Coindesk what is bitcoin

What is Bitcoin?

Shirley Siluk

What is Bitcoin?

What is Bitcoin? Bitcoin is a digital currency that uses an open-source, peer-to-peer protocol to conduct, verify and record transactions. It is a decentralized form of currency not backed by any government or financial institution, or pegged to the value of any hard commodity such as gold.

Bitcoins are digitally generated according to an algorithm that creates a new block of bitcoins [i] around every 10 minutes. These new bitcoins are “mined” by participants in the bitcoin network who contribute their computing power to validate every transaction by solving a series of cryptographic puzzles. Every transaction is archived in a log known as a “blockchain.” By providing a publicly available, network-distributed ledger of all transactions for every bitcoin, the blockchain prevents users from being able to double-spend the currency.

The blockchain-verified, peer-to-peer basis of the currency enables users to exchange bitcoin funds across a global network without the need for third-party processing or verification services (banks or credit-card companies, for example), which typically take a percentage for enabling transactions using other currencies such as dollars, euros, pounds, yen or yuan.

Bitcoin: In the beginning

First described on a cryptography listserv in November 2008, the Bitcoin concept originated with a person or organization going by the name of Satoshi Nakamoto whose true identity has never been revealed. (Some theorize Nakamoto, who made his last public statement online in late 2010, could be the pseudonym for a group working at the US National Security Agency or even Google.) Nakamoto mined the first batch of 50 bitcoins – known as the “genesis block” – on Jan. 3, 2009.

According to Nakamoto’s algorithm, the number of new bitcoins generated every 10 minutes will be cut in half every four years or so, which ensures that only a finite supply of the currency will come into existence. (As of 2013, for example, every new batch mined totals 25 bitcoins.) The hard limit for bitcoins is expected to be reached by 2140, by which time there will be at most 21 million bitcoins in circulation. This hard limit prevents what many see as a flaw with traditional fiat currencies, where central banks such as the US Federal Reserve can essentially create new money to manipulate monetary supply and the economy.

Each bitcoin is divisible in value down to eight decimal places. The smallest possible unit – 1/100,000,000 th of a bitcoin – is called a “satoshi.” Those in the bitcoin community say that, if the currency ever needed to be further subdivided into even smaller units, the protocol could be changed, though not without difficulty.

Bitcoin’s decentralized appeal

Bitcoin’s decentralized nature, with no overarching central authority, has given it a special appeal to people who advocate a laissez faire or libertarian approach toward the economy. They see the currency as an ideal vehicle for person-to-person, global commerce free from interference or added fees by third parties, whether those are banks, regulatory agencies or payment processors.

The ongoing economic difficulties across the United States, European Union and other regions have also contributed to the growing interest in bitcoin. In light of the visible failures in traditional, fiat monetary systems since the near-meltdown of the global economy in 2007-2008, for example, a growing number of people are calling for new, more efficient or more equitable means of managing and distributing wealth.

In fact, bitcoin’s most recent “bump” in public recognition has been tied in part to plans to impose a “haircut” on bank deposits in Cyprus as a condition for a bailout of that country by the European Union, the European Central Bank and the International Monetary Fund.

Other advantages of Bitcoin

Bitcoin supporters also cite several other advantages of the currency. As a purely digital currency, bitcoins can be stored on a laptop, thumb-drive, cellphone, browser-based wallet or even a paper wallet (considered “one of the safest ways possible” to store bitcoins, according to the Bitcoin Wiki). Users can even choose to secure their bitcoins via a “brain wallet,” which involves committing to memory a unique phrase that can be converted through hashing into a private key that is then used to calculate a bitcoin address. In this way, there is no record of a person’s bitcoin holdings except in his or her own mind.

Storage strategies like these in theory prevent the ability of banks or other institutions from freezing or confiscating funds. And the unique blockchain for each bitcoin avoids the need for additional identification requirements in transactions, which provides a perception of (though not necessarily actual) anonymity.

(Storage methods for bitcoins can also prove to be a drawback, however, as bitcoins that are lost, either through loss of a storage device or via hacking, can’t be traced back to the rightful owner. In fact, it’s recognized that the hard limit of 21 million bitcoins will likely never be reached as a certain number of bitcoins will “disappear” through device losses, misplaced paper records, computer crashes and forgetfulness.)

The accepted abbreviation for bitcoins is BTC. One hundred bitcoins, for example, can be written as 100 BTC.

[i] Note: Although terminology in the bitcoin economy is not yet standardized, some have advocated a style in which the currency concept system is referred to in upper-case – Bitcoin – while the actual currency is referred to in lower-case – bitcoin. That is the style we follow here.

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Over $20K? Why Is Bitcoin Worth Anything at All?

William Foxley

Over $20K? Why Is Bitcoin Worth Anything at All?

Bitcoin’s price continues to climb, a consistent flow of BTC is leaving exchanges and bitcoin “whale” sightings are becoming more frequent. But beyond the market frenzy, how does it all work?

Is bitcoin money or a technology? Is it a store of value like gold or does it emulate Milton Friedman’s “e-cash” idea?

And while the world struggles to come to terms with bitcoin – perhaps most clearly shown in the discrepancy between bitcoin’s current price and asset manager Guggenheim’s $400,000 figure – it’s helpful to revisit the digital asset’s fundamentals.

Bitcoin’s economic basis

Bitcoin’s groundwork is laid out in the 2008 white paper published by its pseudonymous founder, Satoshi Nakamoto. In the paper, Nakamoto describes their original intentions for the new money protocol, labeling Bitcoin as a proof-of-concept technology functioning as “a purely peer-to-peer version of electronic cash.”

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Nakamoto further describes the Bitcoin network as a decentralized payments system, meaning third-party financial intermediaries (i.e. banks or credit unions) are unnecessary when transferring value with Bitcoin.

The system is also designed to prevent government agencies – or anyone else – from affecting the Bitcoin network’s monetary supply.

“Bitcoin was designed to oppose the existing fiat paper money and central banking regime that has reigned now for a century over the global economy,” Mark Thornton, senior fellow at the libertarian-leaning Ludwig von Mises Institute, told CoinDesk in an email.

Nakamoto goes on to describe Bitcoin’s network analogously to gold. The shiny metal has long been held as a store of value due to a few qualities, namely its natural scarcity and fungibility.

In a similar manner Nakamoto wrote that Bitcoin miners expend “CPU time and electricity” to mimic gold miners smacking away at the Earth’s crust. In return, they receive a portion of bitcoin from the network itself while sending transactions on behalf of Bitcoin users.

Yet, Nakamoto’s argument by analogy of bitcoin to gold does not stand alone. Rather, it is on the shoulders of contributions from others, including academics, over many years. Indeed, Bitcoin’s features such as a hard supply cap and slow inflation rate lends itself naturally to a few select economic schools, particularly those focused on the free market. Valuing the bitcoin cryptocurrency is complementary to these ideologies.

‘Free money’ economics

Bitcoin has storied academic roots, regardless of its reputation for use in illicit markets. Two prominent economic schools of thought, the Austrian school and the Chicago school, are often cited by Bitcoiners as accomplices in the task to free money from government printers.

The Austrian school was founded by Viennese professor Carl Menger in the late 19th century. Even at the time, Menger was known for heterodox views and for sparring with the dominant economic thinking of the time (not much differently from many Bitcoin advocates today).

Arguably, Menger’s greatest contribution to Austrian economics was the development of the subjective theory of value, a component of the study of human action known as praxeology. Menger argued the value of any good is derived from humans themselves; that is to say, no good or service holds intrinsic value.

Menger’s arguments were taken further by the next few generations of Austrian economists including Ludwig von Mises and F.A. Hayek in the mid-20th century. Mises, for one, crafted an argument demonstrating that the market created money, as opposed to the view that the government created money, known as Chartalism.

Hayek, winner of the 1974 Nobel Prize, would go on to advocate the creation of a money system outside of government in the later 20th century.

“I don’t believe we shall ever have a good money again before we take the thing out of the hands of government,” Hayek said in a 1984 interview. “That is, we can’t take them violently out of the hands of government. All we can do is by some sly roundabout way introduce something that they can’t stop.”

Milton Friedman, the most well-known member of the Chicago school of economics, also called for the creation of a digital currency. Friedman believed an “e-cash” was not only a necessary component to the newly founded internet but also a logical tool for limiting government overreach.

“Friedman famously argued for a k-percent rule (growing the money supply by a set, pre-announced % every year, regardless of what happens in the country) and for having monetary policy set by a computer (where it could not be corrupted by humans),” Paul Sztorc, former statistician at the Yale Economics Department and creator of BitcoinHivemind.com, told CoinDesk in a Telegram message.

“By the 2000s Friedman believed that the U.S. should just adopt a ‘fixed supply’ of base money, and declare that they would never change it. Bitcoin instantiates all of these principles.”

Bitcoin vs. inflationism

It’s important to note that Bitcoin is a technological product backed by, or even adopted by, a previous community. That, in itself, distinguishes it from other fringe monetary movements such as #MintTheCoin, which is a purely community-driven phenomenon.

The central tenet of Bitcoin is its 21 million BTC supply cap. The network’s rate of inflation is fixed similarly to how much gold can be mined from the Earth every year.

The issuance of Bitcoin decreases every four years in an event called a “halving.” These technical events decrease the supply of BTC created every 10 minutes by the network until no more BTC will be mined sometime in 2140.

The Bitcoin network’s last halving occurred two months into a global pandemic that spurred trillions of dollars of money printing by the U.S. Federal Reserve and other central banks. Indeed, Bitcoin miner F2Pool included a New York Times headline in the last block mined before the halving:

NYTimes 09/Apr/2020 With $2.3T Injection, Fed’s Plan Far Exceeds 2008 Rescue

Bitcoin’s supply schedule mimics gold, making it a “complete contrast to central bankers who can create money out of thin air,” Thornton said.

“As such, bitcoin has performed very well over the past several years as central banks seem to be hell-bent on destroying the value of their currencies. This would, of course, include the Federal Reserve, the European Central Bank and the Bank of Japan especially. They along with many other central banks have reduced their policy rates to near zero, or even negative rates,” Thornton said.

Valuing bitcoin

Bitcoin skeptics often decry a lack of intrinsic value, a lack of cash flows and a lack of historical precedent for the digital asset, among other points.

Indeed, a rise above $20,000 per bitcoin does not invalidate “bear” sentiments, CoinDesk Director of Research Noelle Acheson said. Bitcoin could crash down to Earth at any point. But that’s also what makes it interesting as an asset class, she said.

“One of the most fascinating things about bitcoin is that it doesn’t conform to standard valuation techniques. There’s no cash flow to discount and no physical assets that back it up,” she said.

Bitcoin and gold hold some correlations from a theoretical standpoint, but it depends on what point you focus on, Acheson said.

“Like gold, it is worth what someone else is willing to pay for it, and that is impacted by overall market sentiment, inflation expectations and technological trends. Unlike gold, though, bitcoin’s supply is not at all impacted by its price, which is one of the reasons it will always be more volatile: There will never be an increase of new supply to meet increased demand,” she said.

Eric Turner, director of research at market data provider Messari, said the $20,000 bitcoin price reached early Wednesday is “an important psychological milestone” for the digital asset as all investors stand in the green. Moreover, Turner said, bitcoin as digital gold “is really the big story of the year,” particularly against a backdrop of “macro concerns and poor monetary policy.”

“In my opinion this is just the start for this cycle, which is going to be dominated by larger and more established institutional investors adding allocations to BTC. The real tipping point is if pensions, endowments and sovereign wealth funds start to get in the game. Whether that is this time around or next cycle remains to be seen,” he said.

Next stop?

A successive all-time high valuation gives additional credence to bitcoin as a digital asset, Sztorc said. Yet, bitcoin remains “aspirational money,” he said.

“Given the sheer distance bitcoin has to travel (from being totally obscure in the beginning, to being one half of every trade in the future global economy), it is probably more accurate to think of BTC as an investment in a unicorn-style winner-take-all tech-company,” he said.

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