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What is Bitcoin and How does the technology work?

Bitcoin is a decentralized digital currency, without a central bank or single administrator, that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries.

By

Skyler Vondra

on

May 28, 2021

What is Bitcoin?

You may have heard that Bitcoin is an anonymous payment system. That's how most people are introduced to cryptocurrency anyways. They heard that Bitcoin was created and is used for illicit purposes like buying drugs on the darkweb.

While this was true in the past, only fools would use it in that way today. That's because we learned more about Bitcoin. (hint: it is NOT anonymous)

Straight from Wikipedia: "Bitcoin is a decentralized digital currency, without a central bank or single administrator, that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries."

Cool! So it's kind of like Venmo (Cashapp, Zelle, etc...) except nobody can shut your account down. Except you can send any amount of bitcoins to anyone else in the world with no limits (it is surprisingly hard to work around transaction limits).

What if you're NOT sending international payments? Or what if you're NOT worried about having a middleman like Venmo, Cashapp, or Zelle? Why would you take the risk?

For that answer we have to dive deeper into what it means to have a "Decentralized" currency.

As I'm sure you know, all money that you use was created by a government. Dollars are created by the United States Federal Reserve. Euros are created and issued by the European Central Bank.

What's wrong with having a centralized currency?

The problem is that the government does not operate to serve your best interests. When the government is given ultimate power over your currency (the most important commodity that we own) that power tends to get abused.

Governments abuse that power by creating more money out of thin air. We are seeing this in live action with the United States dollar. Over 20% of all dollars in existence were created out of thin air in 2020 alone.

Think about that for a minute.

There are 20% more dollars in circulation than there was in 2019. That does not mean that 20% more value was created, or that the United States is 20% richer. It means that every other dollar that existed — including the dollars in your savings account! — was diluted by 20%.

That is an incredible and disgusting statistic to me. The government is literally robbing you of your purchasing power beneath your feet, and not even telling you about it. On top of that they want you to pay taxes on the money that they robbed from you through inflation.

This is where Bitcoin comes in.

Bitcoin does not have a central authority that can manipulate the amount of bitcoins there are in supply. Every transaction that has ever happened on Bitcoin is available for you to see on it's public ledger, and on that public ledger you can see that there are 18,720,431 bitcoins in circulation.

What about inflation? Will any more be created?

The only way for more bitcoins to be created is through the mining process. Around the world there are entrepreneurs who purchased computer equipment called ASICS that maintain the security of the bitcoin network.

The purpose of these ASIC machines is to verify the transactions that happen on bitcoin's network. They provide a high level of security because every single ASIC machine needs to agree (or come to consensus) on what transactions have taken place, and what balance of bitcoin each bitcoin address has.

How Bitcoin mining creates the blockchain:

24 hours a day 7 days a week there are transactions happening using bitcoins. Every transaction that happens are between two public keys that look like this: 3KukxeMW9wrpHXr8UThqrUEwvVk1YpsxEf

So every time a transaction occurs, this information is sent to miners to agree upon and settle as final.

It will look something like:

(long string of numbers) sent 0.5 BTC to (another long string of numbers)

The ASIC mining machines I mentioned before will see this information, and they will basically say "Did everyone else see that transaction? Does it look legit to you?" and when they all come to agreement, they package that transaction nicely into a Block with a bunch of other transactions. Once the block is full of transactions (there is a capacity) the computers agree once again that all of the transactions within the block are legitimate. When they come to consensus, that block of transactions is finalized and settled, and added to the last block of transactions, creating a long line of blocks that show every transaction in Bitcoin's history. This chain of blocks is called the blockchain, AHA!

As a reward for doing this work, miners are paid in Bitcoin after each block. This is the only way for new bitcoin to be introduced into the system.

So bitcoin will always have inflation since miners have to be paid for doing work?

This is the fun part. There will only ever be 21 million bitcoin. As you can see in the chart below we will have most bitcoin in circulation by 2040. The important thing to understand is that Once you own any amount of bitcoin, you will Always own that same percentage of all bitcoin. It cannot be diluted! No other monetary system works in this way.

Think about this: If all bitcoin was only held by the millionaires in the world. The most each millionaire could have is 0.4 bitcoin. You can see why they are rushing to get their cut while it's still cheap.

If we know how many bitcoin there are, what is causing the surge in price?

Every four years the bitcoin reward for mining a block on the blockchain is cut into half, and right now that reward is 6.25 bitcoin. This process for dividing supply is called the HALVENING. During the last halvening on May 11, 2020, this reward reduced from 12.5 bitcoin to 6.25. This shows that scarcity is literally programmed into the protocol of Bitcoin.

So the price appreciation comes down to simple economics. When supply goes down, and demand continues to rise, price has nowhere to go but up.

This assumes of course that demand will remain stable. But anywhere you look you can see that Bitcoin's adoption is accelerating and not decelerating. Massive corporations like Square, Paypal and Tesla are investing into bitcoin. During the last halvening in 2017 nobody could have predicted this. There is also evidence that sovereign wealth funds (money that governments own) are investing into bitcoin. Right now there are only 29 million active bitcoin addresses with any amount of bitcoin inside of them. Bitcoin visionaries expect that once we achieve mainstream adoption, everyone worldwide will have an active Bitcoin address.

So Bitcoin is decentralized, and there is a fixed supply that no one can tamper with. What now? Should I use it to buy and sell things or just to hold?

So, because every four years the supply of new bitcoin is cut into half, the price is likely to go up. For this reason I think it's wise to buy and hold instead of using it to spend or transact. Especially considering there aren't many merchants who accept bitcoin right now, and the technology that will make transactions much quicker and easier is still being developed. If you're interested in the future of transactions made with bitcoin look up "Layer 2 Bitcoin" and the "Bitcoin Lightning Network". Once these technologies are fully developed you will see people buying coffee with Bitcoin, right now that is not practical.

What about using other cryptocurrencies for payments? Should I just use those if they are faster and cheaper?

Yes!

At this stage in Bitcoin's life it should be viewed as a "store of value". In the same way that gold is used to protect you from inflation. I tell people to use Bitcoin as your savings account that also doubles as an investment.

On the other hand if you're looking to make a very quick payment to someone that you know and trust, it might be easier to use another cryptocurrency. It's important to know though, that these other currencies and not NEARLY as secure as Bitcoin is — security was the #1 priority when Bitcoin was created. So just know this when you're making a transaction. I also would suggest that after sending or receiving money through another crypto, that you convert it quickly back into Bitcoin for safety reasons.

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