Bitcoin 101 - Why is it more important today?

What exactly is bitcoin?

Bitcoin is the world’s first digital currency, created in 2009 by the alias ‘Satoshi Nakamoto’. It is the most popular cryptocurrency, with a market cap exceeding $300 billion, dominating the cryptocurrency market with a 79% market share. Bitcoin is unique due to its early success in implementing blockchain technology allowing fast, low-cost transactions without the need of financial institutions to process transactions, as well as having a capped supply of 21 million. As a result of Bitcoin’s intrinsic values and its ever-increasing network effect, Bitcoin is reaching new all-time highs as investors envisage Bitcoin’s future widespread adoption.

Satoshi Nakamoto is the pseudonym for the creator/s of Bitcoin. Despite several individuals claiming to be the founder, to this day it is unknown who the individual or group creators were behind its release in 2009. Satoshi Nakamoto published Bitcoin’s whitepaper in October 2008, stating how the decentralized currency would be implemented. At the start of 2009 Nakamoto mined the first block of the Bitcoin network, launching the digital coin. Since Bitcoin’s release, there have been many contributors who have supported the network with updates and fixes. Github lists more than 750 contributors.

How does it work?

To create the peer-to-peer transaction process, Bitcoin uses blockchain technology. Bitcoin’s blockchain allows for instant and transparent transactions without the need for financial institutions. When a transaction occurs, the blockchain network records the sender and receiver’s Bitcoin addresses along with the amount being transferred. This information is then uploaded to the ledger (blockchain), which is updated across every 10 minutes (known as the ‘block rate’).

Miners (also referred to as ‘nodes’) will receive the transaction information and will group into ‘blocks’ which are processed and verified. The procedure of verifying blocks is time consuming and very computer intensive. Miners power the Bitcoin and blockchain network and in return are rewarded for their efforts with the digital currency itself. In 2009, the block reward for miners was 50 Bitcoins, however the reward is halved every 210,000 blocks (approximately 4 years), currently, the reward is 12.5 Bitcoins.

Subsequently, as miners are rewarded with Bitcoins the circulating supply increases however at a decreasing rate due to the halvings. Bitcoin is capped to a supply of 21 million, which at current halving rates will lead to the final coin being mined around 2140. Bitcoin is divisible to the eighth decimal place, which are referred to as Satoshi’s.

Bitcoin’s strengths as an asset lie in its properties stemming from its usage of blockchain technology. For instance, Bitcoin’s security is very high. This is due to the nature of all transactions being uploaded to the ‘public ledger’, which allows transparency of all value transfers between peers. Furthermore, the network provides significant security as blocks are verified between miners, ensuring new data is consistent and accurate, preventing counterfeits. The lack of counterfeits along with the asset’s diminishing supply output, Bitcoin is considered to be an asset useful for storing value.

The significance of the supply halvings which occur every four years are best represented by the ‘stock to flow’ (S2F) model in figure 1. S2F showcases how many years, at the current production rate, are required to achieve the current stock. The figure represents the value of Bitcoin’s scarcity, and how it this will increase overtime. The model presents that with each halving, S2F dramatically increases and as a result so too does Bitcoin’s value.

Bitcoin Stock to Flow chart

The future of Bitcoin and its value.

However, S2F has been labelled as an inaccurate predictor of Bitcoin’s future price as the value of Bitcoin is demand based. Though, Bitcoin’s demand has grown substantially indicating the network effect is occurring. The network effect states that the value/utility of a good or service depends on the number of users, and this is clearly increasing as shown with the growth in crypto wallets, in figure 2. Furthermore, for the first time, institutional money as entered the digital asset world through Bitcoin.

Institutions such as Square and MicroStrategy invested in Bitcoin in late 2020, due to the overpriced equity markets as a result of quantitative easing. Thus, institutions were led to explore new investment options, such as Bitcoin — attractive due to its immunity to devaluation unlike FIAT currency. Evidently, Bitcoin’s current and future supply and demand trends indicate substantial growth within the coming years.

Number of user wallets created on Blockchain.com, Jan 2012 — Nov 2020

On the other hand, Bitcoin’s greatest weakness as cryptocurrency comes in the form of its relatively slow processing times. Its average 9-minute block time is substantially slower than the majority of other currencies, such as Ethereum, with its block time of 13 seconds, with other altcoin averaging 2 minutes.

Furthermore, Bitcoin’s uses are limited compared to some altcoins. For instance, Bitcoin’s largest competitor, Ethereum, allows users to create applications based on the Ether blockchain. Therefore, allowing the blockchain to serve as the infrastructure for the exchange of sub tokens aside from monetary assets. As a result, the altcoins can be viewed as significant competition due to their adaptions and potential improvements over Bitcoin by new developers.

The greatest risk to Bitcoin’s future is state intervention. The decentralized nature of Bitcoin empowers the individual peers by allowing anonymous discreet transactions, and potential tax avoidance. This serves a risk to the central bank monopoly over the financial system, thus, there is anxiety of government intervention.

Measures range from taxing owners to banning the asset altogether. Though such a threat looms, realistically, it would be hard for governments to implement such measures without repercussions. For instance, the banning of Bitcoin would have to be universal across nations to be deemed as effective in preventing its growth.

Furthermore, with the flood of institutional money, it is hard to see such a ban due to the consequences to firms such as Square and MicroStrategy. Therefore, the realistic outcome of government intervention is for central bank adoption of their own digital assets, as seen with the Bank of England detailing plans to implement a CBDC — central bank digital currency. Therefore, the threat to Bitcoin may lie in the ousting by central bank introducing their own forms of digital currency.

Why is it rising and becoming more relevant now?

Since its creation, Bitcoin has dominated the crypto market. Initially, only those within the crypto sphere recognized the potential of blockchain technology. In recent times, Bitcoin has maintained its position as the largest cryptocurrency, with the network effect continuously increasing, Bitcoin looks set to lead the blockchain revolution.

The COVID-19 crisis has been the catalyst for Bitcoin’s recent rise, with greater media attention, retail funding but most importantly institutional funding. The opportunity that has risen from the coronavirus pandemic has provided Bitcoin the foundation of increased awareness and knowledge to be able to start its pioneering climb. With Bitcoin Price breaking through an all time high $20,000 fundamentally, it has the attributes to become a mass payment system and a store of value.

These intrinsic values in combination with the weakening of FIAT currency due to monetary response to the coronavirus lockdowns has forced retailers and institutions to seek refuge in alternative assets, such as Bitcoin. Thus, 2020 has been a landmark year for Bitcoin, not only in catalyzing its growth but laying the foundation for the promising future of potential mass adoption across all financial consumers.

Article by Lucas Gabetto Morrison.

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