Bitcoin may seem like a complex concept to understand. Something that is more targeted to techies, libertarians, economists and finance professionals. For the most part, you could say that this has been true in the past. Now, after a decade Bitcoinis becoming mainstream. Bitcoin essentially introduced two breakthroughs in economic evolution. Firstly, it introduced borderless cryptocurrency/digital money, and secondly it introduced to the world the first application of blockchain technology. For the purposes of this primer, we will focus on Bitcoin’s monetary application.
Bitcoin – Andreas Antonopoulos calls it “the internet of money” due to it being global, borderless, and permissionless and that it is not owned by anyone. It is the first network-centric protocol-based form of money. Yet if we look at it in its most basic form, we come to understand it simply as a decentralised digital form of money. It is money reimagined. Which then begs the question – what is money?
Essentially money functions as a:
1. Medium of exchange – used as a medium to be able to buy goods and service;
2. Unit of account – a common standard for measuring relative worth; and as a
3. Store of value – it holds value over time.
Bitcoin may not look like money as we know it, traditionally as pieces of paper or metal coinage with some numbers on them that indicate value. Though if we consider what the function of money is, then Bitcoin makes perfect sense. We are able to use Bitcoin as a permissionless and borderless medium of exchange; it is divisible down to 8 decimal places thus holds a unit of account; and as we have seen over the last 10 years, Bitcoin is a store of value (albeit with volatility) unlike the world has ever seen. Still to this day, Bitcoin is the best performing asset in the last decade (2010 – 2020) which depending on the day you look at the price, fluctuates between 8,000,000% and 10,000,000% in total returns since inception.
What is Bitcoin?
Bitcoin is money for the people by the people. It is a trustless, permissionless, decentralised, open source peer-to-peer digital currency, or in the words of its founder Satoshi Nakamoto “a new electronic cash system that’s fully peer-to-peer, with no trusted third party”. There is no central bank or centralised administrator of the Bitcoin network. It is borderless, which allows for global finance. It is censorship-resistant, which allows for the Bitcoin holder to express their financial and political will without control or censorship from a third-party. It is pseudonymous, which allows for a higher level of privacy for the Bitcoin holder than existing monetary systems.
Bitcoin’s decentralisation means that governments and authorities cannot close it down, for no one owns or controls it. There is no CEO, no building and no staff. Bitcoin is run by an open network of 10,000+ computers spread globally, all acting within a consensus mechanism of proof-of-work (POW) that facilitates agreement between the computers/nodes, validating transactions on the blockchain ledger.
As a major monetary innovation, Bitcoin iconically solved the problem of double spending and reversibility of digital payments, paving the way for a new class of digital currencies and assets to emerge. Bitcoin was envisioned as a new, modern form of money for the digital age. A digital age that required a native digital currency.
More than that, a digital currency that innovates on the existing system, and maintains the core functions of sound money:
Durability – Bitcoin is durable as it is completely digital and will stand the test of time due to its digital nature. Bitcoin will not experience the wear and tear of time or the environment. As long as there is a digital network, Bitcoin will continue.
Divisibility – Bitcoin is divisible down to 8 decimal points. A Bitcoin can be broken down into smaller payment pieces i.e. 0.00001 Bitcoin.
Portability – Bitcoin due to its digital nature can be easily transported anywhere from $0.01 to tens of billions of dollars on a USB drive, hardware wallet, online wallet, written on a piece of paper, or even memorised.
Intrinsically Valuable & Rare – Similar to gold, Bitcoin is scarce and rare and will only ever have a supply of 21 million coins. This is why it is called digital gold.
Rather than being backed by gold and silver, or by trust in Government or central authorities, Bitcoin is backed by computer code – In Code We Trust, which in Satoshi Nakamoto’s words is “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party”. Bitcoin redefines how we view trust, and how we apply it in our everyday life.
Bitcoin is a liquid, equity-based asset, not a debt-based one like the current forms of fiat currencies and bank-issued money (deposits, credits). This means that there are no liabilities attached to Bitcoin and there are no counterparties. If you hold the private keys to your Bitcoin, you own that Bitcoin, not a promissory note of a Bitcoin.
It is not an IOU. Debt-based assets like the digital fiat money in your bank account and the physical fiat money in your pocket are another’s liabilities, which opens up the counterparty risk of a default. In the banking world, for every deposit made, the bank issues an IOU. Debt-based assets are IOUs.
On 31st October 2008 Satoshi Nakamoto released a white paper titled Bitcoin: A Peer-to-Peer Electronic Cash System that posited “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”.
Nakamoto then went on to release the genesis block of Bitcoin in early January, to which we can deduce from a line hidden in the code “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” was released either on or after January 3rd 2009. This could both be seen as a time stamp and as a statement on Nakamoto’s thoughts on the fractional reserve banking system which had just caused the global financial crisis of 2008, and had been bailed out by the US government to the tune of 700 billion dollars after Bush had signed the Emergency Economic Stabilization Act (EESA).
Although we can say that Bitcoin was born out of the 2008 financial crisis, and in a loss of faith in the financial institutions responsible for it, Bitcoin’s beginnings can be traced back even further to the 80s and 90s, in the Cypherpunk movement. The Cypherpunks valued Privacy Enhancing Technologies (PETs) and cryptography as a proactive instrument for transformation of the social and political landscape. Prior to the widespread use of the internet, the Cypherpunks connected through a regular mailing list that discussed their ideas and philosophies relating to privacy, anonymity, government monitoring and surveillance, and individual sovereignty. Drawing on the Cypherpunk movement, Bitcoin was the merging of thor-like cryptography, game theory incentive models and privacy-enhancing technologies that allowed libertarians, technologists, economists and investors to express themselves in a manner that suited their ideologies. For the Cypherpunks, it was about freedom of civil liberties and privacy. From the Cypherpunk manifesto, Eric Hughes gives an interesting distinction between privacy and secrecy:
“Privacy is necessary for an open society in the electronic age. Privacy is not secrecy. A private matter is something one doesn’t want the whole world to know, but a secret matter is something one doesn’t want anybody to know. Privacy is the power to selectively reveal oneself to the world”.
We can also see, in addition to the Cypherpunk movement how the early manifestations of digital money, blockchain and proof-of-work innovations helped pave the way for Bitcoin.
David Chaum was the first to discuss and describe digital money in his paper ‘Blind Signatures for Untraceable Payments’ in 1982 and he subsequently gave the world ecash/Digicash.
In 1991, Scott Stornetta and Stuart Haber published a paper, ‘How to Time-Stamp a Digital Document’, which laid the foundations for cryptographically secured blockchain technology. Essentially Stornetta and Haber wanted to implement a system that documented tamper-proof timestamps, which then found it’s real-world application in Bitcoin 28 years later.
Adam Back gave the world Hashcash in 1997 which was “a proof-of-work algorithm, which has been used as a ‘denial-of-service counter measure technique in a number of systems”, and has become an essential piece of the Bitcoin mining algorithm.
In 1998 Wei Dai gave the world B-money which was “an anonymous, distributed electronic cash system” and “a scheme for a group of untraceable digital pseudonyms to pay each other with money and to enforce contracts amongst themselves without outside help”.
In 2004 Hal Finney proposed and developed Reusable Proofs of Work (RPOW) and was recognised as the first decentralised proof-of-work digital cash system that created reusable tokens (or more correctly, tokens that are used once and then exchanged for a new token that can be reused) that allow for the transfer of value.
Through the 90s and leading into 2005 (or 2008 depending on which story you subscribe to) Nick Szabo published a Bit Gold proposal in his blog Unenumerated. Although it was never implemented, Bit Gold could be considered to be Bitcoin before Bitcoin, whereby Bit Gold is created by participants performing proof-of-work functions and the solving of cryptographic puzzles through dedicated computing power. It should be noted that Nick Szabo is also credited with having coined the phrase and concept of ‘smart contracts’.
Bitcoin was not the pure harvest of Satoshi Nakamoto’s labours, though he/she/they can be credited as the founder and inventor of Bitcoin, you could say that he/she/they had plenty of giants to stand on the shoulders of in the creation of what we know today as Bitcoin.
Bitcoin has revolutionised how we view money, trust and value. It has stood the test of the last decade, and even through the volatility, has gone on to be the best performing asset over this time. Beyond its monetary innovation, it has also presented to the world the first application of blockchain technology that records the provenance of digital assets.
Bitcoin has emerged over the last few years as a serious contender for an alternative system of value that caters to a broad demographic of potential users and holders. For Family Offices and HNWIs, Bitcoin is an uncorrelated asset that represents quantifiable portfolio value; for Venezuelans, Zimbabweans, Lebanese as well as other countries affected by hyperinflation, Bitcoin and other cryptocurrencies are a stable hedge against their respective sovereign currencies; for libertarians, Bitcoin represents non-sovereign money and a way to transact value privately and outside the purview of the government; and for everyone, Bitcoin is an individual’s personal Swiss Bank that they can carry around in their pocket, allowing for private peer to peer transactions to anyone in the world, instantly.
All in all, Bitcoin is a non-sovereign, borderless, permissionless, censorship-resistant, pseudonymous, decentralised, peer-to-peer, digital form of money that has provided a compelling value mechanism to the traditional global system of banking and finance. The traditional system will have a hard time of keeping up with decentralised digital money innovation, because you can build banking services on top of globally-available Bitcoin and blockchain technology, but you cannot build it the other way around.
3. Bitcoin has a key pair: private key and a public key that controls the access to the Bitcoin. A private key is an encrypted alphanumeric code that allows the holder to spend their Bitcoin, thus are to be kept secret and safe. A public key is an alphanumeric code that generates an address that allows Bitcoin deposits into it and can be publicly shared.