13 April 2020
In this article, I’m going to make the case for considering to allocate a small amount of your savings to Bitcoin. I’ll do that by explaining what Bitcoin is, along with how and why it might become valuable.
Prior to the invention of Bitcoin, there were many attempts to create “digital money”, but they all suffered from the same basic problem: How do you prevent a unit of digital money from being copied, the same way you can copy an MP3 file? If you could duplicate a unit of digital money, you could then spend it more than once, making it worthless.
An anonymous person (or group) named “Satoshi” published a solution to this problem, in which a global network of computers in which anyone (known as “Bitcoin miners”) can participate, compete to process collections (“blocks”) of Bitcoin transactions every 10 minutes, adding those transactions to an ever-growing global database of all transactions, known as the “Bitcoin blockchain”.
Once the database has been modified (a new block of transactions added), the only way it can be changed is for a majority of all miners to agree to modify it. This solved the “double-spend” problem. I can try to spend a Bitcoin twice, but the network of Bitcoin miners will simply reject it, since its original spend is permanently recorded on the blockchain.
Miners are incentivized to compete to process transactions since, anytime they “win”, and get to add a block of transactions to the database, they earn both newly minted Bitcoins, as well as all the fees present in the current block of transactions.
Finally, only 21 million Bitcoins will ever be created, ensuring the “scarcity” that’s such a fundamental characteristic to anything used as “stable money”.
(There is no limit to how many US dollars can exist. Since the United States government can create new money at will, and have always done so, the value of the US dollar, in terms of its purchasing power, can drop as much as 90% over a typical person’s lifetime.)
Once the last Bitcoin, i.e. the 21 millionth Bitcoin, is issued to some miner, future miner revenue will come exclusively from the fees people pay to make bitcoin transactions, and the fees themselves are determine in a free-market process.
In short, Satoshi described, and set into motion, a system of money that runs on the internet, solves the double-spend problem, is permissionless in the sense that nobody can stop you from acquiring or spending Bitcoin, in exactly the same way that nobody can stop you from sending and receiving email, and above all is “sovereign”, meaning that, just like the internet, it’s under the control of nobody and everybody at the same time, such that no state or government can globally stop it.
There is only one thing that gives Bitcoin value, and that’s social agreement. It’s the fact that an ever growing segment of the global population agree that it has value. And since that segment is growing, the demand for Bitcoin tends to exceed the supply (or people willing to sell their Bitcoins) such that, over time, the value of Bitcoin measured in US dollars has increased from zero to (at present), nearly $7,000.
This might seem strange, but there’s nothing to stop society from agreeing to assign value to a scarce commodity. In fact, we’ve been doing that for thousands of years—i.e. gold! With Bitcoin, it’s exactly the same.
Bitcoin has many of the same money-like properties that make gold valuable, but with improvements:
Just like the US government has three branches to provide for checks and balances (the President, the Legislature and the Judicial), Bitcoin has three fundamental groups that independently and inter-dependently control Bitcoin:
In a famous historical dispute, one group wished to increase the number of Bitcoin transactions that get processed every 10 minutes, thereby allowing the Bitcoin network to function more like the Visa network (high transaction volume, low fees). Increasing the number of transactions per block would result in only those with the most powerful computers being able participate in Bitcoin mining (transaction processing).
The Core community preferred to keep the number of transactions fixed, thereby trading off higher fees (as many transactions compete to be included in the next constrained-sized “block”, the transaction fees get bid up) for ensured broad distribution (minimal centralization) of Bitcoin mining.
The conservatives won that dispute, and the “big blockers” duplicated the Bitcoin software, creating what’s known today as “Bitcoin Cash” (a completely different cryptocurrency.) Bitcoin Cash (known as BCH) has never achieved the value of Bitcoin Core (BTC).
There are many scenarios that would lead to different values of Bitcoin in the long term:
What we can be fairly certain of, is that in ten years from now, Bitcoin will not be $7,000. It will likely either be worth zero, or much much more than it is today. And as every year passes, the latter outcome appears more probable!
The dramatic range of possible outcomes for the price of Bitcoin in the long term (zero to millions of dollars) makes investing in it a tremendously asymmetric bet. For that reason, it would seem to make sense (as recommended by successful entrepreneur Wences Casares) that everyone should own a small amount of Bitcoin, perhaps one to five percent of your wealth.
At that level, if it goes to zero, your life won’t be impacted too much, but if it increases by 100 from where it is today, it would have a big impact on your net worth.