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What is Bitcoin and Why it Matters

What I learned from The Bitcoin Standard

Jan 13 · 6 min read

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Photo by André François McKenzie on Unsplash

Different people have different interpretations of what bitcoin is; some have a philosophical definition, some say it is a Ponzi scheme, some see it as a false system made to disrupt economic stability, and others see it as a monetary revolution of the 21st century.

Here, I will explain Bitcoin as a medium of exchange and store of value that can be used to transfer value between individuals and emphasize its importance in our current economic structure. My explanation of what Bitcoin is is based on the book ‘The Bitcoin Standard’ by Saifedean Ammous.

What is Money

Let’s look at our history and try to understand what money is. I am leaving out the barter system because I assume the readers are aware of its limitations and it feels irritating to read the same thing again.

Before we start, let’s define some key terminologies.

Stock to flow ratio for a commodity is defined as its years of inventory relative to annual supply. In theory, a good with high stock to flow ratio should retain its value for the long term.

Salability — A salable good is one which is fit to be sold and maintains its value across space and time

According to Investopedia, a Store of Value is essentially an asset, commodity, or currency that can be saved, retrieved, and exchanged in the future without deteriorating in value. In other words, to enter this category, the item acquired should, over time, either be worth the same or more.

So what exactly is money?

Anything that can be used as a store of value, common medium of exchange, is salable across space and time, and is hard to produce can be used as money.

Now, let’s break it down.

Imagine a hypothetical society where cattle are used as money (At one point in time, they were money!). Now, because cattle are money, for whatever good I want to purchase I will exchange hens, cows, or dogs with the good. What is the problem with this arrangement?

Each animal will have a different lifespan, fertility rate, milk production, and other varying factors, so you can’t exactly give value to them. You cannot trade 1.5 or 2.7 of a cow posing another problem with exchange.

They will have a different age at any point in time, thus decreasing their value with time. Thus, this form of money is not salable across time, we cannot use it as a store of value because it is depreciating in nature.

Let’s take another example of copper.

If we use copper as money, then copper mining becomes the most rewarding job in the world. Everyone will shift to copper mining because of its abundance, increasing its supply, and decreasing the value of existing copper in the market. This means copper has a low stock to flow ratio.

Copper cannot be used as a store of value because it can corrode easily, decreasing in value with time. It is easy to produce, and with time, the supply of copper has just increased because of its ever-increasing demand for industrial use and almost unlimited supply, decreasing its price.

Money which is hard to produce and can withstand the test of time is essential for the growth of any society.

Why Bitcoin Matters

Many have associated Bitcoin with gold, and now it is popularly known as digital gold. Why Gold?

Gold has been used as money or a store of value for more than hundreds of years, and it still maintains a special position among all the assets. It has retained its value throughout this time because of scalability across space and time.

Chemical properties of gold allow it to be almost indestructible, making it salable across time, and its rarity allows it to store a large value in fewer quantities, making it salable across space. A limited supply of gold and the complexity involved in its mining gives it a high stock to flow ratio, making it a good store of value — A safe Haven.

Even today, after the world has rejected the gold standard, central banks have stockpiles of them reserved because of gold’s high purchasing power and it is only actual money, everything else is just credit.

When the world was under the gold standard, banks issued dollar bills that represented gold in their storage. But as the demand for money kept increasing to fund wars and to make weapons, more and more money was printed, more than the available gold. This led to a decrease in the purchasing power of the money and gold became more and more expensive. While gold retained its value, money was depreciating in value.

This is the problem with the current system of money. The government can print as much money as they like for negligible cost and it is the citizens who face the harshest consequences.

With the advent of the internet, anyone can be connected to anyone in the world. This technology made the blockchain, decentralized network, and Bitcoin possible.

Bitcoin is a cryptocurrency in a peer-to-peer decentralized network that stores the record of all the transactions ever made using blockchain.

Bitcoin, amongst many other problems, aims to solve this problem of an ever-increasing supply of money. Central banks can print as much money as they want because money is not backed by anything. They can create credit out of thin air thus devaluing the currency and leading to inflation.

Bitcoin is made and runs through algorithms, and the maximum supply is fixed at 21 Million coins. No matter what, this number cannot be increased unless there is a 51% attack, which is almost impossible.

The mathematical cryptographic puzzle required to create a block and then mint bitcoin is a proof of work algorithm which gets harder after each halving. The halving takes place every 210,000 blocks (almost every 4 years) reducing the supply of bitcoin with time, giving it a high stock to flow ratio.

I know there were a few technical terms there, but in simple terms, it means that you can use Bitcoin anywhere you want, free from the clutches of any government. You can make transactions anonymously. You can use Bitcoin as a store of value because of its high stock to flow ratio, and no one can increase the supply of bitcoin, making it an ever-increasing value asset.

This is important because bitcoin empowers people with control over their own money, and no sole party can influence the value you hold.

With the traditional money, it is the government that has all the control over it and the ability to create it in unlimited quantities whenever they see fit to fund whatever they think is right. In the short term, it might work and may not have serious consequences, but in the long term, hyperinflation is inevitable.

We have seen the same with various governments around the world, and a prime example is Venezuela. A country which was once the richest in the whole of Latin America in 2000, now has the minimum wage fixed at 0.9 € per month because of 53,798,500% hyperinflation between 2016–2019.

It is hard to even imagine the hardships of people in Venezuela. This is the reason they have shifted to cryptocurrencies to store their value and a medium of exchange.

So, what is Bitcoin, and why it matters?

Bitcoin may not be the best for day-to-day transactions because of its low transaction per second and high transaction fee, it may not be the best solution for all our monetary problems at the moment. But it is the first cryptocurrency and the first idea which made it possible to empower people with money.

As we use gold to store value for the long term and not for day-to-day transactions, I believe that Bitcoin will be used for the same. There are other coins such as NANO with zero transaction fees and low latency suitable for everyday transactions and there are other cryptos like Ethereum and Cardano to support other applications.

Bitcoin has inspired many people and showed that it is possible to create a digital currency and a digital ecosystem ruled by the people and not by a particular entity. Bitcoin has a networking effect and is the most accepted cryptocurrency thus it is the one you can trust to store value.

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