Bitcoin is a first-generation cryptocurrency that is used for buying goods and services.
When its white paper was published in 2008 by the pseudonymous person (or persons) Satoshi Nakamoto, the aim of it was to deliver an alternative to the banking system for the global population. At publishing, it remains the number one cryptocurrency with a market cap valued at $62.7 billion, according to CoinMarketCap.
It is built on a concept called Proof-of-Work, which is created through the process of mining. In order to mine a Bitcoin, a node needs to solve a complicated algorithm. The node that solves the answer first is rewarded with newly minted Bitcoin. At the moment, 12.5 Bitcoins ($42,000) are rewarded. The third and next “halving” – the point at which the reward is halved – is to take place in 2020 when the number of Bitcoin rewarded falls to 6.25.
Why Do Bitcoins Have Value?
Currency is usable if it is a store of value, or, put differently, if it can reliably be counted on to maintain its relative value over time and without depreciating. In many societies throughout history, commodities or precious metals were used as methods of payment because they were seen as having a relatively stable value. Rather than require individuals to carry around cumbersome quantities of cocoa beans, gold, or other early forms of currency, however, societies eventually turned to minted currency as an alternative. Still, the reason many examples of minted currency were usable was that they were reliable stores of value, having been made out of metals with long shelf lives and little risk of depreciation.2
In the modern age, minted currencies often take the form of paper money which does not have the same intrinsic value as coins made from precious metals. Perhaps even more likely, though, individuals utilize electronic currency and payment methods. Some types of currencies rely on the fact that they are “representative,” meaning that each coin or note can be directly exchanged for a specified amount of a commodity. However, as countries left the gold standard in an effort to curb concerns about runs on federal gold supplies, many global currencies are now classified as fiat. Fiat currency is issued by a government and not backed by any commodity, but rather by the faith that individuals and governments have that parties will accept that currency. Today, most major global currencies are fiat. Many governments and societies have found that fiat currency is the most durable and least likely to be susceptible to deterioration or loss of value over time.
Bitcoin Compared Against Fiat Currencies
When Bitcoin was launched in 2009, its developer(s) stipulated in the protocol that the supply of tokens would be capped at 21 million.5 To give some context, the current supply of bitcoin is around 18 million, the rate at which Bitcoin is released decreases by half roughly every four years, and the supply should get past 19 million in the year 2022.6 This assumes that the protocol will not be changed. Note that changing the protocol would require the concurrence of a majority of the computing power engaged in Bitcoin mining, meaning that it is unlikely.
The approach to supply that Bitcoin has adopted is different from most fiat currencies. The global fiat money supply is often thought of as broken into different buckets, M0, M1, M2, and M3.7 M0 refers to currency in circulation. M1 is M0 plus demand deposits like checking accounts. M2 is M1 plus savings accounts and small time deposits (known as certificates of deposit in the United States). M3 is M2 plus large time deposits and money market funds. Since M0 and M1 are readily accessible for use in commerce, we will consider these two buckets as medium of exchange, whereas M2 and M3 will be considered as money being used as a store of value. As part of their monetary policy, most governments maintain some flexible control over the supply of currency in circulation, making adjustments depending upon economic factors. This is not the case with Bitcoin. So far, the continued availability of more tokens to be generated has encouraged a robust mining community, though this is liable to change significantly as the limit of 21 million coins is approached. What exactly will happen at that time is difficult to say; an analogy would be to imagine the U.S. government suddenly ceased to produce any new bills. Fortunately, the last Bitcoin is not scheduled to be mined until around the year 2140.8 Generally, scarcity can drive value higher. This can be seen with precious metals like gold.
21 million Bitcoins is vastly smaller than the circulation of most fiat currencies in the world. Fortunately, Bitcoin is divisible up to 8 decimal points.9 10 The smallest unit, equal to 0.00000001 Bitcoin, is called a “Satoshi” after the pseudonymous developer behind the cryptocurrency. This allows for quadrillions of individual units of Satoshis to be distributed throughout a global economy.
One bitcoin has a much larger degree of divisibility than the U.S. dollar as well as most other fiat currencies. While the U.S. dollar can be divided into cents, or 1/100 of 1 USD, one “Satoshi” is just 1/100,000,000 of 1 BTC. It is this extreme divisibility which makes bitcoin’s scarcity possible; if bitcoin continues to gain in price over time, users with tiny fractions of a single bitcoin can still take part in everyday transactions. Without any divisibility, a price of, say, $1,000,000 for 1 BTC would prevent the currency being used for most transactions.
One of the biggest selling points of Bitcoin has been its use of blockchain technology. Blockchain is a distributed ledger system that is decentralized and trustless, meaning that no parties participating in the Bitcoin market need to establish trust in one another in order for the system to work properly. This is possible thanks to an elaborate system of checks and verifications which is central to the maintenance of the ledger and to the mining of new Bitcoins. Best of all, the flexibility of blockchain technology means that it has utility outside of the cryptocurrency space as well.11
Thanks to cryptocurrency exchanges, wallets, and other tools, Bitcoin is transferable between parties within minutes, regardless of the size of the transaction with very low costs. The process of transferring money in the current system can take days at a time and have fees. Transferability is a hugely important aspect of any currency. While it takes vast amounts of electricity to mine Bitcoin, maintain the blockchain, and process digital transactions, individuals do not typically hold any physical representation of Bitcoin in the process.
Durability is a major issue for fiat currencies in their physical form. A dollar bill, while sturdy, can still be torn, burned, or otherwise rendered unusable. Digital forms of payment are not susceptible to these physical harms in the same way. For this reason, bitcoin is tremendously valuable. It cannot be destroyed in the same way that a dollar bill could be. That’s not to say, however, that bitcoin cannot be lost. If a user loses his or her cryptographic key, the bitcoins in the corresponding wallet may be effectively unusable on a permanent basis.12 However, the bitcoin itself will not be destroyed and will continue to exist in records on the blockchain.
Thanks to the complicated, decentralized blockchain ledger system, bitcoin is incredibly difficult to counterfeit. Doing so would essentially require confusing all participants in the Bitcoin network, no small feat. The only way that one would be able to create a counterfeit bitcoin would be by executing what is known as a double spend. This refers to a situation in which a user “spends” or transfers the same bitcoin in two or more separate settings, effectively creating a duplicate record. While this is not a problem with a fiat currency note—it is impossible to spend the same dollar bill in two or more separate transactions—it is theoretically possible with digital currencies.
What makes a double spend unlikely, though, is the size of the Bitcoin network. A so-called 51% attack, in which a group of miners theoretically control more than half of all network power, would be necessary. By controlling a majority of all network power, this group could dominate the remainder of the network to falsify records. However, such an attack on Bitcoin would require an overwhelming amount of effort, money, and computing power, thereby rendering the possibility extremely unlikely.