A Guide to What Is Bitcoin

Jun 27, 2022 · 7 mins read
A Guide to What Is Bitcoin
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In 2021, the price of a single bitcoin, the largest cryptocurrency, surpassed $60,000, and the total market value of all cryptocurrencies surpassed $2.5 trillion. Bitcoin’s promise to create a new decentralized financial system independent of governments and banks has caught the world’s attention. It’s turned into a social phenomenon. Rather than becoming a new form of currency, bitcoin has evolved into a highly volatile investment asset with large winners.

Investors have sent its price skyrocketing during the pandemic and big losers. Overnight, the crypto-value dropped by a third of a trillion dollars. For those who believe, bitcoin is still a digital stepping stone to a better future. For skeptics, the cryptocurrency market is nothing more than a digital casino, much too unpredictable to be trusted. So what will become of the bitcoin dream?

The beginning

It all began in 2009, somewhere in the world, when a mysterious figure going by the name of Satoshi Nakamoto generated the first bitcoin. It marked the beginning of a digital revolution. Bitcoin and the thousands of cryptocurrencies that have followed are nothing like actual coins. They are code that is kept on a digital ledger that grows in length as more people use them. For the initial batch or block, of bitcoins, Nakamoto’s code included a newspaper headline. Bitcoin’s developer included that headline in the first block to convey a signal. He intended to demonstrate that following the financial catastrophe, people were seeking alternatives, and the question that people were asking was, “Can we trust banking institutions with our money?” Bitcoin was the answer.

Trust is at the heart of the current financial system. Banks and other financial organizations govern the movement of money throughout the economy. It is critical that they have faith that their ledgers are correct. This is due to the fact that money is merely a social convention. It exists and has worth because we all agree it does. This arrangement is only possible because we have faith in financial organizations such as banks. Bitcoin does not necessitate the use of trusted institutions. Nakamoto desired to build a secure system that did not rely on any trust. To do this, the currencies are registered on a blockchain, a breakthrough technology that is a database of transactions that is not owned by a centralized authority. Instead, transactions are validated and logged by a global network of computers in a process known as “mining.”

Bitcoin Mining

Bitcoin mining has two purposes: one is to create new bitcoins for circulation, and the other, equally important, is to validate network transactions, although it is a complicated operation. If someone wishes to conduct a transaction, everyone on the network is notified. The transactions are confirmed by “miners.” They first validate the transactions; once a miner has validated a few thousand transactions, they bundle them together into a “block.” That was the simple part. The miners then contend for the chance to add this block to a chain of previously identified blocks known as the blockchain. They compete to solve a complex numerical problem to accomplish this. The first miner to solve it sees their block added to the chain and is rewarded in bitcoin. This entire procedure consumes a lot of energy and contributes to the climate crisis. As of May 2021, Bitcoin mining consumed more power per year than the whole Netherlands. To keep bitcoin scarce and to help maintain its value the number of bitcoins that can be mined is capped at 21m. To date, almost 19m bitcoins have been mined but it cannot yet be classified as money.

Bitcoin as a Currency

To be considered money, something must function in three ways: as a medium of exchange, a store of value, and a unit of account. So far, bitcoin is not superior to the solutions that we already have, which are fiat money and other means of payment, hence the main reason why you can’t really call it a currency now.

Here’s why Fundamentally, bitcoin is a string of code with limited use. Like a gold bar, it doesn’t produce any revenue but compared with the price of gold the value of a single bitcoin is hugely volatile and a single tweet can change people’s faith in it as a future currency. As a result, its price fluctuates drastically as people buy and sell it.

Unlike the dollar, there is no central bank or government to defend its value This volatility also makes bitcoin very hard to use as a medium of exchange. So a seller on Amazon is unlikely to accept bitcoin for their goods, as the following day the price could vary dramatically. As happened on May 19th, 2021, the price plunged by about $8,000 in less than an hour, but El Salvador seems unfazed.

The Central American country became the first to recognize bitcoin as legal money. It’s a major gamble. Bitcoin doesn’t really work as a means of payment because it’s very inefficient, it can process only ten transactions per second when, you know, Visa, the credit card company can do as much as 24,000 per second.

So if bitcoin doesn’t work as a way of paying for things what gives it value? Like shares and bonds, it is also traded as an investment. This has led to a speculative mania where teenagers have become millionaires and others have lost it all. In 2013, one unfortunate man in Wales literally scoured a garbage dump for a hard drive containing 7,500 unintentionally discarded bitcoins. There is no way to get the money back without the file because there is no central server that keeps a log of it. If he could only find it, that hard drive would be worth $280 million today.

Investing in cryptocurrency is no longer limited to early adopters and armchair investors; it is attracting the attention of some of the world’s largest banks, including Morgan Stanley, which now provides investors with access to bitcoin funds. However, even cautious buy-in from some financiers brings increased scrutiny. Banks are making hesitant moves into bitcoin. Regulators are keeping a careful eye on this, and so far, they’ve only authorized banks to do a restricted number of things. They can provide clients with market access, but they cannot wager on the markets themselves, for example, with their own money.

The Test of Bitcoin

Regulators are wary because bitcoin has a dark side. As a result, bitcoin has been used to fund criminal activity or to launder money. If you venture on the dark web, which I did for an article recently, you’ll find that everything from stolen credit card details to drugs is priced in bitcoin. There’s also been a lot of theft from crypto exchanges and a lot of fraud. Criminality is not the only source of concern.

Leading economists have warned that bitcoin is a dangerous bubble, destined to burst and join the graveyard of historically hyped-up investments. Like the tulip frenzy in the 1630s, when the price of tulip bulbs skyrocketed before plummeting catastrophically; or the late-1990s dot-com boom.

In 2018, there was reason to believe the skeptics might be right. The sharp rise and subsequent drop in bitcoin prices mirrored previous historic bubbles, a pattern that lasted until the first half of 2021. The price skyrocketed to well over $60,000 before plummeting again.

The bitcoin market is very fragile. In 2020 and 2021, we’ve seen these sudden sharp drops in price on the basis of very little and then they partially recover for other bits of news that are completely unpredictable. Supporters see cryptocurrency as a burgeoning asset class with real value, more like gold than tulips but the jury is still out on whether the comparison is accurate.

Bitcoin or another cryptocurrency may become a relatively stable or trustworthy asset class, similar to gold, but it is too early to say since, as we can see today, demand and value fall as soon as people believe it is no longer a viable investment. Satoshi Nakamoto, the mysterious creator of bitcoin, maybe the largest beneficiary of its rise. Assuming, of course, that Nakamoto is a real person who is still alive they’re thought to own more than 1m bitcoin currently worth around $37bn.

Bitcoin may yet become a stable asset like gold or prove to be a bubble that bursts spectacularly but one thing is for certain, the idealistic dream of bitcoin becoming a new form of money independent of governments and central banks remains as elusive as its inventor.

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