If you’ve never learned about Bitcoin before or you’ve tried to learn about it only to get discouraged by how complex it is, you’re not alone. In fact, many of the wealthiest and most influential people in the cryptocurrency world today have told stories about how they initially dismissed Bitcoin as a short-term fad, nerd money, criminal money, or otherwise something less interesting than it really is.
Of course, it wouldn’t help matters if a good portion of the cryptocurrency enthusiasts you’ve ever met could be described as either lacking in social skills or being one of those people who just latches on to one fad after another, always trying to get rich quick. Anybody who’s spent much time socializing in the crypto industry knows there’s some truth to both of those stereotypes.
As for you, the Bitcoin and blockchain beginner, there’s good news and there’s bad news.
The bad news is that you aren’t going to become an expert on economics, blockchain technology, or Bitcoin by the end of this article. The good news, though, is that you don’t have to be an expert — or even close — to discover what’s interesting and potentially revolutionary about Bitcoin and blockchains.
You see, understanding how Bitcoin and blockchains work in technical terms is extremely difficult and time consuming. On the other hand, understanding why Bitcoin and blockchains are important is extremely easy. Not only that, but understanding why they are important is, itself, far more important than understanding how they work in the first place.
Now for the really good news…
If you follow through with the extremely easy task of learning why Bitcoin and blockchains are important, you’ll be armed with knowledge that most people — (approximately 99.95% of the world’s population) — don’t have. And as anybody from Mark Cuban to Warren Buffet can tell you, knowing something important that most people don’t know is an investor’s dream come true.
Understanding how money has evolved across the millennia is a critical step in understanding how money might evolve in the future.
And in fact, currency as we know it today is actually a relatively new thing.
The first form of trade involved no money at all, but instead depended on bartering. As an example, a farmer from thousands of years ago might trade some of their grain with a blacksmith in exchange for tools they could use to more efficiently plant and harvest the next season’s crops.
Bartering was much better than no trade at all, but it severely limited the amount of trade that could take place. It wasn’t until people began using other goods as mediums of exchange that trade was really able to flourish.
Some of the earliest known mediums of exchange were cowrie (sea snail) shells, beads, and other collectibles, with evidence of their use existing in ancient China, Africa, and India. These objects made intertribe trade possible, meaning that tribes could collectively prosper by specializing in producing whatever goods were most abundant in their local area and then selling them for currency to buy the abundant goods produced by surrounding tribes.
Of course, sea shells and beads were far from ideal currencies. They would have been far more valuable to some tribes than others, and they lacked much use beyond jewelry. And so, over the course of the Bronze Age, humans eventually began using metals as currency because metal is generally far more durable, portable, fungible, and divisible than shells and beads.
There’s a downside to metal coins though — they can weigh a ton. Merchants who traveled between towns and regions realized that it would be of great benefit to have a currency that was more lightweight. From that idea, the first banknotes were issued in China around the 11th century and eventually reached Europe by the 13th century.
Fast forward another few centuries and you find something very closely resembling currency of today, with paper bills and metal coins. However, there was one more major event in the evolution of money that you should know about.
That is, of course, the loss of the gold standard. You see, for most of their history, paper bills have been directly redeemable for metals — in particular, gold. Under the gold standard, all of the various units of exchange found around the world were united by that simple fact that they had a set value in terms of gold.
The gold standard was a check on the power of governments because it limited inflation to the small amount of value that could be mined out of the earth in a given time period. With the abandonment of the gold standard by all of the global economic powers in the 20th century, modern day fiat currency — backed by nothing other than faith and trust in governments — was born.
As Alan Greenspan, former chairman of the US Federal Reserve, put it:
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.”
Indeed, if the gold standard was still in place, it’s far less like that Bitcoin would not exist today. But more on that later…
If you’re interest to learn more about how trade and mediums of exchange enabled human civilization to flourish: Shelling Out: The Origins of Money by Nick Szabo
Before we begin to describe Bitcoin, it can be a helpful exercise to spend some time thinking about what an ideal currency for the modern world might be.
Technology is playing an ever-more important role in our daily lives, and it’s changing practically everything about our society. With these technological advances — in particular, smartphones — most tasks have become much more convenient than they used to be.
Banking and finance are no exception to that, but it’s also fair to say that many aspects of the banking and financial industries are lagging behind. For example, domestic and international money transfers are still expensive for the typical citizen and also take multiple days to process in some situations.
So, if we were to use a currency to bring the banking and finance sectors fully into the 21st century and benefit maximally from modern technological advances, what would that look like?
Let’s break that question down into three parts.
Anybody who has ever travelled or lived outside their home country should be aware of the fact that currencies of today are far from global.
The United States, Canada, Australia, and 19 other countries all have dollars, but these dollars are different from each other and can’t be used interchangeably. Mexico, Argentina, Chile, and several other countries have pesos, but all of these, likewise, are not interchangeable.
Then you’ve got the Yen in Japan, the Yuan in China, the Euro in much (but not all) of the European Union, and so on. All in all, there are some 180 unique, recognized currencies circulating around the world today. Each one of them fluctuates in value relative to the others, and switching between any of them for another is almost impossible to do for free.
Alternatively, imagine that a currency exists which you could use just about anywhere in the world, with the same convenience as you use your local currency in your home country today.
You wouldn’t need to exchange currencies when you travel internationally, which would save you money and a potential hassle. Currency exchanges in airports and city centers often charge service fees in addition to giving customers exchange rates that are far from market value, and some of them are downright scammy.
It’s not their fault — at least not the honest ones — as they obviously have to make a profit somehow to stay in business. But who in their right mind would willingly lose money every time they cross an international border if they had an alternative option that was more convenient and affordable?
In this scenario, it seems clear that having a global currency would be more economically efficient at the very least.
On top of that, there’s the all-too-often undiscussed matter of remittance payments. In case you aren’t familiar, remittance payments are transactions in which migrant workers send money back home to their families. According to the Pew Research Center, the size of the global remittance market in 2016 was $574 billion, and it’s projected to keep on growing alongside the trend of urbanization in the years ahead.
Unfortunately for these separated families, the fact that international remittance payments almost always involve multiple currencies contributes to making them slow and costly. Fees frequently exceed 10% of the total value transferred, while wait times are typically 24 – 72 hours.
Again, let’s imagine an alternative scenario. In this hypothetical, migrant workers and their families can both use the same currency. As a result, they can transfer it between each other within a matter of minutes or seconds, and at a cost of 2% or less of the total transaction value.
If you know 2nd grade math, then it’s pretty easy to see that a global currency would be beneficial for everybody who’s reliant on remittance payments around the world.
With that being said, there are a couple ways that one could make a case against global currency being good for the world.
One downside can be found when you consider the possibility that our many different currencies might somehow contribute to the many diverse cultures present across the globe. By replacing them with a global currency, would we lose a piece of human culture in the process?
The answer to that may well be ‘yes’, to some extent, anyway. Nonetheless, different foods, languages, ethnicities, customs, and celebrations would continue on, with or without a unique currency in every country.
Italians didn’t stop making delicious pasta or speaking musicly when they switched from the Lira to the Euro in 1999, nor did Germany suddenly become less organized or less competitive in the World Cup when they ditched Marks for the Euro the same year. Culture runs far deeper than currency.
A more compelling downside, though, could be that having a global currency changes the way that governments can influence economies. The argument for that is better made in a different context, however, and we’ll get there soon.
In the meantime, what can we conclude about the merits of global versus local currency?
Well, we know that global currency has a couple of big advantages in terms of efficiency. It would make international travel and cross-currency payments significantly easier, not to mention facilitating easier international trade. All in all, the upside is undeniable.
Now, let’s move on to part two by asking another question about what would make for an ideal currency for the modern world.
Answering the question of whether or not the ideal currency would be digital is about as straightforward as it’s gonna get in this article.
Do you like online shopping?
Do you have any apps on your phone for managing money, such as a banking or budgeting app?
What about apps for sending and receiving money, such as PayPal, Venmo, Square, Apple Pay, WeChat Pay, Revolut, Zelle, Alipay, etc., etc.
Would your life become better or worse if money only existed in a physical form such as today’s paper bills and metal coins? Would you be willing to go to the bank in person anytime you wanted to move money around or even check your account balance?
The modern reality clearly shows that an ideal currency would be digital, as that’s the easiest way for most of us to use it in our daily lives. And that becomes even clearer if you consider an estimate from economists that approximately 92% of all the world’s currency exists purely in a digital form, already.
As technology improves, one can only imagine that the 92% figure is only going to increase from here.
Let’s move on to part 3.
As mentioned in the section on whether or not the ideal currency would be global, one consequence of having global currency would be reducing the role that governments play in influencing their economies.
Specifically, governments would have a greatly diminished capacity to implement expansionary (i.e. increase inflation rate and lower interest rates to encourage consumption) or refractory (i.e. decrease inflation rate and raise interest rates to encourage saving) monetary policy based on the ever-changing needs of the economy.
In some circumstances, it could be argued that having a currency which can be controlled by a centralized governing body is a good thing. People who make this argument could talk about how it might make recessions preventable and less extreme.
To that point, an obvious counter argument would be to simply begin listing all of the countries where governments and their monetary policies have caused disastrous outcomes for their citizens. Some examples include Venezuela and Zimbabwe, two places where national currencies were hyperinflated to such extremes that they became practically worthless.
That argument, valid as it may be, probably isn’t the most compelling one against having currency controlled by third parties though.
Another counter argument could be (and has been) made that trusted third parties are security holes. That argument has only been bolstered by recent finance-related security breaches, such as the 2017 Equifax hack that affected as many as 143 million U.S. consumers.
Once again, valid as it may be, that argument still likely isn’t the most compelling one we can make.
Rather, the most compelling argument we can make against currency being controlled by third parties is to simply quote the 19th century historian and moralist known as Lord Acton, who famously said:
“Power tends to corrupt, and absolute power corrupts absolutely.”
What greater power is there in modern society than the power to print money out of thin air? Other than the power to launch nuclear missiles, it’s hard to think of anything.
Whether it’s civil forfeiture cases in which local police abuse their power to steal from citizens, or its bank executives taking home millions of dollars in taxpayer money as “bonuses” for contributing to the Great Recession of 2008, the same words ring true. Power tends to corrupt, and absolute power corrupts absolutely.
As long as people have the power to control currency, some of those people will use that power to enrich themselves.
So, think about it… Would the ideal currency be controlled by humans with lots of power? Or, if it were possible for a currency to exist outside the control of any single person or group, would that be closer to the ideal?
Alan Greenspan has another relevant quote here, and we’ll wrap up this section with it:
“Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. … It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster.”
We don’t have to go back very far to see how currencies and economies could function without governments having the unchecked power to print as much of them as they see fit. It’s too late to reinstall a gold standard, but it may not be too late to remove trusted third parties from the equation.
Up to this point, the goal of this article has been to give you the proper context within which you can understand Bitcoin’s value proposition. Now, it’s finally time to tell you exactly what that value proposition is.
We aren’t going to get into the technical details here so that everything remains as easy-to-understand as possible. However, we will provide some links to other resources which you can use to learn more about how Bitcoin works if you’re interested.
So without further ado, let’s begin!
Bitcoin is a 2-in-1 solution that addresses the problems and shortcomings of fiat currency. It is both digital gold and electronic cash, and its biggest feature is that you don’t have to trust anybody to use it.
If you understand those 2 descriptions and that single feature well by the end of this article, we’ll have accomplished our goal and you’ll be more informed about Bitcoin than approximately 99.95% of the world’s population.
When the economic powers of the world abandoned the gold standard in the 1900s, they simultaneously gave all of the future installations of government the power to “print” money arbitrarily. This is why Alan Greenspan said that there is “no safe store of value” anymore.
You may have noticed that print is in quotation marks in the paragraph above. That’s because that’s not exactly how it works.
You see, central banks aren’t necessarily printing new bills and minting new coins to create money. Rather, central banks all around the world control their nation’s money supply by manipulating interest rates to influence economic activity and control inflation.
If the central bank makes interest rates low, citizens can borrow money cheaply so they have greater incentive to spend and expand. On the other hand, making interest rates high makes it expensive to borrow money, encouraging citizens to save and cut back on consumption.
When interest rates are low, the supply of money that’s circulating in the economy increases quickly while the supply of goods and services grows more slowly. As a result, prices of goods and services increase to meet the demand of all the consumers in the economy who are eager to spend.
This is the true meaning of inflation: one unit of currency has less purchasing power now than it did in the past. If a currency’s circulating supply increases faster than the amount of goods and services offered in the economy, then the relative value of that currency decreases.
Here’s where Bitcoin’s ‘digital gold’ moniker comes in…
Unlike all fiat currencies, Bitcoin has a fixed supply. It’s built straight into the Bitcoin protocol. Only 21 million bitcoins will ever exist.
That means that Bitcoin is a scarce resource, like gold. Only so much gold can be mined in a year, and the same is true of Bitcoin. This is important because people value resources more consistently when they are scarce.
Why did the original Salvator Mundi sell for US $450.3 million in 2017 when it can be easily replicated to look exactly the same on thousands upon thousands of copies? That’s easy… There’s only one original, and there will only ever be one. It’s the ultimate scarce resource.
So Bitcoin’s fixed supply makes it scarce, and people value scarce resources more than ones that aren’t scarce. That’s very important to know.
We’ll come back to this point again at the end of the article, but for now let’s move on.
There’s a reason that gold wasn’t the final stage in the evolution of currency, right?
Imagine paying for everything with gold. It’s scarce and intrinsically valuable, but it’s also incredibly inconvenient to use in day-to-day life. It’s heavy and difficult to move, it’s not easily divisible, and it’s not very secure either. Gold is good for storing value, but not for transferring it.
In this way, Bitcoin and gold are opposites. Bitcoin exists purely in its digital form.
Bitcoin is the first unforegabley scarce currency that’s existed since the gold standard was abandoned, and it’s also as transferable as modern day fiat currency.
Those are its two most important characteristics, and now it’s time to learn about its most important feature.
As stated at the beginning of this section, Bitcoin’s biggest feature is that you don’t have to trust anybody to use it. Such a statement likely begs the simple question, why?
Why don’t you have to trust anybody to use Bitcoin and why is that Bitcoin’s biggest feature?
Here’s the deal:
The Bitcoin network operates in similar fashion to a bank or any other modern payment processor. It keeps track of account balances and it processes all of the transactions.
The difference between the Bitcoin network and any of those other payment processing networks is that anybody can participate in the Bitcoin network, without permission. There are no rules or requirements restricting who is allowed to supply computing power to the network to help process transactions and maintain security. All are welcome.
What the Bitcoin network does have is a very specific architecture that incentivizes anybody who participates in the network to do so in a way that’s beneficial to the whole. In other words, Bitcoin’s design is meant to make it profitable to participate by processing valid transactions and costly to participate in order to try processing invalid transactions.
To summarize, you don’t need to trust anybody to use Bitcoin because:
If you’re interested in a much more in-depth and technical explanation of how this all works, you can read Chapter 2 of Mastering Bitcoin by Andreas Antonopoulos.
Legacy financial institutions do the same thing that Bitcoin does, except that they do it behind closed and locked doors. They don’t let you verify and validate that they are being honest, and they have the power to shut you out and refuse you service if you have a poor credit score, or even if you’ve done nothing wrong at all.
More than that, the second you deposit your money in a bank it ceases to be exclusively your money. Thanks to legal fractional reserve banking, some banks can use more money than they even have (your money included) to give out loans and generate a profit for themselves. But hey, if you’re really lucky they might pass along enough of their profits for your account grow as much as the inflation rate. Unfortunately, though, they probably wont.
To learn more about the importance of trust in money, you can read (or listen to): You Don’t Understand Bitcoin Because You Think Money Is Real.
I never said there wasn’t a catch, did I?
Bitcoin might have been sounding too good to be true so far, and you’d be right to think so. But just in case that thought hadn’t crossed your mind yet, let’s do a quick recap.
Based on what we know so far, Bitcoin sure seems like a good bet to be the next successful evolution of currency.
The catch is that in order for Bitcoin to be secure, outside the control of third parties, and open for anybody to participate as well as use it, a sacrifice was made in terms of transaction processing capacity. As currently constructed, the Bitcoin network cannot process nearly as many transactions per second as legacy payment processors like banks and credit card companies.
It’s digital gold plus electronic cash, but if too many people start using it as such the network will get overwhelmed. That might sound like a dealbreaker right there… but there’s a catch to the catch.
Bitcoin is programmable money, and as such it can be upgraded and continuously evolve over time.
In its early days, it was very commonly thought that the internet would fail to scale and that it would be but a temporary fad.
In 1995, Clifford Stoll wrote an article for Newsweek that you simply must read. In it, he said:
“Visionaries see a future of telecommuting workers, interactive libraries and multimedia classrooms. They speak of electronic town meetings and virtual communities. Commerce and business will shift from offices and malls to networks and modems. And the freedom of digital networks will make government more democratic.
Baloney. Do our computer pundits lack all common sense? The truth in no online database will replace your daily newspaper, no CD-ROM can take the place of a competent teacher and no computer network will change the way government works.”
Clifford deserves a break. After all, predicting the future is really difficult, especially when it comes to technological innovation.
Nonetheless, we can learn a lot from Clifford’s terribly inaccurate prediction and others like it. One big takeway is that just because we don’t know how something is going to work, that doesn’t mean that it wont work.
Bitcoin’s scaling problem is no exception. Just because it can’t process thousands of transactions per second at super low fees now doesn’t mean it won’t do so in the future. In fact, we already have some good ideas of how it’s going to evolve in the years ahead.
One way that Bitcoin might scale is through a recent innovation called the Lightning Network.
The goal of the Lightning Network is to maintain all of the key properties and characteristics of Bitcoin (i.e. the green check marks in the table above) while simultaneously making it possible to use Bitcoin for thousands of transactions per second.
Not only can the Lightning Network do this, but it can also process all of those transactions instantaneously and with such low fees that they’re practically free.
In the future, you could have a simple and easy-to-use app on your phone that connects you to the Lightning Network and enables you to spend and send Bitcoin all over the world in the blink of an eye.
If this becomes reality, merchants everywhere would be able to collectively save billions of dollars per year in fees that they currently have to pay to payment processors such as Visa and Mastercard.
There are still hurdles to overcome, and the Lightning Network’s eventual success isn’t guaranteed. The point is that it can succeed, just like scalability solutions for the internet have succeeded in the past 3+ decades to make it the most transformative technology of its time.
If you’re interested to learn more about the Lightning Network and how it works, you can check out this article: How the Lightning Network Can Resolve Bitcoin’s Scaling Issues.
You probably didn’t read all of this article purely to satisfy your thirst for knowledge about distributed ledgers. Nope, let’s get honest here!
It’s a bit more likely that at least part of you is trying to figure out whether or not you should buy some Bitcoin.
We aren’t in the business of giving investment advice, and no part of this article should be construed as such. You need to decide for yourself what you are going to do.
What we are going to do, though, is leave you with some questions that are worth pondering, so that you can get in the mindset of a seasoned investor.
So… here goes!
First, did currency stop evolving in the past, or has it been changing and adapting to technological advancements throughout human history?
Do humans value things that are scarce more than things that aren’t?
Who benefits the most when a currency or commodity becomes more popular over time: the people who bought into it first, or the people who joined in with the rest of the crowd?
Is a global, digital currency that can’t be controlled by third-parties more ideal for modern society than hundreds of local, third-party controlled currencies?
Are the wealthiest people of the world — from America to China and everywhere in between — likely to store at least some of their wealth in an asset that can’t be seized or stopped by governments?
Are retailers and online merchants likely to adopt a technology that can save them money if it provides a good enough user experience?
Did the internet become mainstream overnight, or did it develop and grow over multiple decades before truly transforming the global economy?
If there will only ever be 21 million bitcoins in the world, and there are nearly 8 billion people on the planet, how many bitcoins exist per person?
We won’t make you do the math on that last question, the answer is 0.000125 BTC / person. Good thing bitcoins are divisible!
Finally, we’ll leave you with a quote from An (Institutional) Investor’s Take on Cryptoassets) and some last words of analysis:
“… the potential value of a winning monetary store of value protocol can be measured in relation to the total value of gold bullion and foreign reserves, suggesting a potential value in the USD 4.7–14.6 trillion range. If Bitcoin were to become that monetary store of value (and it currently appears to be the strongest contender by some margin), it could be worth USD 260,000–800,000 per BTC, i.e., 20–60x its current value. If one places a higher than ~5% chance of Bitcoin succeeding in this way, it is a rational and attractive investment for a long-term investor before considering other potential upsides stemming from payments and unit of account utility.” — John Pfeffer
The quote above was written in December of 2017, at the peak of Bitcoin’s bullish ascent to US $20,000 per BTC. Given current prices at ~$3,500 per BTC, the math is a little different.
Supposing Bitcoin were to become a winning monetary store of value, it’s reasonable to estimate that one coin could be worth 70–230x its current value. That begs the question…
If an asset has potential to increase in value by 70–230x, how likely would such an increase have to be in order for it to be rational to invest at least some portion of your portfolio in that asset?
As Pfeffer shows in his paper, a straightforward way of answering that question is to simply divide 100% by the lower bound of the potential increase in value — in this case, 70. In other words, Pfeffer believes it would be rational to invest a portion of your portfolio in Bitcoin if you think Bitcoin has a greater than 1.4% chance of becoming a winning monetary store of value in the long run.
Our final question, then, is this:
Do you think Bitcoin has any chance to succeed? We are 10 years in and have just begun :)
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