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You need to understand Bitcoin

This post is a breakdown of what Bitcoin is and why you need to understand it.

What is Bitcoin

Bitcoin is a technology. Just like cars, cellphones and solar panels are technologies, Bitcoin is also a technology. Bitcoin combines the fields of computer science, economics and mathematics to produce a unique innovation that will have an impact as great if not greater than the internet.

The fundamental aspects of bitcoin are the following:

  1. It uses blockchain technology
  2. It uses advanced cryptography
  3. It has a monetary policy

We will go through each of these points briefly.

The Role of Blockchain Technology

Blockchain is a relatively new invention in the world of computer science. A blockchain is like an accounting ledger. However, once a record has been made into the ledger it cannot be changed. The technical word for this is immutable.

Bitcoin uses blockchains as the fundamental layer for how transactions are recorded. When someone sends Bitcoin to someone else, a transaction is recorded on the blockchain. That transaction includes the sender, the receiver, the amount being transferred and many other details. The blockchain is also public. All Bitcoin transactions that have ever occurred can be seen on the blockchain.

The reason it is called a blockchain is that the ledger is made up of many blocks. Each block contains hundreds to thousands of transactions. These blocks are then linked together to produce a chain of blocks i.e. blockchain.

The Role of Advanced Cryptography

Bitcoin is regarded as an innovation because of its usage of cryptography. Cryptography is a practice of converting plain text into unintelligible text and vice-versa. To understand the nuances, consider the following situation:

Imagine Bob wants to send a message to Alice. But a third party, John, is trying to intercept the message. Bob and Alice can agree to put the message inside a box and lock the box with a key that only they have. This is called encryption.

When Bob sends the message he puts it inside the box and locks it. Then, when Alice receives the message, she unlocks the box with her key. This is called decryption.

Instead of using a box and key, Bob and Alice can use a cypher. A cypher is like a virtual lock. Cyphers allow Bob and Alice to scramble their messages so that they would appear meaningless if John intercepted it. This is where the study of cryptography begins.

Bitcoin Wallets

To own Bitcoin you need to have a Bitcoin wallet. We're used to the typical definition of a wallet - a place where you can store money. However, a Bitcoin wallet does not store Bitcoin. It stores keys. One is called a public key and the other is called a private key. These keys are a pair and can only be used together.

The public and private keys are very important because they are used to sign transactions when you send Bitcoin. Hence it makes more sense to think of a Bitcoin wallet as a vault where you store your keys.

It's also important to know that when you make a transaction, your public key will be visible on the blockchain. However, your private key is never publicly visible.

Transactions

When you send Bitcoin a transaction is made into the blockchain. Using cryptographic methods, other participants can verify that your transaction was made by you. What this does is it creates a trustless system. Meaning that I do not have to trust that you are who you say you are. I only need to verify it.

One of the most popular sayings in the crypto world is Don't trust, verify.

The Role of Monetary Policy

Monetary policy is the control of the quantity of money available in an economy and the channels by which new money is supplied

Investopedia

Bitcoin has a very simple monetary policy: only 21 million Bitcoin will ever be produced. This is enforced by the code behind the Bitcoin project. Smart contracts ensure that the supply will never be more than 21 million.

Just like most currencies can be denominated in cents i.e $1 equals 100 cents, 1 Bitcoin contains 100 million units called Satoshis.

This means that there will only be 21 Trillion Satoshis. The reason for why 21 Trillion is the number is because when Bitcoin was created in 2008, the world economy at the time was calculated to be roughly 21 Trillion US dollars.

The fact that Bitcoin is capped means that it is deflationary. This means that over time each Bitcoin is worth more. Contrast this to any currency today such as US dollars where every year there is inflation causing each Dollar to be worth less than it was the previous year.

Why you need to understand it

50 years ago the US Dollar went off the Gold Standard. Looking back we can see the effect this has had not only on the United States but also throughout the world. With the rise of inflation it has become ever-more important to understand money. Countries like Zimbabwe and Venezuela experienced hyperinflation leading to economic disasters, while many other currencies have devalued significantly. All of these money problems are rooted in the fact that today's money is not sound money.

Inflation

Sound money is money that is not prone to sudden appreciation or depreciation in purchasing power. When the US Dollar was backed by Gold it meant that the Dollar value could not depreciate as long as there was enough Gold reserves to back up the amount of dollars in the economy. Today the US Federal Reserve adds credit to central banks with a click of a button. Trillions of dollars are injected into the economy for any reason. This is not sound money.

You might be wondering then, is this only about inflation?

No. But Bitcoin addresses this problem in that its monetary policy prevents Bitcoin from being created by anyone. The fixed supply means that it is both predictable and sound money. The fact that Bitcoin is deflationary means that it will increase in value over time.

For example, if you were to buy a loaf of bread today using dollars or any other currency you might pay $1. In 5 years you might pay $3 and in 10 years you might pay $8. Over time it gets more expensive. If you were to pay in Bitcoin today it might cost 1 Bitcoin. In 5 years it might cost 0.5 Bitcoin and in 10 years it might cost 0.01 Bitcoin. It gets cheaper.

You have to ask yourself, why would I want things to be getting more expensive every year?

Sovereignty

For as long as governments have existed they have always had control of the money. They decide when to increase the supply of money, and when to contract it. Bitcoin is the first money that is decoupled from the state. It cannot be manipulated by anyone.

Bitcoin provides sovereignty over your money. This means you have complete control over it. As long as you have the keys in your wallet you will always have control over it.

Conclusion

Bitcoin is a fascinating innovation combining multiple areas of study. It is a store of value with a deflationary monetary policy that increases value over time. It is sound money that cannot be influenced by anyone.

While it is complex and there are many things to explore about it, I hope this primer explains the basics and convinces you to learn more about Bitcoin and why it has risen in value so much.