This is the first part of three to five blogposts about Bitcoin. This first one was written mainly on 2019-10-25 and finished between 2019-11-05 and 2019-11-07. The Bitcoin price changes between those days had little to no impact on the content.
What is Bitcoin
Bitcoin (short: BTC, or XBT) is an electronic asset.
It is the world's first "cryptocurrency" and was invented by an anonymous author around 2009 - so it is approximately 10 years old!
Financial assets are approximately divisible into commodities (e.g. cotton, coffee, lithium,..), receivables from debt (e.g. bonds) and equity (e.g. stocks).
Currency is a medium of exchange to facilitate easier trade.
Traditionally currency was either made from non-corroding precious metal commodities, or I-owe-you paper for a commodity. An example for such a commodity was gold (short: XAU) because of its desirable properties as currency: its stable, limited supply and demand to make jewelry and therefore stable value, its fungibility (all gold is the same), and its non-spoilability.
But these days all common currencies are all "fiat" money, meaning they don't represent a claim to anything else. Money has become its own asset class (also called "cash and cash equivalents").
Bitcoin believers and gold bugs will be quick to remind you that because currencies aren't "backed" by anything - meaning they don't represent any equity, receivable or commodity of value - that makes them worthless.
"It has value because we think it has value. It is money out of thin air."
I don't agree. I think traditional currencies such as USD, EUR, YEN or Pound gets its value because you have to accept it by law. In Austria where I live currently you are required to accept payments of debt in EUR by law. And that is a very strong argument for its use. It is the sovereign body's power that gives it value. So it isn't exactly out of thin air.
But it is true that state controlled currencies can be inflated at will of the central bank. Print 10x the money? No problem! So as an investor you are always at risk holding currency. That's why some very careful investors want to hold commodities such as gold instead. You know - as an insurance if shit hits the fan. You can't create gold or cotton as easily as the central bank can just buy goverment bonds for billions of freshly printed money.
In fact, even a lot of central banks still hoard gold for emergencies, in case they want to trade with it. Especially if they can't use their own currencies, for example because their own currency is not accepted any more.
What desirable properties does Bitcoin have as a digital commodity?
The very nice thing about BTC is the way it has been designed with a fixed number of coins. There can never be more than 21 Million Bitcoin. Out of those 21 Million Bitcoin only 3 Million Bitcoin are left to be created, and approximately 3 Million are lost. That leaves us with an incredible scarce resource.
Not just that, the Bitcoin code is programmed in a way that the amount of newly created Bitcoin is halved approximately every 4 years. Think of this as: every 4 years half of the gold mines are permanently destroyed. So in 4 years you only have half the supply in 8 years you only have a fourth, in 12 years you only have an eighth and so on.
Those halfings are predicable events where the supply drops off abruptly, the next time will be next year.
Soon 99% of Bitcoin will be mined, with the remaining tiny fraction being spread out until 2140.
Together with the aforementioned lost BTC (people losing wallets). This leaves us with a de facto deflationary resource.
No central bank can easilty devalue your wealth, by creating more Bitcoin.
You can trade it on its own network of servers that has no central point of failure
Even though BTC is a very scarce, deflationary resource, that you can actively exchange over the internet in very little time (10-20 minutes per transaction), it has no single point of failure.
This means that there is no single server that you can go to and take over to
- block a transaction from happening
- revert a transaction
- confiscate Bitcoin during a transaction or from a wallet
Instead the power is spread out over 10.000 (and growing) different servers all over the world that memorize which wallet keeps how many Bitcoins and what was transacted. Those servers vote with their computing power (which needs costly electrical energy and investment into computers) which transactions are legit. Legit meaning that e.g. someone can not spend their Bitcoin twice, once it's transacted away from your wallet it has left your control.
And while 10-20 minutes to do a transaction seem long, it is all done electronically and you don't have to verify commodity purity manually like if you were trying to transact with e.g. gold.
Ensuring this decentralized working with mathematics and programming is the main innovation of BTC actually. https://bitcoin.org/bitcoin.pdf
The great thing is that because this resilient network is spread out over the whole world, you need only computers and power to participate. So no single sovereign country, no government can easily control the BTC network of servers.
The server operators are rewarded for their services by receiving all newly created Bitcoin and by receiving transaction fees from the one trading Bitcoin.
More desireable properties of BTC
Even though you only have 21.000.000 BTC (Approx 0.0027 BTC per Earth's 7.7 Billion humans) it is nicely divisible.
Unlike an EUR which can be divided into 100 Cents, each BTC can be devided into
100 Million "Satoshis". So you can split it up much more fine grained.
At the time of this writing 1,000 Satoshi bought on the free market cost you 7.4 EURO cent. So even if Bitcoin was to appreciate a thousand times (1000x) in fiat currency value to 7.4 Million Euros we could still transact it in nice little 7 EUR Cent increments.
Gold is not easily divisible in contrast, except with a very fine calibrated scale that is trusted by both parties.
It doesn't spoil
Bitcoin is stored in virtual electronic wallets. As long as you know the key to the wallet you can create copies of the wallet that let you control the Bitcoin inside it.
The key is nothing more than a long number. You can print this long key number on a piece of paper. And as long as you keep this piece of paper you can create instances of your wallet with it that let you control the Bitcoin you stored within. Just don't lose that piece of paper.
Howerver most people store their Bitcoin wallet key in a safe little computer so they don't have to type it in every time they want to transact. These types of computers are made just of that purpose to be a wallelt, and thus are not easily hackable because it is made just to do this one thing and so it doesn't have a lot of ways to exploit it.
Although most people still have a backup on a piece of paper in their bank safe or in their head (don't die without telling your relatives the key).
There are also ways to memorize this long number by memorizing e.g. 15 words. So if you would like to do so, you can keep those 15 words in memory and store potentially billions of Dollars/Euros worth of goods inside your head. Except for torture nothing can extract those billions from you.
You can't take it from the owner, you can't restrict or block transactions, you can always take it with you
I always have to smile if I land back in Vienna by plane, and there are signs that you have to go through customs, if you carry more than 10.000 EUR with you. Because when your wealth is stored electronically distributed there is no transporting or importing of money. It is always accessible to you and it is everywhere. The wealth just is. And capital controls are not enforcable at the border. How could the customs agent know what 15 words you have memorized in your brain?
While you can use Bitcoin like a currency to buy goods (someone famously payed 10,000 Bitcoins for a pizza in 2010). Bitcoin doesn't have all ingredients to be great virtual cash currency.
Firstly because of technical reasons: while Bitcoin is an ingenious invention, you can't always transact it as fast as cash bills or a Paypal transaction, nor as anonymously as today's cash.
And for legal reasons: You can't legally pay your goods, and debt in Bitcoin today.
Since Bitcoin's creation 10 years ago there has been a lot of research and engineering in the direction to extend or build on top of Bitcoin to create better money. So Bitcoin or Bitcoin's technology could be a central building block to create currency that replaces cash payments.
And legal frameworks are slowly reacting as well.
In summary BTC is extremely portable. The transaction mechanism doesn't have a single point of failure. It is cheap to store. It is very scarce and cannot be inflated beyond 21 Million coins. Each coin is very divisible so you can transact a single Satoshi. It is durable, it doesn't spoil. It is unconfiscatable without the wallet key.
But while Bitcoin is not cash or currency (yet) it is a valuable commodity with excellent properties to store wealth - like gold on steroids. Those inherently desirable properties are what give it value, not the sovereign power of a nation.
Read in part two why I didn't invest in Bitcoin earlier and why the concernes that I had back then are not an issue any more.