A Friendly Introduction to Bitcoin
What is Bitcoin?
Bitcoin is a digital currency that you can exchange without a third-party intermediary, like a bank or a government.
As economist Saifedean Ammous once said, “Bitcoin is a peer-to-peer software for operating a payment network with its own native currency that is protected from unexpected inflation, without having to rely on any trusted third parties.” Let’s break this definition down into pieces.
- Peer-to-peer software: anyone with an Internet connection is able to download the Bitcoin software. Then, they can trade with anyone else who is running the software on their computer. There are no gatekeepers.
- Payment network with its own native currency: the Bitcoin software’s purpose is to run a payment network between users. Whereas most people in the United States spend physical dollars to buy things, the Bitcoin software allows people to spend digital tokens to buy things. These digital tokens are known as Bitcoin.
- Protected from unexpected inflation: Anyone alive today is familiar with the frustrating reality of inflation — your physical dollars buy less over time. Prices tend to rise because the number of dollars circulating in the economy can increase without limit. Worse, inflation is impossible to predict, since governments create new dollars whenever they want. The supply of Bitcoin, on the other hand, is scheduled to increase at a predetermined rate. This increase of supply will end when the total number of Bitcoin in circulation is 21,000,000. At that point, no more Bitcoin will ever be created, and so inflation becomes impossible.
- Without having to rely on any trusted third parties: Anyone can trade Bitcoin to anyone else on the Bitcoin network without requiring permission by any company, bureaucrat, or government. Also, the history of every transaction on the Bitcoin network is permanently recorded on a public ledger that anyone can see. Because of this, using Bitcoin does not require a user to ‘trust’ the person on the other side of the trade. The technology underlying this public ledger is known as “the blockchain.”
What is Bitcoin Mining?
When a gold miner extracts gold from the earth, he adds to the global supply of gold. Bitcoin mining, on the other hand, plays a more extensive and integral role in the Bitcoin ecosystem. Bitcoin miners are only rewarded new Bitcoin for spending time and energy processing and validating a group of earlier Bitcoin transactions. Put differently, the only way to be rewarded new Bitcoin (to ‘mine’ them) is to fortify the Bitcoin network in the first place!
The technical details of how these digital mining works are beyond the scope of this post. Concepts like proof of work, block rewards, and hashing are crucial to Bitcoin mining and will be explained in later posts.
Is Bitcoin the Best Money Ever Invented?
A resource must have certain properties to be useful as money. For example, it should be salable across time and space, highly liquid, difficult to increase in supply, easy to store, difficult to counterfeit, and durable.
Gold definitely has many of these properties, but its sheer weight and volume make it hard to trade across space. It can also be stressful to store since it leaves the owner vulnerable to theft (this is one reason why owners of vast amounts of gold tend to trust third parties — banks — to hold them). Finally, although the increase in the supply of gold has historically been low, there is no hard limit to how much the gold supply can increase.
What about fiat currencies, such as the U.S. dollar? While it is very liquid and durable, its supply can be increased at the arbitrary will of governments. This reduces the purchasing power of current holders of dollars, as I mentioned earlier. As former hedge fund manager Robert Breedlove said, “[Modern central banking] is a legal monopoly on currency counterfeiting.”
How does Bitcoin compare with gold and dollars? Because it’s digital, it can be sent back and forth between any two people with an Internet connection across the world in minutes or hours. Unlike the easily inflatable dollars, Bitcoin’s supply will grow at a predetermined rate and then halt once there is 21,000,000 Bitcoin in circulation.
Bitcoin is also far easier to store than the cumbersome gold since Bitcoin is digital. Because of its decentralized validation process and publicly visible public ledger, Bitcoin is far less prone to counterfeiting like dollars and gold. Finally, while paper money and even gold do not last forever — dollars tear and gold becomes tarnished — Bitcoin is infinitely durable precisely because it is not physical.
What is Bitcoin Used for?
Since Bitcoin is ‘just’ money, the most obvious thing you can do with Bitcoin is buy things. As Bitcoin becomes more widely adopted, it will become easier to spend it in grocery stores, gas stations, and any other commonplace of doing business. In fact, you’ll be able to spend Bitcoin on goods and services that are currently out of your reach. Right now, people who live under different polities often struggle to trade with one another. Governments typically force citizens to use their own currency and impose regulations on trading with foreigners. Bitcoin allows people across political boundaries to trade with each other without the permission of their governments and with a single, universal currency.
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