Essential Facts of Bitcoin(1)
Lets listen to Important Facts of Bitcoin
- Third generation of currency
- It has a clear purpose
- It’s not always harder to mine
- It has failed as a currency despite succeeding as an investment
- Bitcoin’s biggest fan is its bad enemy
Third generation of currency
Human beings have been buying, selling, and trading things since the dawn of time, but currency is quite a different concept. At its core, currency is a store of value. The first currencies had intrinsic value, which could be anything from yams in Chinua Achebe’s Things Fall Apart to precious metals. Under the economic system of mercantilism, buying and trading gold became an obsession that sparked widespread colonization, imperialism, and war. Having a gold standard means that money was tie to how much gold a country had, not the wealth of a nation itself.
Adam Smith famously criticized this policy in his book The Wealth of Nations, published in 1776. One of his core arguments was that economies should grow based on incentives, productivity, technology, and industrialization, not how much gold you have. The result was capitalism and the popularization of fiat currency. Fiat currencies, like the U.S. dollar, are easily transferable stores of value meant to represent the wealth of a country or collection of countries despite being worthless in and of itself. (And we should note China figured this out long before Smith, having adopted fiat currency around 1000 AD.)
Bitcoin is the third generation of currency. It doesn’t have any intrinsic value like gold or silver, or representative value like the U.S. dollar. But it has a limited supply, it’s hard to counterfeit. And Also it can be transfer without a third party. (This isn’t to say it’s been successful as a currency — more on that later.)
It has a clear purpose
Bitcoin was develop during the global financial crisis and made available to the public in early 2009. Whether the crisis played into the development of bitcoin is unknown. But the context is key. Widespread distrust of banks and a crippled economy paved the way for new ideas. Cryptocurrency is a natural fit because it provide a way to conduct private transactions without going through a bank. Bitcoin became the first established cryptocurrency and combined the ease of a credit card with the privacy of cash, independent of an institution or government.
Bitcoin was made for a clear purpose, the details of which are outlined in “Bitcoin: A Peer-to-Peer Electronic Cash System,” now commonly referred to as “the bitcoin white paper.” Published in 2008, it detailed the flaws of existing currencies and outlined the benefits of a decentralized peer-to-peer network that eliminated the need for a third-party middleman like a financial institution.
The problem and solution that bitcoin’s founder(s) identified can be best summed up by the following excerpt from the white paper: “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud. And routine escrow mechanisms could easily be implemented to protect buyers.”
The takeaway here is that bitcoin wasn’t founded to make money like a corporation. It was never intend to be an investment. Rather, its purpose was to change commerce itself by protecting consumers from corruption, whether that be from a government or an institution.
It’s not always harder to mine
It’s a common belief that each successive bitcoin is harder to mine than the last. While that is generally true, there are plenty of times when it isn’t. In fact, just a few weeks ago, bitcoin was easier to mine — that is, it took less computing power. The explanation is simple.
Let me back up. While bitcoins can be buy, or received for goods or services, they’re also found (mined) by exerting computing power to solve a puzzle. These puzzles are random and require a lot of guesswork, so it’s easier to solve them by increasing computing power. But there’s a catch. The puzzle difficultly will increase based on the total computing power being used on the network. This is because bitcoin’s founders want to limit supply by ensuring that one block of bitcoin is mined, on average, every 10 minutes. To counteract rising computing power, the difficulty adjusts every two weeks based on the prior period’s average computing power.
The bitcoin reward per block also decreases. In fact, it halves after every 210,000 blocks are mined. It started at 50 in 2009. And since May 11, 2020, it’s been 6.25 coins per block. Despite a surge in computing power (the cost to mine), and puzzles that are literally trillions of times harder now than 10 years ago, bitcoin’s price increase has helped mining remain profitable.
Mining will continue to be profitable as long as the costs to mine remain less than the reward for mining. But because it takes so much more computing power and electricity to mine now than before, investing in a mining rig only makes sense if you believe bitcoin can stay above a certain price.
It has failed as a currency despite succeeding as an investment
Bitcoin has been a great investment but a terrible currency. As I mentioned earlier, fiat currencies like the U.S. dollar can’t compete with bitcoin’s security or flexibility. But the surge in bitcoin pricing has similar effects to hyperinflation. Currencies are meant to be stable. Lately, the value of the U.S. dollar has been decreasing by less than 2% per year (known as inflation), which is counteract by saving and wage increases. But bitcoin can never be stable if the price routinely moves up or down by 1% in one day, let alone by 5% or more in a day. Just last week, bitcoin crashed 13% on Tuesday and then rose 7% on Wednesday. Imagine buying a car for 2,000 bitcoins in 2016 then selling it for two bitcoins in 2021. Or trying to buy a gallon of milk for 0.0001 bitcoin. Volatility has been bitcoin’s fatal flaw as a currency.
Bitcoin’s biggest fan is its worst enemy
As of Friday, Jan. 15, the cumulative value of all bitcoin was $678 billion, right behind Alibaba Group and ahead of Taiwan Semiconductor Manufacturing. If it were a company, it would have been the ninth-most valuable company trade on a U.S. stock exchange. We can verify this math by taking the supply, about 18.6 million, and multiplying it by the value of each coin, around $36,500.
Bitcoin’s surge in value is due in part to Wall Street’s interest in it. Jamie Dimon, the CEO of JPMorgan Chase, went from calling it a fraud to thinking it has upside. PayPal and Square have allowed their users to buy and sell cryptocurrency. And hedge-fund managers are even starting cryptocurrency funds to get in on the action. The irony is potent and painful — the very institutions and third parties bitcoin’s founder(s) was trying to avoid are now its biggest fans. As mentioned before, heightened trading drives volatility which increases transaction fees and makes bitcoin an ineffective currency. Bitcoin could very well continue to succeed as an investment. But it needs to be boring to succeed as a currency.
