Demystifying Bitcoin – The Magic Internet Money
What Makes Money Worth Anything?
I am completely fascinated by the concept of money. What makes a picture of our first president on a piece of paper worth a dollar? I used to believe that our money was backed by gold. Turned out this hasn’t been the case for almost a half century. The only thing that makes a dollar worth a dollar is because of faith. People have faith that a dollar today is worth a dollar tomorrow. If I exchange that piece of paper with a picture on it for goods, the person that received it believes they can exchange it for the same amount of goods tomorrow. Faith.
What Makes Currency Work?
Currency is nothing more than a token of value and that value is based purely on supply and demand. As the supply of currency increases, the value decreases. If demand should decrease, so will the value. However, if supply decreases or demand increases, the value increases. Sheep were used as currency. As sheep became more plentiful, you needed more sheep to purchase land. If there was famine and you had sheep, your wealth, the value of your holdings, skyrocketed. Moving sheep around was very difficult and sometimes messy. So, tokens of value were used instead. If I have 8 sheep, and exchange them for a token that says I own 8 sheep and everyone is on board with that token being worth 8 sheep, then I could use that token for exchange of goods. For currency to work, it doesn’t need to be backed by anything but the faith of those who use it as an exchange medium.
Increasing the supply – Inflation
The problems with currency are well known. Counterfeiting currency occurs. This causes the value of the currency to go down as it actually increases supply. A decision to just print more money by the issuing agency will decrease value. If we decide to print twice as many bills as we have in circulation currently, the value is cut in half. What would happen if the decision was made to never print another bill?
What is this Magic Internet Money?
8 years ago next month, a computer programmer or group of them using the alias Satoshi Nakamoto released #Bitcoin. They released a very technical white paper that can be found at https://bitcoin.org/bitcoin.pdf
The gist is Satoshi set up tokens of value on the internet. To address the problems of inflation, he first set a limit of 21,000,000. There will never be more than 21,000,000 created or in circulation. Denominations of Bitcoin can be divided down to a millionth of a bitcoin, known as a Satoshi. If the wealth of the whole world is stored in Bitcoin, a satoshi would be worth about $0.04. With a finite supply, the only way value is decided is by demand.
To get these in circulation, computers must have special software to confirm transactions. Anyone can own these computers and software. The transactions are broken up in blocks that go to different computers to be confirmed. This allows no one full access to a bitcoin and the network of many confirms the transaction. The incentive of confirming these transactions is gaining bitcoin through fees or through confirming enough transactions to release a bitcoin which is then in this “miner’s” wallet. Almost 16,000,000 are currently in circulation using this method. Once all 21,000,000 are in circulation, the miners will be paid by fees alone.
By not having the flow controlled by an issuing agency and the ledgers and balances not being kept by a bank means there is no risk of inflation, no mistakes by one central authority, and a conglomerate of network miners verifying transactions based on simple supply and demand. A miner in New Zealand may confirm the first part of a transaction while a second part may be confirmed in Argentina and a third in Kenya.
To prevent counterfeiting, the code of bitcoin is based on all the transactions being recorded along with when it was transacted. The code is considered unhackable because it is constantly changing, complex, and decentralized. You would need to get the right codes off of many different miners to recreate the chain of transactions, then put them in the right order, and then get it confirmed before another transaction occurs. A virtual impossibility.
If value is increasing, then demand is increasing, right?
So, the question becomes demand. Why would anyone want Bitcoin? The average amount of currency is “taxed” by #banks at 3% through fees. If you take $50 out of an ATM, you could pay anywhere between 6-10% in fees. When you use a debit card at a store, that store is paying 1.5% in fees. A credit card average fee is 3% for the store plus any interest accrued by the consumer. If a store is netting 8% of its revenue, then these fees are taking 20% of its profit. Those costs are passed onto the consumer in 2-3% price increases.
With Bitcoin, the fees can vary between 0-0.2%. I sent $18.00 worth of Bitcoin to a bookseller in Austria for $18.01. This transaction was confirmed in 8 seconds. International transfer fees from banks can be as high as 21%. If I travel from the US to Jamaica, I will now have more to spend through Bitcoin as I will not have exchange rates and bank fees to pay for. Wiring money can have fees of over 10%. With bitcoin, it is a transfer of data from one virtual wallet to another with fees less than .2%. $582 billion dollars were sent in remittances to home countries last year. This means the fees for that were at least $58 billion. With bitcoin, $1 billion in fees MIGHT be paid. If your family will receive 10% more value, you are more likely to use bitcoin.
So, yes, demand is rising. As is speculation. People are buying bitcoin to sell later at a profit. Unfortunately, this also is causing fluctuations in value. In 2010, a Bitcoin was worth $0.08. In 2011, it went from $1 to $31 and then back to $2. It has gone as high as $1000 and has hit a low of $200 since then. As I write this, the value has varied between $570 and $630 just in the last month. How much faith would you have in a dollar if it could be worth $0.95 or $1.05 in a month? With wild fluctuations like that, merchants will fear accepting bitcoin. It does not have the faith needed yet to make it a viable currency, but its demand and acceptance is growing.
Well, Where Do We Go From Here?
The Yap in the Eastern Pacific used large limestone as currency. Instead of moving handheld currency, the stone was a public ledger that was used to show who owned what value. A riveting story to read up on if you ever get the chance. It had me doing a ton of research as to what makes money have any value. We use the dollar today instead of gold because of fluidity and a common value. We can go almost anywhere and get something in exchange for a dollar. The value of that dollar is generally accepted as fact only because IT IS GENERALLY ACCEPTED. If we were dealing with a culture that does not know of a dollar, they would laugh at you for attempting to exchange those pieces of paper for work or goods. Just as you would laugh at the Yap for offering a piece of their stone for your computer.
Bitcoin’s value is solely based on demand as supply is finite. Miners are inflating the amount of bitcoin in circulation by 4% per year currently. This will be cut to 2% in 2020 as the amount of bitcoin released is cut in half every 4 years. This is programmed in and cannot be changed. Once that 21,000,000th bitcoin is released, then no more bitcoin can be mined.
Demand far outweighs supply currently and continues to grow. The factors that can stop this are still plenty. Banks and financial institutions drastically dropping fees. Another #cryptocurrency being created that makes Bitcoin look like Atari or MySpace. A buyer hoarding bitcoins suddenly sells all theirs (It is estimated that Satoshi holds 1,000,000 bitcoins).
Use and acceptance has been doubling almost every year since bitcoin crossed parity with the dollar. If I believe bitcoin will double in value every year, that makes a bitcoin worth 5 figures in 5 years. I believe this will occur and invested in bitcoin. However, I also know that something better may come along and make bitcoin valueless. I can’t put all my eggs in one basket.
The Bottom Line
Cryptocurrency is the future of money. The evolution is upon us and occurring as we speak. The internet of the early 90s is the cryptocurrency of today. Whether we like it or not, this is happening. I believe the market share bitcoin owns ($9.6 billion of $12.1 billion) and 8.5x larger than the next cryptocurrency forces bitcoin to be more readily accepted than the others. Putting speculating on the future aside, I see cryptocurrency becoming the world standard of value and that will occur sooner than we ever expected. Le Roi Est Morte, Vive Le Roi.
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