Why Bitcoin Matters And Why You Should Care

I want to start with a quote by Vijay Boyapati, author of the Bullish Case for Bitcoin

This is the thesis that I want to reinforce in this article, which is the underlying foundation to my first YouTube video in 2020. It got translated into multiple languages and is still used as a resource for beginners.

The first part of the article, will cover most of the WHY, by looking at Bitcoins economical properties. What is money and it's history? Inflation, Bitcoins value proposition in that context and a few foundations of the Austrian School of economics.

The second part is about HOW. How is Bitcoin able to fulfill it's value proposition. We will look at it from more of a Computer Science perspective here, however I'll try to keep it simple yet complete. We will look at the Byzantines Generals Problem or Double-Spending Problem. The Blockchain and Bitcoin Mining as well as Cryptography and the Proof of Work algorithm.

To finish off the article I'll end with a section on where I think Bitcoin will be going and how the landscape will evolve as well as some final notes.

Let's start!

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Economics & Ethics of Bitcoin

To understand what Bitcoin is and why it matters there is no way around it's underlying economics and the history of money. Let's start with the latter. Bitcoin can look quiet complex and even the anonymous creator Satoshi Nakamoto knew that.

So to understand why it's not just a weird digital token used by nerds we need to do a bit of history lesson and remember where money came from and how it changed through time.

History of Money

When we think of money today, we think of dollar bills or credit cards. While those mediums of exchange were not existent at the early stages of society the properties of money have been very consistent since we exchange things.

Initially money was not necessary. The community was small and people bartered. This is by the way one of the key differentiators between humans and every other animal. We understood that everyone is better of through division of labour and free trade.

Barter however is really inefficient. First of all both involved parties need to have what the other wants. If you want my meat, but I don't want your fish, but something else instead we can not trade.

In a bartering society it's also very difficult to hand out change as a lot of items are not divisible. If I want to trade livestock I can only trade you the whole animal and not one part of it.

Taxation and Accounting also have drawbacks when bartering.

So money was invented which in its essence is a good that's widely accepted as medium for exchange.

I buy something from you and give you money. You can use the money to buy a different good from someone else. So you can store value in money to purchase something in the future from someone else.

Everything could be used as money as long as we all decide to use and accept it as our medium of exchange. But not every money is good money.

To give you a counterexample: Fruits. We could decide to use fruits instead of dollars. However they would be bad money, because they rot and therefore lose their purchasing power over time. Some early examples of better money were Sea shells, animal teeth and beads. These stay the same over longer periods of time. They have the property of durability.

Staying with the example of Shells, they are also portable, so you can bring them with you, to buy what you need.

However the problem with shells is: they are not scarce. When you have a boat you can ride to a beach and pickup a ton of shells. You inflate the supply of shells in the community which makes them less precious so they lose purchasing power.

Scarcity is key for any store of value. Think about other collectibles like first edition cards from trading card games. They rise in value, because there is a very limited supply of them (with an existing demand).

Throughout history humans continued to move to better monies that are more scarce, divisible, portable and durable. The final frontier were precious metals and finally gold.

Think about why Gold is great as a store of value. It's scarce, divisible through melting, portable, and really durable.

But we didn't stop there. Next up: Paper Money, which is even more portable. It appears to be the superior money on first sight. Initially all paper money was backed with 1:1 ratio by gold. A 10$ bill equals a 10$ gold coin. So you could change paper money back and forth with the actual gold. This is known as the Gold Standard or La Belle Epoque in which humanity and technological advancement flourished.

However greed and concentration of power changed things. Banks started to print more money than they have gold. This is troublesome, because when to many people want to change their paper money back into gold the bank doesn't have enough gold to serve it's customers. Which is exactly what happened.

In 1971 the US government made the decision that no paper money can be exchanged back into gold. That decision combined with the establishment of central banks led us to the FIAT Standard which is still in place today. The Dollar and other currencies are not backed by gold anymore. In fact they are backed by absolutely nothing besides our trust in the government. Since 1971 governments have a monopoly on money creation and we will explore why that is unethical and uneconomical.

Inflation

Ending the gold standard resulted in an explosion of public debt, growing income inequality, currency crashes, and inflation. There is actually a website with the fitting name wtfhappenedin1971.com with lot's of data and graphs.

There are two different problems that can best be explained at once. One is Inflation, the other is the monopoly of who controls the inflation.

Monetary inflation means expanding the money supply and thereby the devaluation of money, because it becomes less scarce. Inflation by authorities is not a new phenomenon. It happened with the debasement of metal coins, when kings added less precious metals like tin to the gold coin to put the rest of the gold into their own pockets and it still happens today through printing of paper money. The issue is that inflating the money supply by printing paper is infinitely easier than mining more gold for example. Paper money lacks scarcity which makes it useless as a store of value if it's not backed by something scarce like gold.

Printing of money first leads to mild inflation which always leads to outright inflation as Austrian economist Friedrich Hayek noted. Since 1971 almost 50 years have passed in this experiment of easy money printing and worldwide fiat currencies. When you look at the graph of the money supply of the US Dollar it doesn't look like the experiment we live in will last another 50 years. A paradigm shift to a new monetary policy will inevitably occur.

The following paragraph was written in 2020 and turned out to be very true with inflation in double digits in many places.

Here is an interesting thing. The Central Banks of the world printed trillions worth of dollars during the pandemic and yet we don't feel any inflationary effects. Prices didn't go up so far.

The Pandemic is a deflationary force. People cut down on expenses and save their money, because they are uncertain and scared of the future. This is displayed by the velocity of money, which is really low right now. The velocity of money displays how often it moves from one entity to another. A good economy has a high velocity of money. Currently the velocity of money is not going upwards even though the supply of money is getting increasingly larger.

There is a very dangerous cycle playing out right now, because when the pandemic is over and the economy is great again at some point, the velocity of money will pick up as people don't cut down on expenses anymore. The money supply doesn't suddenly vanish, so at some point there is a way higher supply of money circulating on the market. This is the real inflationary impact. Even economists that believe in controlled inflation know, that a contraction of the money supply is necessary after expanding is. Problem is, the contraction never happens when you look at history.

Austrian Economics, which builds the foundation for Bitcoin is even clearer here:

The endgame of exponential growth of the money supply can also head us into hyperinflation which is not a pretty sight as witnessed countless times throughout history all around the world. And to be frank none of the thousands of fiat currencies in the history of humanity have survived given a long enough timeframe.

To recap: inflation reduces the moneys capacity as a store of value. That's not all though.

Inflation is a great accelerator for inequality through something called the Cantillon Effect. It's a wealth shift from the lower and middle class to the upper class. And could literally be described as theft as it has many times before by economists mostly of the Austrian School.

The Cantillon effect works as follows. Banks and financial institutions receive newly printed money first. That means they can buy services and assets while the prices are still lower and not affected by the new inflation, because the new money did not circulate on the market so far. After that it benefits CEOs and other top tier shareholders through higher marketcaps of companies. At the end of the road are the middle and lower class that don't benefit from inflation at all, but just have to cope with higher consumer prices. To create more equality the poorest people would need to get newly created money first to benefit from inflation.

This is also displayed by the velocity of money.

Paper money is also not natural money that came into use voluntarily through its intrinsic superiority, because in many regards it's simply not.

Remember when I said, that banks were committing fraud by giving out more money than they have gold in the vault? The exact same thing is accepted common practice today. It's called fractional reserve banking. Governments give banks the license to cheat by letting them hand out more money than they actually have. When people suddenly do a run on the banks and want their cash like in the 2008 financial crisis, the bank fails and gets bailed out by the government through more money printing. This is an incredibly unfair advantage and one of the reasons for why capitalism has got a bad reputation (eventhough this is not capitalistic at all).

In a better version of capitalism the free market would let banks, that commit fraud, fail and by doing that set an incentive to not commit fraud.

The only longterm solution out of this mess is denationalization of money and to make it a free market not controlled by a government or a company or anyone else. A task that was not possible for a loooong time.

Enter Bitcoin

That was Austrian Economist Friedrich Hayek sort of predicting Bitcoin in 1984. An open, public, permissionless, borderless, neutral, decentralized, censorship-resistant alternative to central banking. The best form of money in history has been gold. So Bitcoins natural rival is not the US Dollar or any other fiat currency, but gold instead.

Bitcoin vs. Gold

Gold is way superior to the Dollar as a store of value as the inflation of gold is slow and won't be increased dramatically. Gold is scarce. Bitcoin is often described as digital Gold and it's actually a hundred times better.

Let's compare the two and see why. The necessary characteristics for a store of value are plenty. Let's focus on the most important. Scarcity, Divisibility, Portability, Durability and Recognizability.

Yes, Gold is scarce, but Bitcoin is programmatically scarce. There will never be more than 21 million Bitcoins. This rule is part of the code an no one can change it. The distribution rate of Bitcoin is also fixed you can look up how many bitcoins will exist at any date in the future. It's hard to argue against mathematics. With gold you only have a vague idea how big it's supply is and with fiat currencies like the dollar, well you don't know at all how much money will be printed next year. And you have no vote on this decision either.

Gold is divisible though not easily divisible through melting. Bitcoin is really divisible. 1 Bitcoin equals 100.000.000 Satoshis which is the smallest unit. Just like 100 pennys make up for 1 dollar.

Gold is sort of portable in small sizes, but getting millions of dollars worth of gold from one place to another is not easy and very costly, because of security that would be necessary. You can send millions worth of bitcoin to the other end of the world pretty much instantly for a few dollars. Bitcoin is so portable that if you remember your private key or seed phrase which is like a password to your Bitcoins, you can access them from anywhere anytime with an internet connection.

Gold is very durable. It gets slightly compromised through use as a currency, but has proven it's durability throughout history. Bitcoin is can't be physically harmed as it's digital. It can not be destroyed, but it can be lost. If you own bitcoin and lose access to your private key, the coins are lost forever.

Gold is not easily recognizable. You either need an expert that you have to trust or special equipment, to find out if your gold really is 100% gold and not some sort of mixture. Bitcoin is verifiable. The system works without trust. "Don't trust, verify" is a common phrase for Bitcoiners. We will see how the system works in the next section.

The only argument that speaks for gold is that it's proven and has history. However in an increasingly digital world I don't believe that kids born today want to deal with a metal when they become financially responsible.

Winner: Bitcoin.

Another viewpoint of Bitcoin is that it shifts time preference. If your dollars loose value and saving rates go down it enforces mindless consumption and instant gratification. There is no opportunity cost in spending when your money gets worthless over time. Bitcoin as a store of value teaches you how to save and plan for the future. There is an opportunity cost, because everything you spend now could have been worth more in the future. The concept of delayed gratification.

I could go way deeper into the economics here explaining Bitcoins underlying game theoretics, psychological elements like us having the desire of scarce collectibles or laying out how functions like lending work with a deflationary currency, but this is outside of the scope of this article. So let's continue with the technological aspects of Bitcoin to understand how it's making sure these characteristics stay true and to make clear why it can't be stopped.

Technology of Bitcoin

First things first: Yes, Bitcoin is complex, but to be honest most things are. You don't need to understand how Bitcoin works in order to use it. Just as you don't need to understand how the TCP/IP Stack or the Hypertext-Transfer-Protocol works in order to use the Internet or how the banking system works in order to use it. That being said, getting the technical premises of Bitcoin gives you the confidence that it actually works and it undermines the understanding of the different narratives like censorship resistance, decentralization etc.

In it's essence Bitcoin is the solution to the digital double spending problem or Byzantines Generals Problem. One of the great attributes of digital files is that they are infinitely copyable at pretty much zero cost. If I have a funny video on my phone that I want to share with you I can send it to you and you have the video as well. I don't lose it on my phone. This makes a currency useless though. If you send 10 digital dollars to my phone but keep them on yours as well this is known as double spending. To solve double spending you usually would need a central authority which is a bank in most cases that holds all accounts in a central database and whenever someone sends you 10$ to your bank account you trust the bank that they substract the 10$ from the sender and add them to your bank account.

Bitcoin solves this problem without a third party that you need to trust which is a tremendous achievement in the field of distributed systems.

Instead of a centralized database with Bitcoin you have a decentralized database that everyone can access and verify. It's not stored in one place. It's stored all over the world on everyones devices who decide they want to store it.

Instead of a bank there is not a server and several clients that interact with the server. Instead the Bitcoin protocol runs on a flat network with no hierarchy. Everyone is seen as peers. A peer-to-peer network that no one can turn off, because there is no central point, no single point of failure that you can shut down. Peers can enter and leave the network whenever they want without permission from anyone. Bitcoin is not a company. It's a stack of protocols, just like the internet is a stack of protocols. No one owns the internet. As long as the whole internet won't be turned of Bitcoin will be up and running. And btw the internet was designed to survive a nuclear war, so a complete internet or electricity shutdown is really unlikely to ever happen and if it does happen we have other problems to worry about anyway.

Bitcoin uses Blockchain Technology which became a buzzword a few years ago. It's a distributed ledger or database that everyone can access with the key feature that everyone can trust the state of the database or output of the database without the need to trust anyone in the network. So the blockchain is integral to Bitcoins value proposition. No third party, like a bank is necessary to see that all transactions are valid.

Okay, so blockchain, why block and why chain? The blockchain consists of bocks that are linked one after another. Each block contains a list of transactions, a block hash a random number and the hash of the previous block which acts as a reference of the order of the blocks.

This means that Bitcoin actually doesn't exist physically and also not on anyones device. Bitcoin as a currency IS the transaction history recorded in the blockchain that everyone is saving. Because with the transaction history you can always retrace which account or in Bitcoin terms which address owns how many Bitcoins.

So we need to look at the blocks themselves and understand whats happening here. What is a hash and why do they contain a random number?

But before that let's reason from the ground up and follow the course of a singe transaction. One person sending Bitcoin to another.

A transaction consists of three elements. The sender, receiver and the amount. These weird looking strings of characters and numbers are bitcoin addresses. They are 256bit numbers with some format restrictions. Which creates an unthinkably large amountof possible numbers. This is done so that the chance you create an address that someone already uses is basically zero. As a comparison, there are only 2 to the power of 63 grains of sand on all beaches of the earth, which is a way smaller number.

Every bitcoin address has a public key and a private key. The public key is whats displayed here. You can compare it to an email address. Everyone who has your email address can send you an email. So everyone who has your public key can send you Bitcoin.

But just by having your email address it doesn't mean the person can read your emails, they can only send to the address. The same applies to Bitcoin. To send transaction you need the private key of the address which acts like a password. Only difference: private keys are way more scure than your email password.

So back to our transactions. To confirm it the sender needs to sign it with his private key. The great part is that everyone else can verify that the transaction is valid by seeing the signature and public key. The verification checks if the signature was used by the private key that belongs to the public key. Asymmetric cryptography makes this verification possible without knowing the private key.

Now that all parameters for the transaction are filled and its signed by the sender its time to broadcast it to the network. The network participants verify if the transaction is correct and adds it to the Memory pool. Here all transactions are stored that didn't get bundled into blocks yet and add to the blockchain. At this point the transaction is already part of the Bitcoin network, but it's unconfirmed.

The next step is called Bitcoin Mining. Bitcoin miners take transactions out of the memory pool and put them into a block.

As we learned the block contains the list of transactions, the hash of the previous block, a new hash and a random number. One of the most important aspects of Bitcoin comes into place here. The SHA256 hash function or Secure Hash Algorithm. What does it do? It takes data like a string of text or a file and outputs a unique 256 bit number called a hash. It was developed by the NSA and is widely used for security.

Miners take the the transactions of the block and the hash of the previous block and apply the hash function to get the new hash of the current block. There is one limitation though. They need to find a hash with a predefined number of zeros at the beginning. This is the algorithmic problem they solve. To find that special hash they add a random number and increment that number over and over and over again until the solution was found. Once it was found every Miner needs to discard the Bock it's currently working on and start again. Here another core principle comes into play called proof of work. It takes work to find the right number by guessing, but it's very easy to verify if it is the correct number once it was found. If someone cheats and broadcasts the wrong solution everyone else will be able to see that it's wrong and don't accept it.

Another important question: Who defines with how many zeros the hash needs to start and why does it matter? This is defined by the protocol and adjusted dynamically in an automatic way. The numbers of zeros reflect the difficulty of the problem. The more zeros the more difficult. If the network gets more and more computing power through better hardware and more miners the solutions to the problem would be found faster and faster. This is not desired behavior. Instead a solution should be found on average every 10 minutes. This has two reasons.

First: Very fast confirmations would lead to some miners finding solutions simultaneously. This would fork the Blockchain in all sorts of ways and no one knows what the right order of blocks is anymore.

The order of blocks is really important though as it describes the exact transaction history. That's also why the blocks need to contain the hash of the previous block. It's a design feature that makes it really costly to change the transaction history. If one block is changed the hash will also change. So all next blocks have a new input. So their hash also needs to change. All the work needs to be redone. This gives confidence that the transaction history is indeed correct and not manipulated by someone.

If a cheater tries to broadcast a transaction to someone else but not to the whole network, therefore trying to double spend, this will get spotted rather sooner than later, because every participant of the network trusts the longest chain. To manipulate the longest chain you would need to have 51% of the whole computing power of the whole network. Here is a great explanation on how this fraud would not work out and just cost the attacker electricity:

Second Reason why the difficulty gets adjusted: The blocks contain a reward of newly created Bitcoin. These should not be distributed faster and faster, but instead on the prescribed 10 minute schedule.

But hold on a second, the block reward means issuance of new coins? That sounds like wide inflation all over again! It's very different. First of all no matter how many miners there are a new block gets created every 10 minutes. This means that the inflation rate is programatically fixed. You can look up yourself how many Bitcoins exactly are in circulation and how many there will be 10 years from now. No one can change this rate.

The other great thing: every 4 years an event called the halvening takes place, which cuts the block reward in half. Again, this is part of the rules and can't be changed by anyone. So the rate of newly created bitcoins gets lower and lower capping out at 21 million. Never ever will there be more than 21 million Bitcoins and no one can change this fact. This true scarcity plays a huge role in Bitcoins narrative to become digital gold. Miners also collect transaction fees, when you send funds to someone else, so even when all 21 million Bitcoins are mined they will still have a financial incentive to secure the network.

When I first understood how Satoshis design works it was completely mind blowing. And it still is today. It's an incredible achievement in the field of distributed systems. To summarize how incredible the technology comes together here and why Bitcoin definitely matters from a technological standpoint:

• The blockchain as a distributed ledger combined with asymmetric cryptography to create a system that works without trust in any actors or a third party
• Mining as a financial incentive to secure the network
• Proof of work preventing double spending and other fraudulent activities
• Dynamic difficulty adjustments to keep the confirmation of blocks and creation of new coins steady, no matter how advanced computing becomes.
• Halving the issuance of new coins every 4 years to create deflationary properties and make Bitcoin work as a store of value

Where will Bitcoin go?

When a medium of exchange is generally accepted in society, it is called “money.” So right now, Bitcoin is not money.

We are somewhere between stages one and two with Bitcoin. The store of value narrative becomes increasingly stronger as all fiat currencies get devalued rapidly.

Bitcoin is not really suitable as a medium of exchange right now because of high transaction fees and very limited scaleability. This is gradually changing through a second layer that builds upon the Bitcoin protocol. The Lightning Network is the contender in that area. But even if that would never happen and we never reach further than the second stage - Bitcoin has the greatest store of value properties that will ever exist, which is big enough of a value proposition to own some already.

There are also good arguments on why Bitcoin will bring financial services to the people who so far don't have access to banking to enable economic development. 2 billion people are still unbanked, a lot of them have internet access through some cheap android phone. Bitcoin is a solution for people living in countries that approach hyperinflation or have overly corrupt governments.

Bitcoin is unstoppable at this point as the internet or the worlds electricity would need to be shut down.

It makes no sense to ban Bitcoin from an economical point of view. If one country bans bitcoin and another doesn't, the second one will profit massively through human and monetary capital.

And of course it makes no sense from an ethical standpoint either. Bitcoin is code, which is speech. As long as we agree that freedom of speech is a good thing, you can't ban Bitcoin for ethical reasons.

And last but not least I believe that if a state tries to ban Bitcoin this raises doubt in the government even more. The harder you try to restrict it, the more obvious it becomes that it's entire value comes from not being restrictable. It's censorship resistant.

The fear that another Cryptocurrency will come up and crush Bitcoin like Facebook crushed MySpace is unfounded. MySpace has a market cap of 12 billion Dollar. Bitcoin is already more than 20 times as big as $250 billion dollar asset that has all sorts of network effects going for itself. History shows that once an asset and especially a network establishes a $100 billion valuation it has won. Bitcoin also profited from path dependence and an anonymous creator that left the project 9 years ago. Other cryptocurrencies either have a central face or are not big enough to be stopped by governments. So the order of how the events played out matters.

To be honest almost no Bitcoin critic gets it. While this sounds incredibly ignorant, I'm serious. Almost every critic just points out things that have been refuted before. Whether that's energy defficiency, missing scaleability, Bitcoin not having intrinsic value, government regulations, other new cryptos coming up as competitors, quantum computing destroying mining, Bitcoin getting hacked, Bitcoin being too volatile as a store of value and the list goes on and on.

Bitcoin has been announced dead by the media hundreds of times and yet it's still here up and running.

In my opinion the 3 biggest problems are one: concentration of mining pools, two: people not getting it, but fraud gets exposed over time, so the current system will not stay forever and three: a bug in the code that wasn't found within the last 13 years. While Bitcoin can still go to zero I give it a low probability.

In the end I believe Bitcoin is still the most convex bet of my lifetime. An investment with way higher potential upside than potential downside. Something that is bigger than an investment. Because in the end bitcoin is money.

Btw, don't consider this investment advice. It's an educational article I'm not here to tell you what you should spend your money on and how to plan your future. My advice is that you dig down the rabbit hole yourself and start to understand what's going on. Otherwise you will just have weak hands and sell whenever Bitcoin crashes, which will happen more than once down the line.

Central Bank Digital Currencies

Another interesting factor in the landscape will be Central Bank Digital Currencies (CBDCs) which will probably arrive as the next monetary system.

The eDollar and eEuro or whatever they will be called will just drive adoption of digital currencies though. They don't compete with Bitcoin, because they are still centralized. Someone is in control of the supply, so they are useless as a store of value. Inflation will be even cheaper compared to printing paper bills. They might also come with the big downside of zero privacy. You could be automatically taxed on each transaction and the state has all of your transaction data. So yeah, the incentive to own Bitcoin won't be lower at all once Central Bank Digital Currencies are here.

In the end no one knows where Bitcoin will go, what the value will be and when that happens. People who tell you they know what will happen are people you should right click and mute.

The longer the timeframe the better the chances that it will be up by a lot. Bitcoin is still tiny compared to Gold and therefore naturally volatile. Yeah Bitcoin is volatile, but it's mostly upwards volatility, something you actually want to be exposed to. My timeframe is longer than a few months or years. I believe Gold will go up as well in the midterm, but Bitcoin has more potential to grow and will eventually eat golds market cap through its superiority as a store of value.

Without a black swan event I'm confident that Bitcoins price will be higher in the future than it is now. The longer the time frame the better. That's all.

And if not at least I followed the most liberating peaceful try of a revolution of the 21st century that tries to defeat the moral hazard of the current system.

Final Notes

Bitcoin is the most fascinating, intellectually challenging thing I ever came across and this article was only a small non-complete summary.

The Bitcoin ecosystem attracts some of the smartest people in the world. From the best first principle thinkers, to cypherpunks, polymaths and a new generation of entrepreneurs.

And still as Jameson Lopp stated: "No one has found the bottom of the Bitcoin rabbit hole".

The Link In Bio For Bitcoiners

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