Definition from Oxford dictionary: Bitcoin is a type of digital currency in which a record of transactions is maintained and new units of currency are generated by the computational solution of mathematical problems, and which operates independently of a central bank.
Definition from Google: Bitcoin is a digital currency which operates free of any central control or the oversight of banks or governments. Instead it relies on peer-to-peer software and cryptography. A public ledger records all bitcoin transactions and copies are held on servers around the world.
Definition from CoinDesk: Bitcoin is the world’s first successful decentralized cryptocurrency and payment system, launched in 2009 by a mysterious creator known only as Satoshi Nakamoto. The word “cryptocurrency” refers to a group of digital assets where transactions are secured and verified using cryptography – a scientific practice of encoding and decoding data. Those transactions are often stored on computers distributed all over the world via a distributed ledger technology called blockchain
I have included three separate definitions of Bitcoin because it can be a bit difficult to define since it means something different to different people. For some it is a speculative investment, for others it is freedom technology and hope, some already use it as a currency, some use it purely as a savings technology for the time being and still others are focused on building businesses and new technology on the network of Bitcoin, from banking services to social media protocols and applications.
What is clear in these definitions is that it is a peer-to-peer, censorship-resistant network of transacting value without a third party. Bitcoin is a digital bearer asset backed by real world energy and cryptography. This real world energy includes, capital to buy miners and pay for electricity, along with the building of infrastructure to support the mining equipment and conversion of hydroelectric, solar, wind and other types of energy production. Bitcoin cannot just simply be created out of thin air like fiat currency or a digital picture. It is the first time in history that true digital scarcity has been achieved.
What does this mean?
Bitcoin solved a major issue in the digital realm that people have been trying to solve for decades. Everything digital can be infinitely copied at no cost whatsoever. Think of all the cat pictures and videos online that make there rounds. This is a huge problem when addressing digital currency. Bitcoin was not the first try at creating scarce digital money. Bitcoin was just the first one that worked. There have been attempts at creating a decentralized money online since about the 1970’s and Bitcoin used several of the inventions of other attempts and bootstraps them together to harness real world energy to create digital scarcity. This means although Bitcoin is digital, it cannot be replicated, or spent in two places at the same time. Bitcoin is truly the first digital bearer asset.
There are five aspects of Bitcoin that we are going to cover to get a better idea of what this thing is and how it is different than the fiat currencies that dominate the world.
21 Million Hard Cap
Proof-of-Work
Difficulty Adjustment
The Halving
Stock-to-Flow
21 Million Hard Cap
The most important part of Bitcoin is that there will only ever be 21 million coins available (each Bitcoin can be divided into 100 million units know as Satoshis). The halving cycles and difficulty adjustment work in tandem to give us a good sense of when the last Bitcoin will be mined, which will occur in the year 2140. There is no other asset that has this predictable supply issuance and that is a big deal because Bitcoin is solving one of the most important problems in the world today.
That problem is that there can be an infinite amount of fiat currency printed. There is no cap to fiat currencies and the people making the decisions to make more are easily influenced to do so. As we discussed in earlier articles, this devalues everyone’s money and set’s up extremely poor incentives in business, politics, trade, and personal life. Money touches almost everything in our lives and Bitcoin is the first money we have ever had that has a fixed supply cap. This will level the playing field for everyone on the planet and the system is completely voluntary. You can chose to use it or not, unlike most all fiat currencies that you are forced to use depending on which country you are born in. With Bitcoin everyone knows how much wealth they have relative to the entire system. In fiat the equation when thinking about your wealth equals your Dollars divided by potentially infinite dollars, but in Bitcoin your wealth equals your amount of Bitcoin divied by 21 million. By holding Bitcoin you cannot have your wealth devalued. It is the ultimate savings technology over the long run.
Proof-of-Work
It does help to think of Bitcoin as digital gold. The analogy works well because like gold, Bitcoin uses a Proof-of-Work mechanism to “mine” new coins. Much like gold miners uses physical labor (energy) and capital to extract the the metal from the earth, Bitcoin miners use real world energy and capitial to mine bitcoin. Although it is mined in the digital realm, it still takes real world resources to mine the asset. This is much different than fiat currencies and other cryptocurrencies that are digitally printed with no work or value added. This Proof-of-Work mining process links bitcoin to the real world, as there is no free Bitcoin and no one can simply create more on their own.
Difficulty Adjustment
Keeping the Gold comparison in mind, bitcoin has a key feature built into the protocol that separates the two assets. The feature is called the difficulty adjustment. To understand this feature we need to discuss the mining process. Miners, in bitcoin are simply computers making guesses to solve a mathematical puzzle if you will (this is a very simplified explanation, but it will help us understand the process). When a miner solves the puzzle by guessing correctly, a new “block” is mined and put into the blockchain. In this block is the reward subsidy which at the time of writing is 6.25 bitcoin along with a batch of transactions waiting to be broadcast to the network and all the fees included with these transaction. Bitcoin blocks are mined roughly every ten minutes. This gives the protocol enough time to verify the the blocks without getting bogged down.
Knowing this info we can again compare Bitcoin miners to Gold miners. As the price of either asset goes up, it incentivizes more miners to come into the space. In Gold, more miners means more Gold being extracted from the earth. This rush will last until the supply catches up to the price where it then falls back into a stable range and the frenzy dies down. In Bitcoin more miners come in and can actually find blocks at a faster pace. Just as in Gold this will increase the supply, but unlike Gold, Bitcoin’s protocol readjusts its difficulty to mine blocks every 2016 block or about every two weeks (2016 x 10 minutes = roughly 2 weeks). This mechanism is know as the difficulty adjustment and what it helps foster is a predictable supply of Bitcoin. This means no matter how many miners there are, whether it is 10 or 10 million, the protocol will always readjust the difficulty to mine blocks to roughly ten minutes. This allows us to know within a very accurate window, how much supply of Bitcoin will be available. Unlike Gold and other commodities, there is always a steady flow of Bitcoin being mined and no amount of miners can change this supply in the long run. This ensures that no miners can cheat the system or unfairly distribute coins and it gives the users of the system near perfect predictability of the supply, which is unlike any other asset we have ever known.
The Halving
Another protocol feature in Bitcoin that no other asset on the planet has is called the Halving. This occurs every 210,000 blocks or roughly every 4 years. When Bitcoin fist began producing blocks in 2009, the miner who mined the block was rewarded with 50 Bitcoin. So every 10 minutes a new 50 Bitcoins entered the market. Every four years, this 10 minute reward gets cut in half. We have been through 3 having cycles and the Bitcoin block reward is currently at 6.25 Bitcoin. The next halving is in May of 2024, where the reward will be cut to 3.125 Bitcoin. This feature of the protocol creates a huge supply shock every four years which is about when the price begins to accelerate, before cooling back off in later months. This not only creates a ton a price action and hype, it also brings in a new wave of people that become interested in the asset and with more interest becomes more people who buy and hold for the long term. Which creates even more of a supply reduction over time. Every halving cycle creates a high stock-to-flow ratio for Bitcoin and the asset becomes more and more scarce.
Stock-to-Flow
The difficulty adjustment and the halving play a large role in the Stock-to-Flow of Bitcoin. the Stock-to-Flow ratio is a way to analyze commodities by assuming scarcity drives value.
- Stock: Refers to the existing quantity or supply of the commodity.
- Flow: Refers to the annual production or newly mined quantity of the commodity.
The formula for the stock-to-flow ratio is: Stock divided by flow
A higher stock-to-flow ratio indicates a lower annual production relative to the existing supply, suggesting a higher level of scarcity.
Gold’s stock-to-flow ratio is about 59 which is very high compared to most other commodities. Stock-to-flow of gold = 190,000 tons of stock divided by about 3,200 tons per year = 59
Meanwhile silvers ratio is about 22 which is one of the main reasons Gold has beat Silver out for it’s monetary use as it holds value better. This ratio works well for commodities but is not useful for fiat currencies that can be printed out of thin air at different amounts.
Bitcoins current Stock to flow ratio is 58.3 which about matches gold, however Bitcoin’s Halving feature will eventually make Bitcoin’s stock to flow infinite.
21 Million Hard Cap
The characteristics and features of Bitcoin and its protocol all lead up top the most important part of Bitcoin. There will only ever be 21 million coins available (each Bitcoin can be divided into 100 million units know as Satoshis). The halving cycles and difficulty adjustment work in tandem to give us a good sense of when the last Bitcoin will be mined, which will occur in the year 2140. There is no other asset that has this predictable supply issuance and that is a big deal because Bitcoin is solving one of the most important problems in the world today.
That problem is that there can be an infinite amount of fiat currency printed. There is no cap to fiat currencies and the people making the decisions to make more are easily influenced to do so. As we discussed in earlier articles, this devalues everyone’s money and set’s up extremely poor incentives in business, politics, trade, and personal life. Money touches almost everything in our lives and Bitcoin is the first money we have ever had that has a fixed supply cap. This will level the playing field for everyone on the planet and the system is completely voluntary. You can chose to use it or not, unlike most all fiat currencies that you are forced to use depending on which country you are born in. With Bitcoin everyone knows how much wealth they have relative to the entire system. In fiat the equation when thinking about your wealth equals your Dollars divided by potentially infinite dollars, but in Bitcoin your wealth equals your amount of Bitcoin divided by 21 million. By holding Bitcoin you cannot have your wealth devalued. It is the ultimate savings technology over the long run.
If you find this interesting and you are looking for more resources on Bitcoin I personally recommend these books and podcasts below.
Books
The Bitcoin Standard by Saifadean Ammous
Broken Money by Lyn Alden
Layered Money – By Nik Bhatia
Podcasts
We Study Billionaires – The Bitcoin episodes come out every Wednesday
What Bitcoin Did
Blue Collar Bitcoin
Mindful Hitting 