What is Bitcoin, how it works, why it is a solution

Bitcoin is a decentralized digital currency. Bitcoin being decentralized means you do not need a 3rd party like a bank to store or hold your money. The Bitcoin network is a peer to peer technology that is open source and designed by the public, this means that no one owns or controls Bitcoin and everyone can take part in the network. Why is this important? With a classic currency like the US Dollar, trust is required for the currency to work. An individual must trust the bank to store their funds. Individuals must trust that during a transaction the dollars they are receiving are real. We also must trust that the central bank will not print so much money that currency loses its value. When trust is broken systems break. Bitcoin minimizes the trust required and has some incredible benefits:

  • Anyone can use it worldwide 24/7
  • No ID required, which can help the 1.7 billion unbanked in the world.
  • No one can block or stop transactions (Like Visa or MasterCard can)
  • Transactions are irreversible

How does it work? Bitcoin operates through a proof of work system which is done with public key cryptography. Here is an example: If I was to send you $5 in bitcoin, I would first send to your bitcoin address, the payment would then be broadcasted onto the network which is called the blockchain. This $5 transaction would then be verified by many decentralized sources to ensure that I am not spending that $5 twice. The decentralized nature of the network is valuable because there is no need for trust, just verification.

How could bitcoin have any value? Have you ever thought about what makes a dollar or gold have value? Here are a few things dollars and gold have historically been used for: a medium of exchange for goods and services, they also act as a unit of account and are a store of value. To put it simply money must be portable, durable, divisible, recognizable, fungible, and scarce. All of which bitcoin achieves. Bitcoin also derives it's value from the security of the Bitcoin blockchain. You would never want to store your wealth in something that could be broken into or hacked.

Bitcoin is secured by "nodes" all across the world. Nodes computers that do what the job of the Federal Reserve or your credit card company do. Nodes store information about transaction and the history of the blockchain which can be viewed by anyone. While the nodes maintain the history and records of transactions, "miners" verify latest transactions and make sure that bitcoin is not duplicated. (Just like dollars have serial numbers on them, the bitcoin network users miners in a way to ensure that no bitcoins are duplicated). Miners are rewarded for verifying transactions, for every block of transactions they are rewarded bitcoin. In another writing we can go deeper into this subject.

Let's talk history for a bit. Starting with the Bretton Woods Monetary System

After World War 2 there was concern that countries would devalue their currency by printing more to boost exports. In 1944, 44 countries met in Bretton Woods New Hampshire to create a new monetary system. The USA had 2/3 of the gold reserves so it made sense for the US to be the world reserve currency backed by gold. Other nations linked their currencies to the dollar because our dollar was linked to gold. There were still concerns globally though about during economic downturns countries would print more money to solve economic problems. This is when the IMF (international monetary fund), the World Bank and the World Trade Organization (WTO) was created. The IMF lends money to countries who need help during a crisis, the World Bank helps developing countries grow and the WTO ensures global trade happens freely and smoothly.

Overtime the US kept printing money to fund their needs. The dollars in circulation kept increasing, and the gold reserves were reducing. In 1971 America completely ended the link between the dollar and gold. Now the dollar is backed by nothing. Below is are quotes from Jerome Powell's 2020 60 minutes interview.

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How does this printing of money relate to Bitcoin? One of the most important aspects of Bitcoin is that there are only 21 million total Bitcoins that will ever exist, no more can be made. There is a predetermined controlled supply schedule of bitcoin that will never be altered. If the printing of the dollar is "inflationary" then it is understood that Bitcoin is "deflationary" because more can not be made beyond the 21 million. Everyone knows with certainty how much Bitcoin is created and is scheduled to be released into the marketplace. Below is an example of what $1 is worth in comparison to Bitcoin, you can see as times passes $1 of purchase power acquires less Bitcoin. This example illustrates the deflationary nature of Bitcoin.

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Scarcity is important when it comes to determining value. Sand, rocks, sticks and dirt are common and could never act as a store of value or medium of exchange because they are not scarce. Dollars as mentioned by Jerome Powell can be printed digitally. It is as easy as adding a digital zero at the end of their account and BOOM more money is made. If dollars can simply be digitally printed at any time what value do they really have? Many people are asking why do we pay taxes if you can just create more money whenever you want? This article by Gold Money illustrates how infinite money printing causes currencies to collapse. In 2013 within the country of Cyprusbanks were lending such crazy amounts of money that they had lent out about 330% of the GDP, meaning they lent out over 3x what their countries economy could create yearly! The banks were broke and the depositors who trusted the bank were overnight out of their money. During this time the depositors who trusted the banks lost anywhere from 40-90% of their savings having to bail out the banks. Depositors were scrambling to get their money out of the banks and into a save haven asset that would not lose 40-90% of its value overnight. Bitcoin hit record values during the Cyprus banking crisis, read here. The Argentinian peso has also gone through hell, you would have been better off holding Bitcoin VS. keeping money in the Argentinian bank.

Why Bitcoin matters globally? We have yet to have our currency collapse in America or have a bank take our net worth overnight like the example above. Other countries are at much higher risk of their currencies collapsing and there has never been a fiat currency that can be printed that lasts without failing. Historically all fiat printable currencies that are centrally controlled have failed. The only thing that has stood the test of time is gold. The sad part is that gold is not easily accessible for everyone in the world, and once accessible you have to store it safely to protect your wealth.

We are in a digital age, we trust computers and algorithms for answers to questions, directions to our destinations and so much more. Trust has eroded and Bitcoin has given the world a solution as a way to store value and transfer wealth globally with ease without the reliance of a 3rd party or government entity. As countries economies print money to fuel growth and the American dollar gets printed to insane new levels (this last week we crossed 7 trillion dollars on our nations balance sheet) we will see individuals move into save havens to protect their wealth. I personally believe Bitcoin will be one of the greatest store of values over the foreseeable future based on prior economic collapses and how the global economy is functioning.

I hope you enjoyed this write up about Bitcoin, how its value is derived and some cases of it's use and needs globally.