The Promise of Bitcoin

Key idea 2

Financial systems are frequently mismanaged by governments and banks.

The ability to facilitate trade is just one function of money. Also, economists note that it acts as a store of value, keeping its purchasing power even as time passes.

But if you look at the past of money, you’ll see that this second characteristic is more common in theory than in practice. The value of money fluctuates in reality. Centralizing monetary authority, giving governments and central banks the ability to manipulate currency values, is one proposed solution.

However, governments and banks frequently abuse their positions of power. As a consequence? Their control over currency devalues over time.

The takeaway is that economic matters are frequently mishandled by governments and financial institutions. 

If a government is in need of funds but has complete control over the currency, it can simply mint more currency. As a result, prices rise and people have less buying power; this phenomenon is known as inflation. More money in circulation dilutes the purchasing power of individual currency, necessitating greater quantities of currency to buy the same quantity of goods.

Inflation isn’t terrible on the whole as long as it stays low. When people see that prices are going up, they often decide to make large purchases like cars right now instead of waiting until they are even more expensive. In a nutshell, this can help the economy. On the other hand, excessive inflation destroys financial reserves and dampens enthusiasm for investment. Static incomes are the result of households having less money to spend and low investment returns that aren’t worth the risk.

Exactly that happened in fifteenth-century China, the first civilization to use paper currency. The government simply printed new bills whenever they ran low on funds. Because of the rapid devaluation of its currency, the country soon had to switch to a digital currency system in which one bill represented only 0.014 percent of its original value.

Banks’ policy of increasing the money supply through the issuance of credit, loans, and mortgages can have just as negative of an effect as the government’s policy of printing money.

Example: the Great Depression was triggered in large part because banks loaned out more money than they had on hand. Fearful depositors tried to get their money out of the bank when the stock market crashed. This resulted in a “bank run,” where customers rushed to withdraw their money all at once, draining the bank of its funds. An estimated $140 billion was lost by American depositors when roughly 9,000 banks went under between 1929 and the middle of the 1930s.

Key idea 3

Free-floating fiat currency has existed since the gold standard was abandoned.

There is no real worth to paper dollar bills or euro coins. Both are worth about the same, as one is just a worthless scrap of paper and the other is a copper-zinc alloy.

Coins like dollars and euros have no material value. It has no connection to underlying markets or commodities like gold or silver. That’s why we call these currencies “fiat money.” One dollar bills and two euro coins have value because governments have declared them to be legal tender, hence the origin of the term “decree,” from the Latin for “declare.”

Fiat currency has no fixed value other than the faith people place in the government that issues it. But suppose you don’t have faith in those nations? In a nutshell, that is the question that Bitcoin aims to solve.

The main takeaway is: Free-floating fiat currency has existed since the gold standard was abandoned.

Currency issued by central banks, or fiat money, is a reliable medium of exchange. For example, consider the US dollar, which is often called the “global reserve currency.” For oil purchases and sales, among other international deals, governments around the world stockpile dollars. As a result, the dollar is widely accepted around the globe.

Yet, it has a poor track record of staying valuable. In 1979, a hundred dollars could get you two pairs of the best Nike sneakers money could buy. It would take more than that today to buy just one pair. A hundred dollars probably won’t even get you a pair of Nike shower sandals in another decade.

In 1971, we entered the era of fiat currency, which has led to a steady decline in purchasing power. After World War II, the US dollar became the reserve currency for many countries, and the value of the dollar was pegged to the international price of gold. Governments’ flexibility was severely limited as a result. Governments could only issue as much currency as they actually had in gold because people could turn in their paper dollars for the precious metal at any time.

However, by the late 1960s, the United States was experiencing severe economic difficulty. It had trade deficits at home and was bogged down by an expensive war in Vietnam. Foreign governments were exchanging dollars for gold, meanwhile, depleting its gold reserves. Because of this, it gave up the gold standard in 1971.

Since then, governments and central banks have been able to print as much money as they need, a policy that has become a go-to in times of economic distress.

There are those who believe the proposed solution is more problematic than the illness itself. So, what are they supposed to do then? To put it more succinctly, to set a new digital benchmark. A new currency, Bitcoin, has arrived.

Key idea 4

Without relying on any trusted third party Bitcoin can verify financial transactions.

To clarify, what is Bitcoin? Cryptocurrency refers to a decentralised digital payment network that uses encrypted digital “coins” to prevent fraud.

Despite this, Bitcoin is about more than just the underlying technology. Essentially, it’s an answer to the issues with centralization and fiat currencies that we discussed before.

Critics of these monetary systems argue that trusting institutions that have previously proven themselves untrustworthy is a necessary condition for using them. What if, however, you had the option to delegate decision-making to some sort of calculating machine that was incapable of making poor choices? Just what Bitcoin claims to provide.

The main takeaway is: Without relying on any trusted third party Bitcoin can verify financial transactions.

Satoshi Nakamoto introduced Bitcoin to the world on January 3, 2009, as his answer to the trust and fiat currency abuse problems plaguing the world at the time.

Even though Nakamoto said he was a 32-year-old Japanese programmer, many believe he was actually Yasutaka Nakamoto, a former courier for the Colombian drug kingpin Pablo Escobar. As with the author, many have speculated that a trio of Australian programmers is responsible.

Regardless of Nakamoto’s true identity, it’s undeniable that Bitcoin is a technological breakthrough compared to previous attempts at creating digital currencies.

Why? All virtual currencies, however, face the issue of double spending. If you spend a dollar, it’s gone forever; you and another person can’t use the same dollar at the same time. Even though it takes some effort, currency counterfeiting is possible. While counterfeiting newly printed government bills is a complicated process, duplicating and spending money online is as simple as pressing control and c.

The conventional approach to this issue is to have trusted third parties (like banks) keep track of and verify all financial dealings. However, after witnessing the 2008 banking collapse, Satoshi was loathe to take such a risk. Blockchain technology can help with this.

Blockchain is a decentralised ledger that eliminates the risk of double spending without relying on centralised authorities. This is known as a distributed ledger in Bitcoin parlance. It’s similar to the dusty old ledgers used by accounting firms, with one key difference: this ledger is shared by all parties involved, from Beijing to New York to Montevideo. Each accountant’s ledger will reflect the addition of a new line in every other accountant’s ledger. Put differently, when a single block of accounting code is added to the blockchain, its contents are immediately and publicly available for inspection.

Because of this, the possibility of double-entry is eliminated, and a distributed, yet secure, system for recording financial dealings is established.

Key idea 5

Bitcoin users’ integrity is protected by “proof of work.”

Bitcoin’s decentralised ledger is what sets it apart from other currencies. A fundamental aspect of the system is that the ledger only keeps track of valid transactions. After all, nobody would have faith in the ledger if there were lots of fraudulent transactions in it, like people trying to spend the same bitcoins twice.

But how can we be sure that only valid transactions will be recorded in the blockchain? Mining is the process of receiving compensation for maintaining the integrity of the ledger.

The takeaway here is that “Proof of Work” ensures Bitcoin users remain trustworthy.

To refresh your memory, think back to the double-spending issue. Checking the serial numbers on banknotes is one way to prevent someone from using a fake $20 bill in one store and a real one in the next.

A large part of what Bitcoin miners do entails performing similar checks on transactions to prevent users from spending the same Bitcoin more than once. Or more accurately, their computers have programmes that do this for them.

For each second spent verifying a transaction, the same amount of computational effort would be required to compare thousands of serial numbers. To confirm or deny a transaction, software must be running on thousands of computers in the Bitcoin network.

These computers “mine” for answers by solving extremely difficult mathematical puzzles, essentially digging and blasting their way through digital mud and rock until they find the answers they’re looking for.

The term “proof of work” is used to describe the reason for doing all this. By the time a problem is solved and a new block is added to the chain, everyone using the system is confident that the transactions it contains are valid.

Miners spend their hard-earned cash on electricity to run this programme, but what purpose does it serve? That’s true, it’s not too dissimilar from playing the lottery. To generate additional bitcoins, a new block must be created. This lottery has odds of about 1 in 21 trillion, but the payout is substantial. For instance, in the early spring of 2021, one miner earned 6.5 bitcoins (approximately $215,000) for solving one of these problems.

But miners can’t just keep producing new Bitcoins indefinitely; doing so would seriously undermine the currency’s value. The Bitcoin protocol effectively caps the total supply of bitcoins at 21 million. After they’re mined out, that’s it. In the future, miners will be compensated in fees rather than newly created Bitcoins.

Key idea 6

Individual Bitcoin miners simply can’t compete with massive mining farms.

It’s easy to see how gold mining is similar to Bitcoin mining. The majority of the early work in both cases, for instance, was carried out by individuals.

Just like the early gold prospectors who flocked to California and Australia in the nineteenth century, the first Bitcoin miners had to make do with what they had on hand.

They improvised “mining rigs,” or computers designed to solve algorithms, create new blocks in the chain, and mine bitcoins rather than panning for gold in creeks. But that’s no longer the case. Bitcoin mining is now primarily performed by global groups with far more computing firepower than most individuals can muster, much like gold is mined by large companies using industrial equipment.

The takeaway here is that individual Bitcoin miners simply can’t compete with large-scale operations.

For a problem that had plagued digital currencies since their inception, mining provided a solution.

Even though many of Bitcoin’s forerunners were well-designed, they were unable to inspire widespread adoption due to a lack of incentive. The mining reward system was Satoshi Nakamoto’s original idea.

At once, it spawned a band of dogged trailblazers and a policing mechanism that was both more equitable and more open than the banking system’s offerings.

Because anyone can join in the mining activity without asking for special permission. In the same way that no one person or organisation can stop the world from mining, no one can stop Bitcoin transactions.

Despite the lack of restrictions, mining is still challenging. Actually, the Bitcoin protocol makes it harder and harder to verify payments. There is an ever-increasing mathematical difficulty with each new exchange. The end result is that more and more processing power is needed to confirm transactions and create new Bitcoins.

Individuals operating makeshift mining rigs in their bedrooms and basements have been gradually replaced by mining pools since the cryptocurrency’s inception. These well-funded, well-organized groups can deploy more computing power than most individuals could ever hope to afford on their own.

Consider Bitcoin-specific computing hardware. This type of device employs ASICs, or application-specific integrated circuits. The average price of a dedicated mining rig based on application-specific integrated circuits (ASICs) is over $10,000. Next, there’s the expense of the electricity used to keep it going for extended periods of time. When you factor in how unlikely it is that you will ever be the one to solve the algorithm for a new block, it’s easy to see why mining is now beyond the reach of lone hobbyists.

However, mining isn’t the only option for acquiring Bitcoin.

Key idea 7

Choose a Bitcoin wallet that meets your needs in terms of security and convenience.

A bitcoin can be thought of as nothing more than a special sequence of numbers. The private key and Bitcoin address are the two parts of a Bitcoin account where these numbers are kept.

One of these storage locations, known as wallets, is required before you can begin exchanging bitcoins for goods and services. In this case, you have a few choices, each with its own set of pros and cons.

The main takeaway is: Choose a Bitcoin wallet that meets your needs in terms of security and convenience.

A Bitcoin wallet is like a traditional leather wallet, except that instead of bills it stores long strings of numbers. To get to its contents, however, you’ll need a key, unlike with a common wallet. Here you will find the secret 64-digit number that serves as the master key.

Wallets can either be considered “hot” or “cold,” depending on the temperature they are kept in. The former are “hot” because they are always online and therefore always doing something. In contrast, the latter are “cold” due to their constant lack of connectivity. The benefits and drawbacks of each wallet type depend on two aspects: privacy and convenience.

First, we’ll address hot wallets. A desktop wallet is a piece of software that can be installed on a computer. Keep your Bitcoin receiving and sending addresses in this file on your computer. This configuration is preferable because it eliminates the possibility of being hacked by storing data on external servers. However, what’s the downside? You must always be in front of a computer in order to get at your cryptocurrency holdings.

That’s where phone-based “mobile wallet” apps come in. These provide a great deal of portability, as bitcoins can be sent and spent from any location and not require access to a computer. However, they put your cryptocurrency at risk if your phone is lost, stolen, or severely damaged.

How about “cold wallets?” Hardware wallets are physical devices that look like standard USB flash drives and are used to store digital currency. Although these are extremely safe, they do require some technical knowledge to install. The paper wallet is a less complicated alternative. Private keys are written down and kept in a secure location, as the name suggests.

To the best of my knowledge, paper wallets are the most secure option. Assuming you have generated your master key securely and are keeping it in a secure location, they are virtually hack-proof. However, there is a major drawback: paper and ink are easily damaged and lost or destroyed by elements like water and fire.

Key idea 8

Coin exchanges provide the most frictionless entry point into the Bitcoin economy.

One method of acquiring bitcoins has already been discussed: mining. However, let’s assume you aren’t one of the few investors who have the resources to mine Bitcoin and the interest to put them to use. What other options do we have?

Exchanges, in a nutshell, are the marketplaces where buyers and sellers of cryptocurrencies can meet.

The takeaway here is that using exchanges is the simplest way to join the Bitcoin revolution.

Bitcoin markets can be compared to your neighborhood multiplex. The latest blockbusters are typically shown everywhere, despite the fact that no two countries are the same and that national tastes vary greatly.

Similarly, there are cryptocurrency exchanges in every country and region. In this case, the “blockbusters” are the most fundamental services they provide, namely, exchanges where one can buy and sell bitcoins. There are differences between the exchanges because of the need to accommodate regional banking standards and currency.

Once you have your ticket in hand, you are free to use it however you like. Just as you can choose to sit with your back to the movie screen, you can choose to buy a few bitcoins, a lot, or nothing at all. Investigation is the key factor here. Consider the options for local exchanges, and pick the one that best serves your needs. More than 300 exchanges from all over the world are listed on the website coinmarketcap.com, making it a good starting point.

Once an appropriate trade has been identified, what then? To put it another way, it’s not too dissimilar from opening a bank account. In order to verify your identity, you’ll need to send in a photocopy of your government-issued photo identification and a recent passport photo. To verify the information you’ve provided, some marketplaces will make a small test deposit to your bank account.

After completing these administrative procedures, you will be able to purchase bitcoins. Money can be transferred from a bank account or a debit or credit card used to make the purchase. The latter is more cost-effective due to the higher transaction fees associated with using a credit card, but it typically takes two days to access your bitcoins. Once that’s done, you have free reign.

Finally, you now have the fundamentals you need to start investing in Bitcoin and taking part in the cryptocurrency revolution. The one rule that always applies to investing is to take your time, do your homework, and use your common sense.

Concluding Remarks

These blinks are primarily intended to convey the following:

Due to the inefficiency of the system, bartering is rarely used. This issue is resolved by money, but it has historically given rise to another problem: currency devaluation by authoritative bodies such as governments and their banks. Bitcoin’s potential lies in its ability to eliminate the need for such centralised institutions. Instead of relying on governments and central banks, who can potentially crash an economy, currency users would be in charge. Bitcoin is similar to the old gold standard in that its value cannot be arbitrarily reduced by any central authority.