, 2 years ago

What is Bitcoin?

Bitcoin is the first cryptocurrency in the world that is based on blockchain technology. Its unprecedented success is fuelled by the idea that a digital currency that is rather backed by a trustless protocol than by a single entity provides more value to mankind than any other invention in the 21st century.

While many people get easily excited by the success in terms of market and price development, it is even more interesting and important to understand how Bitcoin works, because only then one might be able to fathom the potential of this unique and remarkable technology.

In this article, we like to discuss what Bitcoin is, how it works and what kind of implications the technology has.

When was Bitcoin created?

Bitcoin is the result of different approaches to realizing some sort of digital currency. One of its predecessors is Nick Szabo's BitGold and it was most likely inspiring to its creator among other early forms of digital money. The creator of Bitcoin is hiding behind the moniker Satoshi Nakamoto and until this day his or her true identity is unknown to the public. It is also possible that Satoshi was in fact a group of people.

Bitcoin's origin is deeply rooted in the international banking crisis in 2008. There are many hints that Satoshi in fact designed Bitcoin so that it offers an alternative to the global financial system that he and many others believed to be broken. The first block on the Bitcoin blockchain - the so-called Genesis block - carries a very clear message that has been sent by Satoshi himself:

‘The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.’

So, what is Bitcoin? In this sense, it is hard money that aims to preserve value in a world where money is devalued through financial policies.

How many Bitcoins are in supply?

This leads us to the next quality of BTC which is one of the most important vantage points over government-backed currencies. In order to tackle the economic injustice and the constant devaluation of the US-Dollar or any other currency for that matter, Bitcoin comes with a fixed total supply.

That means that there will be a maximum amount of Bitcoin that will ever come into existence. With each block that is mined a certain amount of new BTC will be freshly minted. The block reward started with 50 BTC per block and is decreasing ever since, halving the block reward with each step. The current amount per block is 6,25 BTC and the next halving will approximately occur in 2024. Therefore, Bitcoin has very low inflation that will end once the hard cap is reached. While it is easier and catchier to present a number of 21 Million Bitcoin the precise amount is 20.999.9999.9999.9769 BTC.

The final amount of Bitcoin will approximately be reached in the year 2140 and it is estimated that it will be way lower than 21 Million.

Bitcoin can be lost or wilfully destroyed by triggering a process that is called burning. It is hard to say how many Bitcoin will be burned or lost, but it is safe to say that it will be way less than the originally planned amount which makes it even more scarce.

What is the Bitcoin blockchain?

Now that we have already discussed the total supply and the block reward it is time to take a closer look at the blockchain itself. Bitcoin was not only the first technology to introduce the blockchain, but it also solves two major problems making use of its unique features. It reassures that no party can spend the same amount twice, which is also called the double-spending problem.

The other problem that is solved by the blockchain is that no single entity can control the network in order to prevent its manipulation. Both issues, double spending and control must be solved by all distributed ledger technologies (DLT) that are apt to transact monetary value. Otherwise, there would be no reason to trust the system because a single entity could take over control or any other entity could spend money out of thin air.

But how does Bitcoins blockchain work? If transactions are made, they are contained in a block. The block itself is tied to all other blocks that came before it. This is done by using cryptography, which is why Bitcoin is also called a cryptocurrency. To make sure that the next block is not forged Bitcoin miners are using computational power in a race to be the first to solve a cryptographic puzzle. This way the miners make sure that past and future blocks appear in chronological order and cannot be modified once the network reached a consensus about the transactions contained in a block.

To make sure that all participants receive the same information and form the same chain of blocks, the blockchain and its data are distributed through nodes that validate incoming and past transactions. This is why decentralization is a key feature of Bitcoin. It reassures that no single entity is mining or propagating new blocks on its own, but rather thousands of nodes validate and distribute new transactions.

Bitcoin Mining- How does it work?

Bitcoin mining is a process where there is one solution that needs to be found by computation that is often carried out by many miners cooperating in a pool. Miners need a lot of computational power; they are using this power to compute the right hash.

In order to produce a new block, a Bitcoin miner has to calculate the correct hash which consists of the transactions and the hash of the block that came before. Being dependent on the hash of the last block reassures that the new block has to be necessarily connected with the rest of the blockchain. If somebody would try to change past transactions this would result in an altered hash, which would not match with the past one.

It is very easy to generate a hash, so that’s where proof of work sets in to make it more complicated to generate the right hash. The first miner that computes a matching hash has the right to claim the block reward and get freshly minted Bitcoins.

This reward is the incentive to run expensive hardware and pay the costs for electricity. Miners are competing, because the difficulty to produce a block rises with more miners participating. The difficulty can also be adjusted to be lowered should suddenly more and more miners choose to leave the network. The difficulty adjustment is not only set dynamically but also automatically by the network.

What is Bitcoin used for?

Bitcoin was defined as electronic peer-to-peer cash in its whitepaper written by its creator Satoshi Nakamoto. In fact, it can be used for payments and the settlement of transactions. But since Bitcoin is also very scarce it is also regarded as a store of value and to some analysts a safe haven asset in times of crisis.

Since it is the first cryptocurrency Bitcoin has developed an enormous ecosystem with thousands of online stores accepting Bitcoin as payment. In fact, it is estimated that millions of stores will accept BTC through PayPal if the world's biggest payment processor should choose to roll out BTC worldwide and not only to US customers.

While payments are an obvious use case it was only recently that MicroStrategy put a whopping 425 Million US-Dollar of cash reserve into BTC. The company’s CEO is counting on massive inflation and a devaluation of stocks. While it remains open if his assessment of the world economy will prove to be correct, it shows that company leaders are able and willing to shift to new strategies and acknowledge Bitcoin.

Is Bitcoin digital gold?

Those power moves by different global players raise the question of whether Bitcoin is a better store of value than gold. Gold has served for hundreds if not thousands of years as a store of value and as a medium of exchange until bills were invented.

While gold is perceived as scarce it is not as scarce as many people think it is. Statistics show that each year hundreds of tons are produced and added to the supply. While this is a comparable situation with Bitcoin - which has also inflation - it is not known when the last gold nugget will be mined. Bitcoin's finite supply on the other hand is mathematically ensured and it outmatches gold in scarcity.

In conclusion, it cannot be debated that gold is scarce, but Bitcoin is simply even more scarce. Some analysts believe that with growing adoption the market will open up to the idea that BTC will become a new and better standard than gold in order to preserve value.

How is Bitcoins price determined?

Many critics have pointed out in the past that the price of Bitcoin is not determined by intrinsic value. However, it can be argued that this claim is wrong. Bitcoin is a global, decentralized and censorship-resistant currency with a vast ecosystem. This alone carries value because it enables its users to take full control over their money and transact freely with each other. These things carry an unprecedented value achieved by no other technology on the market.

But even if those statements weren’t true, then Bitcoin's price would still be determined by the good old rules of supply and demand. As we have shown in this article the supply is getting scarcer which leads us to the question of why there should be a constant demand for Bitcoin.

One driving factor is speculation by traders who are simply placing bets on the Bitcoin price and another one is transactions that become more and more attractive in certain countries. While industrialized countries have little or no reason to opt-out and use Bitcoin as money, it shows that less fortunate countries with hyperinflation are getting more and more involved in cryptocurrencies.

This asymmetry between the countries is best explained by the access to banking and having a local currency that offers a stable value. Simply put, the more broken a system is, the more open people become to the idea that BTC is offering a better alternative.

Do I need a lot of money to invest in Bitcoin?

It is a very common misconception that investors will need a large amount of money to get their feet wet. Bitcoin has gained massively in price over the last 5 years and it is true that a single Bitcoin will cost a lot of money.

It is important to keep in mind that Bitcoin can be broken into very small denominations. The smallest unit is called Satoshi in honour of its mysterious inventor. One Bitcoin is equivalent to 100.000.000 Satoshis, meaning that you could buy, sell, hold and transact BTC that is less worth than a Dollar. This means that investors don’t need to buy a full Bitcoin, but can participate in the system by buying a fractional amount.

This opens the opportunity to put even small savings on a monthly basis into Bitcoin. This strategy offers also another advantage because an investor would dollar cost average the price of his investment. Since Bitcoin has historically very high volatility this strategy is attractive to many retail investors.

Is Bitcoin the financial revolution?

Yes and no. Bitcoin has a huge potential to become the biggest financial revolution in history because it is taking control of money out of the hands of any government in the world.

While nobody could possibly prevent this, governments already have reacted to the implications of Bitcoins technology. With central bank digital currencies, different countries are about to explore the possibilities to issue their native currencies on distributed ledger technologies. China is leading in the effort to become the first nation to achieve a fully digital currency.

It remains to be seen, who wins this race. But even if Bitcoin is not succeeding in government-backed currencies it has the potential to become the equivalent of gold in an age where money is becoming a digital good.

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