Within the financial independence community there are a mix of views when it comes to Bitcoin or Cryptocurrencies, as can be expected.
There are some who are vehemently against it all and say that this is simply another fad or bubble, that something that is intangible or unregulated can't possibly be a safe place for your money. While the price may be rising right now, those who put their money in will ultimately regret it.
On the opposite side of this viewpoint there are some who are strong advocates for this phenomena, claiming that decentralised finance is the new paradigm and will completely replace the existing financial system.
And then there are those in the middle who don't really know much about it and are simply trying to make sense of it all, wondering if putting a little part of their portfolio into Bitcoin is a "smart" or "fool's" move.
But let's be honest, this last group of people aren't the only ones who don't know much about Bitcoin. The same could probably also be said about the first two groups despite their honest passion about their views.
Most are basically just repeating titbits of information that they've heard somewhere else but haven't actually gone to the source to verify what it actually means.
For example, when someone says Bitcoin can't possibly have any value since it isn't "real" do they actually know what the technology is and how it works?
And when someone says "decentralised finance is the future" do they know why DeFi is important in the first place?
How many of these people would be able to give an honest "yes" if you asked them if they've read the original whitepaper for Bitcoin?
This article isn't aimed as criticism towards those people because I'll be honest, I myself can't really claim to know the in-depth details of Bitcoin; so maybe I'm just another one of those people on the internet making arguments or standpoints without actually knowing "all that much".
But it cannot be ignored that when the topic is brought up within the financial independence communities there's often not that much information on offer, and more than a little bit of mockery, whenever a brave individual decides to "expose themselves" by asking.
With that in mind I went and did a little digging into some of the fundamentals that I think might be helpful for everyone to know before they ever put their first penny into "investing" into Bitcoin.
Q1: Who created Bitcoin and when?
The Bitcoin network was launched in January 2009 with the first block being mined by Satoshi Nakamoto, the same person who authored a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System published in October 2008. When people talk about the "Bitcoin whitepaper" this is the paper that they are referring to.
Although Satoshi Nakamoto is seemingly the name of an individual, the true identity of this person or group of people is unknown.
Nakamoto continued to contribute to the development of Bitcoin after its launch until 2010 before mysteriously disappearing in 2011. Their last known piece of communication was an email to another Bitcoin developer named Mike Hearn where Nakamoto simply said "I've moved on to other things."
Despite their real identity being unknown there is a public Bitcoin wallet believed to belong to Nakamoto that contains 1 million Bitcoin worth - at time of writing - around $49 billion (yes, billion with a B).
However the thing that's truly bizarre is that those coins have not been accessed, moved, or spent since January 2009.
Q2: What was the original problem that led to Bitcoin?
Unlike "cash in hand" where you can physically see and receive money, if you were to receive an electronic payment directly from someone else, i.e. an online customer to your business, you wouldn't know if that payment was legitimate.
This is due to a potential flaw with the system where "digital cash" could be duplicated or falsified, allowing a dishonest party to spend that money more than once. For example if they had £100 in their digital account and duplicated it, then spent £100 on two different things, only one of those transactions would effectively be "real".
Under such circumstances you would therefore be receiving "money" that someone else also received and this would then cause a dispute to who is the rightful owner of that original £100.
This is known as the double-spending problem.
In today's world the way to "mitigate" this is to go through a trusted third party, typically a financial institution, who can process the payments and verify funds. In fact, this is how most online payments work in the current day - when you buy something online or when you make a payment transfer to someone else you do so via your bank or through an institution such as Visa.
The need to have a trusted third party in order to verify and mediate transactions leads to increased transaction costs, and ultimately a loss of control as you must rely on that third party to complete any payments with a degree of certainty.
Bitcoin was created as a paradigm that would allow two willing parties to transact directly with each other without the need for a trusted third party.
Q3: How does Bitcoin solve it?
Bitcoin's solution to the double-spending problem uses a peer-to-peer network where all transactions are based on cryptographic proof (instead of trust) that can be verified by anyone on the network. The network agrees, based on a majority, which transaction history is the truth and that is the history that will be used going forward for all new transaction proofs. This is known as blockchain.
Think of it as a long audit trail that can be traced back to the very first transaction ever performed on Bitcoin. The audit trail is computationally generated for each transaction by digitally signing a hash of the previous transaction, a timestamp, and the public key of the next owner, then adding that cryptographically generated "proof" to the end of the coin.
The new transaction is then broadcasted to the entire Bitcoin network that will check the entire audit to verify that the Bitcoin transaction is legitimate and isn't a double spend. If a double spend incident has been found then the transaction with the earliest timestamp is the only one that counts and the others are ignored or abandoned by the network.
This new transaction is then accepted by the Bitcoin network as the "longest chain" in the blockchain and therefore the "source of truth" in terms of transaction history. This means that any new transactions will be added to the end of this chain as opposed to any other shorter chain that might have been floating around the network.
This leads to there being only one single history that is unified and can be traced back to the beginning of Bitcoin without any gaps. Since that "unified history" that is accepted by the network contains a record of the transaction the network itself acts as the trust layer.
This would then allow two willing parties to transact directly with each other without needing to go via a trusted third party because they can both simply accept the longest blockchain as "proof" of the transaction being legitimate and not a double-spend.
Author's note: If you're unfamiliar with the terminology don't worry. Basically there is a history of transactions that can be traced back to the very beginning of Bitcoin. Each spend or transaction of Bitcoin adds an "event" to that history chain and the network can then check if this event is not a double-spend by checking for other events that could potentially dispute it. If no disputes are found the event then becomes accepted by the network as part of the history and from that point on the transaction is deemed "proven" and therefore legitimate.
Q4: Could someone rewrite the history of Bitcoin to take back their payment?
The longest chain of Bitcoin is computationally generated by the "honest network" and the speed in which this "honest chain" is generated is based on the combined computational power (CPU) of that network.
If someone made a transaction on Bitcoin and then wanted to "steal back" that payment, they would need to change the block in the chain that contained their transaction and then rewrite it so that the payment never happened, therefore meaning they get to keep their Bitcoin.
The attacker who managed to modify a past block in the "honest chain" would then have a new chain - the "attacker chain" - that they would need the honest network to accept.
However the "attacker chain" would be behind in terms of the computational work that has been done by the network, and is therefore not the longest chain which means it wouldn't be accepted. This is because the honest chain would have continued forward by generating new blocks (transaction events that are recorded) after that past block which was modified by the attacker.
Ultimately the "attacker chain" would need to catch up to the "honest chain" by redoing all of the computational work (proof-of-work) for all new blocks that came after that past block, and then surpass it in order for it to be accepted as the new longest chain.
With a slower rate of work being done by the "attacker chain" due to less computational power than the honest network the probability of an attacker catching up while being behind becomes vanishingly small depending on how large that deficit is. This is described as the Gambler's Ruin problem in Nakamoto's whitepaper and he provides the mathematics to prove the logic.
In simple words, the further back in history that the block the attacker is trying to change is, the less chance they have of succeeding since the honest network will keep ploughing forward, meaning the history that needs to be changed is getting longer and longer.
Since the honest chain is generated via computational power of the honest network, an attacker could theoretically use an alternative method by acquiring more computational power than the combined network as a whole. This is described as a 51% attack meaning that the attacker holds more than half of the entire network's computing power.
With more computational power under their control it simply becomes a matter of time where the "attacker chain" would eventually catch up since the calculations are being done faster by the attacker, meaning that the double-spend of a Bitcoin would become possible.
This would be an incredibly difficult feat to pull off as effectively the more honest nodes there are in the network, the more honest computational power there would be to overcome for the attacker.
However, assuming the attacker did manage to pull this off they would be faced with a choice of changing a historical transaction to steal back their payment, or using that computational power to continue the network in an honest manner and generate new Bitcoins for themselves via mining.
Effectively the attacker would have an incentive to become "honest" as it would be more profitable to do so, since they could use their superior computational power to generate more coins than everyone else combined and it wouldn't make sense for them to undermine the system that grants them this newfound wealth.
Q5: What is Bitcoin mining and the "halving"?
Although there can be a maximum of 21,000,000 Bitcoins not all of them have come into existence as of yet, and they will not do so unless they are "mined".
Mining is a process where honest nodes on the Bitcoin network contribute their computational power to solve computational problems that will further the honest chain.
The more honest nodes there are mining, the more computational power there will be in the honest network making it more secure and more robust (as described in the previous question), enabling Bitcoin to be continued to be used and trusted as a decentralised protocol for payments.
In return, miners are rewarded as an incentive to contribute their computational power to the honest network. Each new block that is mined will yield a number of new Bitcoins into circulation.
When the Bitcoin network was first released the reward was 50 Bitcoins per block that was "mined". However, after every 210,000 blocks the reward gets cut in half in order to keep "Bitcoin inflation" under control and this is known as the "halving".
This means miners would need to spend more and more computational power in order to acquire more new Bitcoin, making it a scarcer and more difficult commodity to acquire, and thus maintaining its value.
Currently (March 2021) the reward for each block mined is 6.25 Bitcoin and the next estimated halving will occur in 2024. However, as the halving occurs based on a set amount of blocks being mined this is simply an estimate based on the rate of mining that is happening at the moment.
It is estimated that the final block of Bitcoin will be mined around the year 2140.
Q6: Who writes Bitcoin's code and how do we know they can be trusted?
Something that people may not realise is that the Bitcoin protocol continues to be developed and evolved through programming code. In the early days it was Satoshi Nakamoto themselves along with some other collaborators who did most of the coding for Bitcoin in order to resolve bugs with the technology.
However since Nakamoto's departure in 2010 the project has become more consensus driven meaning that anybody can try to make changes to Bitcoin's code but it is extremely difficult for it to become "accepted".
It's a bit like a political voting system where a candidate wants to introduce a new policy. Without enough consensus (or votes) from the society they are trying to convince, their policy will never become integrated into that society no matter how many times they try to "introduce" it.
Even if a few groups of people decide to go with that new policy, it wouldn't be "standard" unless the majority accepted it.
Bitcoin code works in a similar way where anyone who develops new code will need to submit it to the development community, which could involve hundreds if not thousands of other Bitcoin developers, for peer review.
If it passes peer review and testing it can be accepted as "committed code" into Bitcoin's code repository by a select few contributors with the access to do so. This essentially means a new updated version of Bitcoin's protocol now exists containing the newly committed code.
However, this isn't the end of the acceptance process.
To mitigate against those select few contributors acting in their own interest by committing code that will personally benefit themselves, the entire network must then "accept" the new version by actually upgrading to it and using it.
This means no single or small group of developers can "force a change" in Bitcoin because the users, i.e. miners and exchanges, are free to choose which version they use.
In order to stay compatible with each other, all users would need a version that complies with the same rules meaning that if only a small part of the community upgrades to a new version, it won't actually become the "accepted version" if nobody else upgrades.
Since Bitcoin only works correctly with a complete consensus among its users there is a strong incentive for the entire community to protect this consensus and this is what makes the development of Bitcoin secure and trustworthy.
Q7: Is it really possible for Bitcoin to reach a value of $1,000,000 per coin?
By design, the maximum amount of Bitcoin is set at 21,000,000 in total and this cannot be changed unless the Bitcoin protocol itself is changed. This would involve convincing the entire Bitcoin community to move to a new version of the protocol where the limit was increased.
As mentioned in the previous question, this is a feat that would be incredibly hard to achieve since there would be little to no incentive for the community to accept a change that would effectively de-value their existing Bitcoin holdings due to inflation.
Assuming the protocol doesn't change, a price of $1,000,000 per Bitcoin would mean a total market capitalisation of $21 trillion for Bitcoin (1 million x 21 million).
Based on the Global Wealth Report 2020 by Credit Suisse, the aggregate global wealth reached $399.2 trillion, with North America alone accounting for almost $124 trillion.
If roughly 5% of the total global wealth in 2020 were to be placed into Bitcoin, the price of each coin would not only reach $1,000,000 but likely surpass it.
If the entirety of total global wealth were to be converted into Bitcoin, that would mean a price valuation of about $19,000,000 per bitcoin.
An alternative way to look at this is to take the total market capitalization of gold, another scarce and valuable commodity, and apply it to Bitcoin. With the market cap of gold currently being around $10.8 trillion the price of a single Bitcoin would reach over $500,000 if its market cap were to reach similar levels.
Not quite a million but it shows that there's plenty of money in the world and if enough of it were to be funnelled into Bitcoin then the price can - quite easily - reach those high valuations.
Q8: So would I need to be a millionaire to get involved with Bitcoin?
A misconception of Bitcoin is that you need to purchase it as a "whole", which makes it intimidating for newcomers as they're faced with the prospect of spending large amounts of money in order to get involved.
However, just like the dollar has cents and pound sterling has pennies, Bitcoin has something called a "Satoshi" which represents the sub-unit.
While the cent is 1/100 of a dollar, a Satoshi is 1/100,000,000 of a Bitcoin (one hundred millionth).
At the current price of Bitcoin (around $49,000 on 6th March 2021) the value of a single Satoshi is roughly $0.00049, meaning you'd get about 2,040 Satoshi for a single dollar.
If you assume the price of Bitcoin reached $1,000,000 per coin a single Satoshi would be valued at $0.01 (one cent). And if Bitcoin reached $19,000,000 per coin a Satoshi would be worth $0.19.
So the answer is no, you don't need to be anywhere near a millionaire to get involved with Bitcoin.
Q9: How is Bitcoin a hedge against inflation?
In the past, money used to be backed by gold meaning the value of your coins and notes could be linked back to something physical which would be representative of its real value. An ounce of gold is an ounce of gold so there could be little to no dispute that your money, which was linked to that gold, would be worth the amount claimed.
Author's note: I'm sure I'm grossly oversimplifying this but it still gets the point across that your money was backed by something physically valuable.
However this gold standard was abandoned in 1971 and was replaced by the fiat money system which is the system that is in use today.
The problem with fiat money is that it is simply government-issued and not backed by any commodity, meaning that the government can simply print more whenever they feel the need to, i.e. as stimulus for a flagging economy.
With more money in circulation due to additional printing the value of a single unit of currency, i.e. the dollar, would be diluted and therefore weaker in comparison to when there was less money in circulation. This leads to inflation meaning more money is needed in order to buy the same amount of goods.
Since the amount of Bitcoin that can exist is locked at 21,000,000 and nobody can make any more after that, the value of a single Bitcoin can never be diluted and therefore its value in relation to fiat currencies will naturally rise as they inflate.
This is what makes Bitcoin a hedge against inflation and is also why Bitcoin supporters use the government's acts of creating stimulus as further confirmation that Bitcoin is a superior "store of value".
Q10: What was the first thing ever purchased with Bitcoin?
The first known transaction using Bitcoin was on May 22, 2010 when Laszlo Hanyecz purchased two pizzas from Papa John's for 10,000 (yes, ten thousand) Bitcoin, worth roughly $41 in total at the time.
To be clear, Hanyecz didn't pay the Bitcoin directly to Papa John's but instead made the offer on the BitcoinTalk forum where he said he would pay 10,000 Bitcoins to whoever ordered him two large pizzas. The offer was taken up by Jeremy Sturdivant who made the pizza purchase with regular money and got Bitcoin from Hanyecz in return.
Author's note: At least I assume that's how the transaction went down.
As Bitcoin's price has risen over the years there have been many comments and jokes about how those two pizzas have become the most expensive ever. Fortunately Hanyecz doesn't seem too bothered by the deal and considering he was an early miner of Bitcoin it's likely he still had (has?) plenty to spare.
In fact, he reportedly went on to make numerous other trades and purchases using Bitcoin.
The day is now known in the cryptocurrency community as "Bitcoin Pizza Day" and is celebrated annually.
My brain sort of hurts from all this digging around for information and trying to articulate it in a way that I think might make sense to a normal reader. Hopefully I managed to achieve that a little...
But in any case, with these 10 fundamental questions being asked you probably now know much more than the majority of people out there who are buying Bitcoin.
Here's the crux of it - While Bitcoin itself isn't some sort of "hard commodity" since it's basically just digital code it doesn't mean that it is simply some magical internet money where the value is purely based on speculation and hype.
Yes, there is some of that going on since most people out there haven't taken the time to look at the fundamentals but beyond all of that craziness there was an original problem, the double-spending problem, that was the driver for Bitcoin's creation.
Can the price of Bitcoin drop to zero and effectively make it worthless?
The answer is "Yes".
Even the FAQ on bitcoin.org mentions this is possible citing other failed currencies such as the German Mark and the Zimbabwean Dollar as examples of how no currency can ever be considered absolutely safe from failures or hard times.
But as time marches forward with the technology behind Bitcoin become further developed and established, it does feel as though the arguments against it grows smaller and more distant while the arguments for it grow stronger and more ever present.
Stimulus, inflation, and institutional involvement are just a few discussion points that often get the Bitcoin community buzzing.
At the start of this article I mentioned that most people looking at Bitcoin don't really know much about it and are simply trying to make sense of it all, wondering if putting a little part of their portfolio into Bitcoin is a "smart" or "fool's" move.
But in a way it feels as though that question has more recently been ever so slightly re-framed, and people are now instead wondering if ignoring Bitcoin is a "smart" or "fool's" move.
It sounds like they're essentially asking the same thing yet in reality the underlying tone simply shows just how far things have come.
With that in mind, how long will you stay in the dark about the fundamentals?
Hey - just one final word before wrapping up - I started listening to the Bitcoin Audible podcast late last year and it has honestly given me a much deeper appreciation of the entire cryptocurrency space and the overall value proposition.
I once thought of Bitcoin purely as a form of money but thanks to the podcast I now think in much wider terms and see it as a game changing network technology that could fundamentally change so much in our world.
With this newfound view and my own investigation into the potential value of each Bitcoin, I simply got to a place where I could no longer ignore it and decided that investing a small portion of my money into Bitcoin was the only logical thing to do.
My mission is to help people understand their money by making financial scenarios or concepts easy to understand.
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