What Is Bitcoin? Introduction To Digital Cash

Bitcoin is a digital currency.

Just like a dollar or a Euro can be spent to buy goods or services, Bitcoin can be used to buy – well, almost anything, from a pizza to a Lamborghini.

But instead of holding a piece of paper or a coin when you go to checkout, you hold exclusive access to an encrypted digital asset (called a “private key.”) This allows you to access your bitcoins and transfer them to someone else.

Thousands of merchants around the world accept bitcoins as payment including Overstock.com, Expedia, and Rakuten.

Some argue that Bitcoin is also (or alternatively) a “store of value” similar to gold.

In other words, like gold, it doesn’t have a lot of intrinsic value or use (gold has some manufacturing uses, but most of it is stored by central banks or given ‘value’ by jewelers). We know from looking at the markets that an ounce of gold is worth some number of dollars on any given day. Bitcoin is similar – the people who hold bitcoins, or want to trade them, mutually agree on what they are worth today.

Traders love the volatility of Bitcoin, which is at times extreme. For example, between October 2017 and January 2018, the value nearly quadrupled from $5,000 to $20,000, but then gradually settled back down to $6,000 and (today, at least) around $11,000. It is with no irony that we say Bitcoin (XBT or BTC) is still very much in price discovery phase, and there are some who believe it could be worth hundreds of thousands or even millions eventually.

To keep to the analogy of gold, Bitcoin is also limited in its total supply. Altogether, the total number of bitcoins that will ever exist is just under 21 million. Again, like gold, there is a method for ‘mining’ new bitcoins which rewards the people who put their time, energy, and cash into complex computer calculations to create new ones. Right now, about 16.9 million bitcoins have been created.

Bitcoin can be traded for fiat cash on digital exchanges like Coinbase, Robinhood, and dozens of others. Most exchanges also offer other digital currencies or ‘tokens’ which you can exchange for Bitcoin, and which may have some real-world utility beyond being a means of payment or a store of value. We’ll get to these later.

 

What Are The Benefits Of Bitcoin?

  • Security

Bitcoin is the first money system to utilize public key cryptography. Imagine trying to rob a bank that kept all of its assets in dollar bills, scattered all over the world… that’s how hard it would be to ‘rob’ Bitcoin! 

  • Simplicity

While currently there is some degree of a learning curve, it has become increasingly easier to send and receive Bitcoin. As the technology improves, and more mainstream companies embrace Bitcoin, the ‘barriers to entry’ will continue to tumble.

  • Divisibility

Because it is a digital currency, Bitcoin is infinitely divisible. Currently you can break it down to amounts as small as .00000001, but as the value continues to rise, the possibility that the network will need to accommodate even smaller amounts increases. This is a benefit primarily because sending ‘exact change’ as well as micropayments takes on a whole new meaning.

  • Verifiable Economy

The public “blockchain” of Bitcoin creates a number of advantages to participants in the economy of Bitcoin. One such advantage is that a user never wonders if a payment will clear — after one confirmation, the transfer is backed by one of the most secure and strong networks in history (if not the most).

  • Decentralization

Bitcoin doesn’t rely on centralized points of control (read: failure.) Instead, Bitcoin stays alive by virtue of ‘self-interested participants’ – of whom there are millions. There is no third-party to approve payments.

  • Freedom

When you own Bitcoin, you own it. “Be your own bank” is more than a cliche in the crypto community — it is a fact that you are the final decision maker when it comes to your money.

 

What Are The Problems Associated With Bitcoin?

  • Anonymity

When you spend your bitcoins there is no getting them back, as transactions are almost always non-reversible. So there have been a number of scams surrounding Bitcoin, and it remains a choice currency of digital criminals. Interestingly, the Internet itself was often criticized for ‘harboring criminals’ in its early days, and it’s still true. But what we’ve seen is that having the Internet has more value to humankind than NOT having the Internet, even if it’s not perfect. We may yet see the same with Bitcoin.

  • Complexity

It’s becoming simpler, as we’ve noted: but people have enough trouble understanding computers generally — wrapping their minds around a limited supply cryptocurrency is a whole different ball game. This being the case, adoption of Bitcoin has a long road ahead, and it may have to adapt to current spending and transaction habits more in the future.

  • Speed

Payments in Bitcoin can settle in under an hour in such a way that no government, attacker, or unforeseen event (except a passing asteroid!) can undo them. Each “confirmation” increases the security of the transaction and happens roughly every ten minutes. However, compared to other cryptocurrencies, Bitcoin can sometimes be “slow.”

  • Transaction (TX) Cost

While block “space” is limited — that is, there can only be so many transactions in each 10 minute interval — the cost of each individual transaction is dramatically lower than bank transfers, Western Union, or even PayPal. Nevertheless, it can fluctuate dramatically depending on the activity of the network, and at various times has been very high.

  • Regulatory

Bitcoin is a currency of the people and their Internet. Governments lack direct control over its mechanisms, and for this reason it is likely that regulation will play a key role in its future. Doing business in the Bitcoin world can imply risks not reasonably foreseen due to changing political tides, similar to other parts of the financial world and some scientific pursuits.

 

 

Why Does Bitcoin Exist?

One of the reasons Bitcoin exists is because in the early days of the Internet, there was no reliable way to transfer value. (There are also lots of reasons related to politics, banking, and the worldwide financial meltdown of 2008 – but that’s for another discussion.)

Even after the advent of secure protocols in 1995, most online purchases ultimately happened over the phone, and this went on for years. Before that, there was really no other way a transaction could take place.

Into the 2000s most online shopping sites, including Amazon, allowed for phone orders or customers could mail in checks and money orders.

Both vendors and customers had plenty of reason to be wary of the web – people did not fully grasp the concept while merchants ran the risk of accepting fraudulent payments or otherwise being scammed.

Initially, online transactions were largely done in the same way that most analog transactions are also done: merchant to customer. Until 1999 (with the advent of PayPal), there was no convenient way for people to securely send money amongst themselves.

If you’re happy with a world where centralized banking systems control every important aspect of a transaction (and such transactions can take days), then it might surprise you that online banking, PayPal (and its varied competitors), and secure online commerce was not enough for Satoshi Nakamoto, the secretive inventor of Bitcoin, who wrote:

While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services.

 

 

Some Other Bitcoin Concepts

In order to operate efficiently, each “block” in the Bitcoin “blockchain” is limited in size, meaning it can only contain so many transactions. Over the decade of its existence, multiple solutions have come around to alleviate transaction congestion, but eventually the heated discussion of how best to achieve the goal of more throughput led to a development “fork” which gave birth to Bitcoin Cash.

Blocks are “mined” by specialized computer systems around the world. “Miners” have two primary incentives for securing and publishing new blocks: the “block reward” and the fees from hundreds and thousands of transactions being conducted. The original block reward was 50 bitcoins per block, today valued at over half a million dollars. About every four years, the block reward halves, currently sitting at 12.5 coins per block.

Anyone can become a miner, and in the early days of Bitcoin it was fully possible to “find” blocks using standard computing equipment. Mining today, however, is a costly endeavor, requiring massive amounts of electricity. Bitcoin mining “difficulty,” a factor created by the network based on how many miners are competing for new blocks, continually increases, as does the efficiency of mining equipment.

Bitcoin is designed to be censorship-resistant, relying on a peer-to-peer mining network instead of centralization. At the same time, the Bitcoin system is transparent and its economics are based on Austrian economics, having a limited ultimate money supply. Unlike nearly all preceding and competing systems of digital commerce, the merchant or recipient of funds is not responsible for transmission fees – instead, the purchaser includes a fee with the transaction which is taken by the “miners.”

To use Bitcoin, a person does not need anything more than a device with which to send and receive it. At the base level, one does not need even hand over any of his personal information to send and receive Bitcoin.

While Westerners may struggle to see that added value besides the obvious increased privacy, people in countries where banks are blacklisted or corrupt find themselves with a suddenly renewed ability to both shop and do business on the global marketplace.

Additionally, people for whom the acquisition of a payment card is difficult have an alternative – within the cryptocurrency industry, this is referred to as “banking the unbanked”.

And, of course, as advocates of the technology, we’d point out that it costs less, works better, and is safer that existing banking technology!


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