Bitcoin – BTC, the first and most popular cryptocurrency created in 2009 has influenced many people’s lives, for better and for worse. But what drives this online phenomenon and why is Bitcoin important?
All information about Bitcoin in one handy overview.
By now most people have heard about bitcoin through the news. Often bitcoin is then mentioned in the same breath with various issues such as crime and money laundering, getting rich quick (or poor) and pyramid schemes. In this article we aim to provide you with an objective view of what bitcoin actually is.
Bitcoin is an invention of one or more anonymous individuals, who operated under the pseudonym Satoshi Nakamoto. The idea was to develop a medium of exchange that would allow transactions to be made over the Internet, without relying on central agencies such as banks.
You may already be familiar with other forms of direct exchange over the Internet (also called peer-to-peer), for example from downloading via Limewire or torrents. These also involve the direct exchange of data, without the intervention of a central authority. Bitcoin works in a similar way, but instead an amount of bitcoin is exchanged, which represents a certain value. Bitcoin is characterized by direct, secure, verifiable and immutable transactions between two individuals, without the intervention of a bank or similar authority.
Unlike traditional money such as the dollar or euro, the amount of bitcoins in the world is not determined by banks; everything is fixed in the way bitcoin is coded. Only a limited number of bitcoins are released each day, and these are distributed to anyone who uses computer power to contribute to the bitcoin network. This is also called mining, and anyone with a computer can participate. As a reward, one then receives bitcoin, and the more one contributes, the greater this reward.
Aside from its lack of dependence on a central authority, there are numerous other things that make bitcoin different from other means of payment. In addition, bitcoin offers a number of major advantages over traditional means of payment.
The smallest fraction into which the euro can be divided is 1 cent. In the case of cash, this is 5 cents in the Netherlands. Bitcoin is divisible into a hundred million particles, making it possible to perform microtransactions. One hundred millionth particle of bitcoin is called a satoshi, or sat for short, so one satoshi is 0.00000001 bitcoin.
Currencies such as the euro or dollar have an unlimited supply, which means that central banks have the power and ability, whenever they want, to influence or manipulate the value of the currency relatively to another currency, for example by creating more money. T =his leads to inflation: over the years, houses become more expensive, supermarket prices gradually go up, stock prices rise… But you can also look at it the other way around: the purchasing power of money decreases relative to all other goods or products, as more money enters the economy.
Bitcoin has a limited supply. There will never be more than 21 million bitcoin in circulation around the world. Currently, about 18.6 million bitcoins have been created, so almost 90% of the maximum supply is already in circulation! A fixed number is added every hour and distributed among the miners, but this number is decreasing over the years. In fact, about once every four years, a so-called halving takes place, where the amount of bitcoin added daily is halved. The next halving will take place in mid-May 2024. Finally, the very last bitcoin will not be mined until around the year 2140.
Currently, 6.25 bitcoin is released per block that is mined. Since it takes about 10 minutes to mine a block, this means that the total number of bitcoin increases by about 900 daily. Starting with the next half-life in 2024, this number will decrease to 450, and so on.
Whereas regular money gradually decreases in value, bitcoin is constructed so that its value will actually increase. Under the condition that bitcoin is embraced more and more by people worldwide, the price will increase, especially as the digital currency becomes increasingly scarce due to the halvings.
So far, this certainly seems to be the case; although there are also occasional steep declines, an upward trend in bitcoin’s value has been evident since its existence. Because the value of bitcoin is so volatile with its large price fluctuations, the medium seems unsuitable for normal payments for the time being. Of course, one does not want to just accept bitcoin in place of euros when the value can increase or decrease significantly in half a day, with all the risks that entails. This is why bitcoin is often used primarily as a store of value, a kind of digital gold which is still in the early stages and therefore lends itself very well to investment purposes.
The discovery has also created an entirely new market that allows for massive speculation on bitcoin and other crypto-currencies. Many of these are based on the technology of bitcoin, and are actually trying to improve the underlying technology, or see in the technology other applications besides the function of value transfer. For example, it is possible to store all kinds of data in encrypted form on the blockchain network; the idea is that this technology will be able to automate many administrative operations, as processes that currently require manpower are processed in code.
Before bitcoin was created, various other attempts happened to develop a digital payment system that works peer-to-peer, directly from person to person. This proved to be a challenging task, because if something is digital and there is no supervisory body to keep an eye on it, how do you prevent fraud? When it comes to cash, it is difficult to counterfeit money in such a way that you are not immediately noticed.
The book money (that we have in our bank accounts) is actually also digital money, because we can exchange it without there being any physical transfer, but it is managed by the banks, which supervise the transactions. Digital money without an overseeing authority seemed impossible, because how do you prevent the system from being hacked, or digital coins from simply being copied?
To solve this problem, Satoshi Nakamoto came up with the principle of the blockchain. This genius invention creates a self-monitoring system, where all transactions are kept in a public register. This register is continuously updated on all nodes (computers that are part of the bitcoin network and have a copy of the blockchain stored).
The blockchain is a concept that is quite difficult to understand. For more detailed information, please visit our article that explains more about blockchain. The most important thing to remember in the context of bitcoin, is that the blockchain facilitates a trustless system. That is, the system ensures that transactions can be conducted properly without the need for the individuals involved to rely on each other. This was a crucial prerequisite for giving a digital peer-to-peer payment tool any chance of success.
“Digital money without an overseeing authority seemed impossible, because how do you prevent the system from being hacked, or people from simply copying digital coins?”
As explained earlier, all book money (the money in your bank account) is managed by your bank. Although people think of this money as their own, they do not own it; so they trust the bank to handle it responsibly. With Bitcoin, this is emphatically not the case; you own a piece of code that is effectively your property and represents a certain value. Only you manage this bitcoin, not the bank.
The fact that bitcoin has had a growing number of users since its birth indicates that a growing group of people see the added value of this. It is also interesting, to note that bitcoin saw the light of day in the aftermath of the previous financial crisis (also known as the credit crisis) of 2008. While a large group invests in bitcoin because they expect demand (and therefore price) to increase, idealistic motives often play a role among bitcoin proponents as well. Be your own bank is a commonly heard slogan in this world.
As with any new technology, it is not immediately optimal; this is also true for bitcoin. There are a number of conceivable disadvantages, for example the variable price. Perhaps bitcoin will also prove better suited in the long run as a kind of digital variant of gold rather than a means of payment. But even then, volatility can be a barrier to global adoption. However, the degree of volatility will decrease as bitcoin grows. To date, Bitcoin still is primarily seen as an investment and not a means of payment (yet);
The variable price makes people use bitcoin mainly to speculate on, it is therefore little used as a real means of payment. It could well be that if you do exactly the same shopping one day you pay 0.025 bitcoin and the next day suddenly 0.04 bitcoin. Thus, your groceries have suddenly become a lot more “expensive” when you only look at the number of bitcoin. In addition, it is also difficult to pay for your groceries in bitcoins anyway, because how much bitcoin is a bag of chips of € 1.49? Most people remember what it was like when the euro was introduced: “how many guilders is that?”, they would ask. And what a hassle it was to calculate that every time. So using a different exchange rate every time you do your shopping is not something that many people want to do.
When the price of bitcoin rises rapidly, the transaction costs (fees) can also increase at a rapid pace, as is currently the case. At the time of writing, it costs nearly $10 to record a single bitcoin transaction on the next block within the blockchain. During the height of the past bitcoin bubble in December 2017, the transaction cost of a single bitcoin transaction was even more than $35.
An update to the bitcoin protocol, called Segwit (short for “segregated witness”), has significantly reduced the cost of transactions. The rollout of this update took place in the first quarter of 2018 and has resulted in a significant drop in transaction costs. Although, at the time of writing, the stock price is twice as high as it was during the 2017 peak, transaction costs are still a lot lower than they were back then. Nonetheless, $10 is quite the expense, when compared to the costs during a quieter period.
VISA, a company that develops one of the most popular payment systems, claims to be able to process 65,000 transactions per second. However, stories on the Internet range from 1,700 to 24,000 transactions per second. Whatever the actual number, when you pay with your debit card, it almost always happens within seconds.
Bitcoin, at the time of writing, can only process 7 transactions per second. This makes it a tremendously slow payment method, especially when you compare it to some other crypto-currencies that claim to be able to process even a higher number of transactions than VISA. When you pay with bitcoin, in cases of high traffic it can sometimes even take hours for your payment to be confirmed. This makes it an unsuitable alternative compared to the well-known payment systems already in circulation.
Although bitcoin is currently slow, the Lightning Protocol (a software upgrade), is going to change that. The Lightning network forms an additional layer on top of the blockchain, and favors as a separate payment channel formed between two parties wishing to make a transaction. Learn more in this video.