Beginner’s Guide to Bitcoin
“Cryptocurrencies are a fad. Bitcoin is a bubble.” This was my first impression of Bitcoin when I first heard about it during 2017 when it came into the limelight. The price of bitcoin was rocketing like anything – it zoomed from $2,000 before making a top around the $20,000 mark, all this within one year (2017). During the year 2020, when the central banks all over the world were busy printing money, it was gold that was rallying. Along with gold, bitcoin had also started rising. That is when I started researching more about bitcoin.
Before you start reading further, I would like to tell you that, nothing in this post is financial advice. As always, I would suggest you do proper research before you make any investment decision.
Before we get into the details of bitcoin, we must first understand what are the traits of a currency and whether bitcoin satisfies these:
- Scarcity: Limited total supply of 21 million
- Divisibility: One bitcoin can be divided into 100 million units (satoshis)
- Portability: Due to the digital nature
- Durability: Resilient to deterioration due to limited supply
- Recognizability: Starting to get universal acceptance
Let’s now look at how different forms of currencies rank against bitcoin:
If we look at the above table, bitcoin ticks all the boxes, barring the last one. But, it is readily getting accepted as PayPal, Mastercard, and Apple Pay have started to accept bitcoins transactions.
Let’s look at the purpose of inventing Bitcoin. The Gold Standard was removed in 1971 and the world shifted towards the fiat currency system. This is what Fredrich Hayek, 1974 Economics Nobel Prize Winner has to say:
“I don’t believe we shall ever have good money again before we take the thing out of the hands of the government. All we can do, is by some sly roundabout way, introduce something that they cannot stop.”
What this means is that over the longer term, the value of all fiat currencies tends to zero due to the decreasing purchasing value. In fact, there are going to be more problems ahead due to high amounts of printing by the central banks. In October 2008, an anonymous person named Satoshi Nakamoto published a research paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”, which aimed at sending cash payments online without going through a financial institution.
The first block of bitcoin was mined in 2009 with a special message saying: “The Times 03/Jan/2009: Chancellor on the brink of second bailout for banks” – indicating that bitcoin’s purpose for existence being a response to a broken financial system.
When any transaction takes place across the globe, banks are used as a medium of exchange for verifying the transaction. The whole point of bitcoin was to remove a third party (bank) from the system and put “something” that would verify the transaction. It was proposed that there would not be any centralized record of transactions (so that no single individual or entity controls the data), instead, these would be distributed across the world (blocks – hence the concept of blockchain). These distributions are networks – indicating no need for 3rd party like banks (decentralization). This implies that there would be no bans, server shutdowns, or blocking of payments. These networks are kept functioning by miners by solving complex equations using their highly powered CPUs. By solving these complex equations, they mine blocks (similar to a database, or page in a record-keeping book). These blocks contain the data of recent transactions. Miners receive bitcoin as a reward (currently 6.25 BTC which halves every 4 years). In total, only 21 million bitcoins will ever be produced and the last of these will be mined in 2140. After every transaction, the bitcoin system becomes more and more secure as every transaction leads to rewards for the miners, and these rewards get invested in building a stronger and more secure system, and this cycle keeps going on like a network effect.
Since the mining network is completely decentralized and there are a large number of miners around the globe, it is very unlikely that fraudulent transactions would be verified by the other miners (since a single individual does not exert control). Therefore, if someone tried to submit fraudulent transactions onto the blockchain, they would waste their expended energy as the network would not verify the transactions that the person claims to have occurred. Since the miners want to receive the block reward for the work they performed, they are incentivized to only publish the transactions that actually occurred on the network.
Now I constantly get this question that if BTC is a currency, why does its value fluctuate so much? What I believe is that the price of bitcoin which we see is worth of the whole blockchain system, whose value will increase with more and more transactions taking place in bitcoin. But, no one is really sure of the worth of the system, and hence the reason for such fluctuations.
The overall worth of transactions globally is estimated to be around $300-400T. We know that there are going to be only 21 million coins, so the worth of each coin would be worth way higher, even if bitcoin grabs even a fraction of the share of the total transactions. The total market cap of bitcoin today is roughly $700 billion.
Bitcoin is not just a currency but also a store of value. It mimics most of the characteristics of gold, and apart from that, it is highly divisible and portable due to its divisible nature. The total market capitalization of gold is around $11 trillion. Based on just this fact alone, bitcoin is highly undervalued, considering the fact that it is an even better store of value as compared to gold, keeping just the factor of established history apart. As time progresses, this will also not be an advantage for gold, making bitcoin a better alternative.
If we look at various institutions looking to add bitcoin on their balance sheets as an alternative to holding cash and treasury bills (both of which depreciating in nature), shows that this is just the beginning of bitcoin getting widely accepted. Michael Saylor (of MicroStrategy), and Elon Musk (of Tesla) are adding bitcoin, and the worth of these are over $1 billion on their respective balance sheets. Another point to note here is that total transactions that took place via bitcoin are higher than that of PayPal, which is the biggest digital cash transaction platform. Now, PayPal, Mastercard, and Apple Pay are accepting bitcoin transactions. With more acceptance of bitcoin, its value is bound to go up.
Here is how “institutions” change their views:
To conclude, we can see that there are many triggers that are indicating that there is a high probability of bitcoin going higher. I see three major ones. First, it grabs a share of the total global transactions – even a small one would lead to a significantly higher value. Second, as a store of value similar to gold, but with better characteristics. Finally, with the huge amount of currency printing, and huge devaluation of currencies in emerging markets, along with inflation, bitcoin will get accepted.
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