On February 16 2021, Bitcoin hit $50,000 in cryptocurrency exchange. This means, one unit of Bitcoin is worth more than a shiny new BMW 3-series in the USA. But what this really means? What is Bitcoin? Why people says that it is the future of currency? We explore in details the technical aspect of bitcoin, why it is worth $50k in the market and what it means to you.
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Bitcoin was invented by Satoshi Nakamoto in 2008. The correct word is probably invented by Satoshi Nakamoto since it was determined that it was a pseudonym of a person or persons working on bitcoin concept. The bitcoin concept was released as a research paper / manifesto about building a digital coin and a public ledger for the internet age. Many concepts in bitcoin are founded on basis of cryptography, privacy, security and peer-to-peer reinforcement of trust.
Based on the paper about bitcoin, the motivation behind bitcoin is to create a digital currency complete with a distributed ledger to track transactions. The trust in any transaction is established through peer-to-peer checks and balance. Of course, when reading between the lines, you can have the sense of libertarian leanings where something as fundamental as money in today’s society would not or should not be involves the government.
There are two major concepts in bitcoin: the electronic coin (e-coin) itself and the block chain. The e-coin is a chain of e-signatures. The e-signatures is the combination of two keys; one private and one public; which creates a hash. The transaction involves by signing the hash of previous transaction and the public key of the next owner. The payee can verify the the signature to verify the chain of ownership. A key it a 64-bit hexadecimal word. A hexadecimal digit has 16 values from 0 to 9 and a to f. In decimal value (the one we everyday use) the number 1234 is represented as 4D2.
Now we have a ledger that keep tracks of each transaction of the coin ownership. Now the problem is what the author call the ‘double-spending problem’. It is a problem of trust where how do you know that the previous owner has not spend the coin elsewhere. The solution to this problem comes in two parts
The first part is that the hash include timestamps. The timestamp hash is chained and must be in ordered because that’s the progression of time. The timestamp hash is widely published.
The second part is the ‘proof-of-work’ concept. In the first part, you have a chain of blocks. Each block records transactions. To record and validate the block, this is where the miners come in. The miners will verify the block. A process which is difficult to guess but easy to verify. What the miners want to do is to create a hash that matches the current block target. Once the first miner found the correct hash, it will announce it to the network and the next block get validated again. The reward for guessing it right is getting the the coins in the block and transaction fee for future transaction on that particular block.
The major technology leap to make bitcoin work is the block chain network. Why it is called the block chain. Imagine each transaction is a block. Just like in any bank accounts or ledger, the transactions are linked from one transaction to the next. This is the chain in the block chain. So block chain is a chain of blocks which hold information about transactions.
The miners comes in to unlock and verify each transactions. It is a racing game where the first to solve and verify the hash will win the chain. The reward for the first to verify the block with the correct hash is having the coin in the block. The bitcoin network has some modification that the amount of coins earned in each block will cut in half for every 210,000 blocks. This will ensure that the coins in circulation is artificially limited.
Another feature of this block chain, once it is verify with the hash, the hash is announced to the rest of the nodes in the network. So the network will work on the next block of chain. Changing any transaction in any verified block will change the hash. The will ensure that fraud is hard to attack.
Why Bitcoin is hitting $50k?
This is the part that many would question. How does a digital currency that is not widely accepted anywhere worth $50,000. $50,000 worth of what?
Bitcoin is traded on an exchange namely Coinbase, CashApp and Binance. The bitcoin prices, just like stocks and commodity, follows the law of supply and demand. The supply of bitcoin is limited to 21 million coins and as of mid-February 2021, there is 18.6 million coins has been mined. Since the amount of coins available in each block is fixed and the amount will half every 210 thousand blocks, it is estimated that all the bitcoin supply will end in 2140.
Now we got the supply side economics out of the way, the question is why is Bitcoin is in demand? Bitcoin is not being used officially as means to settle any debts in any countries unlike any other currency. According to American Institute for Economic Research, the value of bitcoin is derived from the payment system itself. Bitcoin is both money and payment system. Like Visa or Mastercard, services to easily transfer money from one entity to another entity is indispensable.
Bitcoin investors put money in bitcoin holdings because they believe it the value will raise in the future. In other words, just like fiat money, gold, stock and any other commodities, Bitcoin has value because significant number of people believe that it has value. Just like a $100 dollar bills has value of $100 despite it costs the US government 16 cents to make each bill. It because enough people believe that the US dollars has value and backed by the US government. Bitcoin in this case it backed by its own system of blockchain to ensure every transaction is bona fide and secure.
Will Bitcoin be the new money
So now we get the other question that is being popping up in the internet. Will digital currency like bitcoin will be the new money and eventually replace fiat money that is backed and controlled by various governments around the world? In the short and medium term, no, but in the long term, who knows?
For money to be accepted as a reserve currency, it has to be accepted by all parties. Take for example the major reserve currency, the almighty United States dollar. The reserve status of the US dollar is based on the size and strength of the US economy and the dominance of the US financial market. There is many stock exchanges in the world, but the New York Stock Exchange is the big kahuna. And not only US has the largest stock exchange, it has also the second largest stock exchange: NASDAQ. In the list of top 10 largest exchange in the world, the US holds the top two and it’s larger than the next 8 combined.
Despite that, there are a few companies that embrace cryptocurrency. Tesla announced that they had invested $1.5 billion in bitcoin and considering to accept bitcoin for car purchase in the future. That being said, Tesla CEO Elon Musk said that Bitcoin is almost ridiculous as fiat (hard) money.
To be clear, I am *not* an investor, I am an engineer. I don’t even own any publicly traded stock besides Tesla.— Elon Musk (@elonmusk) February 19, 2021
However, when fiat currency has negative real interest, only a fool wouldn’t look elsewhere.
Bitcoin is almost as bs as fiat money. The key word is “almost”.
There are some countries who are not invested in bitcoin but are launching their own cryptocurrency. Dubai has announced it launching it own cryptocurrency called emCash (Emirati Cash) but as of press time, it has not being launched despite announcement in 2017. Venezuela announced it’s own cryptocurrency, Petro, but the venture has failed to achieve the economic independence that it desired.
Bitcoin as a currency can be the libertarian’s dream. A currency that is accepted by society and not controlled by any government, just upheld by everyone in the system through series of cryptography check and balances. For libertarian, hard currency is the “final boss” against government control since basically all hard currency is issued by governments, bitcoin provides a viable alternative.
One of the bitcoin features is that is has a finite supply. 21 million coins and around 18 million plus mined to date. Amount of coins found in each block mined will cut to half every 210 thousand blocks and currently the payoff is around 6.25 bitcoins per block. Because of bitcoin is a finite resource and the demand is expected to rise, bitcoin will suffer from deflation problem. The price of bitcoin will raise as demand rise and the supply dwindle. This will incentivize people to hold on to their bitcoin. One of the reason why governments wants some inflation is to encourage spending behavior. Your spending in my income and my spending is someone else’s income and so on and so fourth. Holding on and not spending means no economic growth. The other problem of this behavior is bitcoin has turned into a speculative assets instead of means of payment as it was designed to be.
Prominent economists also have a problem with Bitcoin and other cryptocurrency. Paul Krugman in his column said that he’s skeptical with currency as a payment utility. Joesph Stiglitz said that bitcoin should be outlawed and does not serve any useful function. Robert Merton said that it is not real money because it cannot be used to settle any tax or accepted as payment. Warren Buffett said that bitcoin is a worthless delusion and rat poison squared. So the consensus among prominent economists, investors and businessman is not good for bitcoin.
Another criticism of bitcoin is the cost of maintaining the systems and mining the bitcoin itself. It has been reported that the current electricity usage to maintain and mine the bitcoin protocol is the same as Switzerland annual usage in 2019. All this to maintain a system that yet to be in widespread usage. The counter point of that is fiat money in use expands more resources to print, distribute and maintain than current cryptocurrency of the day.
A major criticism of cryptocurrency is that the identity of the one who owns the cryptocurrency is shielded. So you don’t really know who owns money in the public ledger. And since the money cannot be seized or maliciously transferred nor traced, it has become attractive for money laundering. In November 2020, someone has transferred around 1 billion dollars worth of bitcoin. In normal banking industry, these transaction would raise some eyebrows since it involved a large transfer of money. However, in bitcoin world, such transaction is possible, but no one would know it belongs to who.
Bitcoin vs Economic Fundamentals
One fundamental foundation of modern economics is the currency is controlled by the government. The government also control how much money banks can loan out to other people. The government also controls how much money to introduce into the system to spur growth or to cut spending. These are the basic macroeconomics principles 101 which the nuances build up to their own specialized field.
Does bitcoin has the same economic switches to improve or control the economics of a nation? If bitcoin is adopted as a national currency does it have the same controls as the current monetary policy. The idea of bitcoin and other cryptocurrency is the control is decentralized so no government can seize, freeze, print or destroy any money in circulation. What’s the consequences of that? I’m not an economics expert so I don’t really know.
To be valuable, money must be accepted by all parties as money. In an example for US dollar, it is expected as the legal tender to settle all debts, public and private because the government through law and social acceptance, accept the piece of money is that is the US dollar is considered as money. In the case of bitcoin, there just no mainstream acceptance to use bitcoin as a form of currency just yet.
On 24 March 2021, Elon Musk, CEO of Tesla Motors tweeted that his company will accept Bitcoin as payment to buy their cars. The bitcoin will remain as bitcoin and not be converted into fiat money. This mark the first major company to accept bitcoin as means to settle debts. Now it remains a question if other companies will follow suit and what might the US government will do about it. Update Elon Musk has decided to drop support for Bitcoin for environmental reasons. He did said that he’s open for alternative cryptocurrency that use less than 1% of Bitcoin energy consumption.
You can now buy a Tesla with Bitcoin— Elon Musk (@elonmusk) March 24, 2021
Tesla & Bitcoin pic.twitter.com/YSswJmVZhP— Elon Musk (@elonmusk) May 12, 2021
So what is the future for bitcoin and other cryptocurrency? In the short term, it would stay alive as it has gained more and more interest. Warren Buffett said that it is currently a mania and bubble waiting to burst. It is not surprising if in 10, 20 years it won’t be use anymore. For now, bitcoin prices is soaring higher and higher and no one is sure what will happen.
On March 2021, there is news that The US government through the Federal Reserve is studying methods about digital currency. Work is being done between Federal Reserve of Boston and MIT to create an alternative to paper currency. How the system will work is expected to be shown on July for discussion.
How bitcoin and cryptocurrency works in general:-
How block chain works:-
How economy works in 30 minutes:-
The first 10 minutes explains money and transaction and how it works in the general economy.
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