimbabwean currency, a dollar that was initially around the same value as the US dollar, but over the decades was hyperinflated, leading to the country’s printing of a one hundred trillion dollar note. Even with that piece of paper, one could not buy a piece of bread. Why do these things happen, and how does a currency lose so much value? It is a combination of many economic forces, but the rapid printing of money and poor local market conditions are large factors. If you were a wealthy businessman in Nigeria or Zimbabwe, and you put a large portion of your cash in the bank, over the course of a decade or two the value of your money has decreased significantly, and you’ve done nothing with it. There was a story of a working man in New York City who stored his hard earned cash in the walls of his apartment. The money was discovered decades later, worth a fraction of its former value. How could one prevent this sort of loss? They could buy another nation’s currency, in hopes that it is stronger, but these currencies, even the strongest ones, experience inflation. The US dollar, thought of as one of the strongest fiat currencies, is undergoing rapid inflation as well. This is all because the central banks of a nation can print as much money as they want, when they want, and direct it to who they want. This is part of the modern economic and political system most nations subscribe to. The government is supposed to fix the money problem however it can. Many have seen recent headlines stating that 40% of all US dollars were printed in the last year alone. Most of this new money comes in the form of loans from banks, who are not required to back all their loans with actual assets. It is just another number in the system. This all works fine until some data is lost, or some numbers are changed.
The common stance is to look towards scarce commodities, such as gold or silver, which have both experienced over a decade of downward movement. On the other hand, Bitcoin is up around 60% year over year, a staggering compounding rate. Gold has been used for thousands of years, and has performed quite well for that period of time, but how will it continue to react to the ever growing forces of the internet and new technology? We’ve seen instances of synthetically created diamonds, as well as new drilling and mining techniques that will unveil new mineral veins all over the world. These advancements lead to the potential rise of a gold supply well past our current estimates, as well as further complications with regard to mining, transporting, and storing of a physically heavy asset. Bitcoin will have 21 millions coins today, tomorrow, and in a hundred years.
No other coin has reached the mass adoption and institutional acceptance that Bitcoin has seen, and there is reason to believe it will continue to be the only coin widely accepted and in the market. Even in the case of Ethereum, the number two crypto by a large margin, but still quite far behind Bitcoin, it suffers from supply uncertainty. That being said, Ethereum itself should not be compared to Bitcoin in the sense of storing value as they are two entirely different protocols and systems in that way. However, I think it is fair to say that no financial institutions are planning to hold Ethereum on their balance sheet in the near future, no matter its recent performance. The analogy some like to use is this: Bitcoin is gold and Ethereum is oil. This is quite a barebones idea but I think it captures some of the initial differences between the two. Over time, with advancements on both of the platforms, they are in many ways becoming more alike. Bitcoin is working towards its own form of smart contracts, while Ethereum is reaching a level of decentralization key to its long term survival. Yet, we’ve seen Ethereum experience quite a few road bumps, and it is certainly not out of the woods yet. Ethereum 2.0 is still on the horizon and users are eagerly awaiting it. Gas fees are incredibly high, and unaffordable for the average user. For the current crypto enthusiast, Ethereum is an untouchable platform as it can cost upwards of $200 to send a coin between wallets. In the meantime, projects like Polkadot, Solana, and Avalanche have been working quickly to release their own crypto platforms. None of these platforms are exactly like Ethereum or each other, all perform their own functions and have specific advantages and disadvantages, but we can all agree that platforms are popping up left and right to present an alternative. The longer Ethereum 2.0 takes, the more market cap they eat away, and they aren’t eating away at Bitcoin as much as they are Ethereum. In the end, no matter which platform wins, or if all of them win, Bitcoin will be around as the first crypto, the basic for the others, and the gold standard.
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