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Bitcoin: Part 1 of 2 - What it is & its Original Thesis

General Breakdown

You may have heard about bitcoin and all its volatility, but does anyone really know what bitcoin is? Beyond what it appears to be or do? If you check the bitcoin website itself; www.bitcoin.com - as a starting point on this learning journey, it would say “Bitcoin is an innovative payment network”. In the simplest of terms, bitcoin is a software, a set of protocols and processes which enables a new form of trustless electronic payment. So in an even simpler form, Bitcoin is a super precise transaction ledger able to keep transactions categorized chronologically, which then goes through a mining process which validates each transaction without the need of a third party. This is without a doubt innovative and of extreme relevance to minimize external parties to a simple transaction.


"We define an electronic coin as a chain of digital signatures. Each owner transfers the coin to the next by digitally signing a hash of the previous transaction and the public key of the next owner and adding these to the end of the coin. A payee can verify the signatures to verify the chain of ownership. The problem of course is the payee can't verify that one of the owners did not double-spend the coin. A common solution is to introduce a trusted central authority, or mint, that checks every transaction for double spending. After each transaction, the coin must be returned to the mint to issue a new coin, and only coins issued directly from the mint are trusted not to be double-spent. The problem with this solution is that the fate of the entire money system depends on the company running the mint, with every transaction having to go through them, just like a bank. We need a way for the payee to know that the previous owners did not sign any earlier transactions. For our purposes, the earliest transaction is the one that counts, so we don't care about later attempts to double-spend. The only way to confirm the absence of a transaction is to be aware of all transactions. In the mint based model, the mint was aware of all transactions and decided which arrived first. To accomplish this without a trusted party, transactions must be publicly announced, and we need a system for participants to agree on a single history of the order in which they were received. The payee needs proof that at the time of each transaction, the majority of nodes agreed it was the first received. "

- https://bitcoin.org/bitcoin.pdf (original White paper of Bitcoin)


The blockchain, while used in a decentralized manner allows for transactions to take place with no third party needed. Instead of a bank or financial institution confirming your transactions, it would be a bitcoin miner validating the transaction over the internet. Bitcoin miners run complex computers to solve complicated puzzles in an effort to confirm groups of transactions called blocks; once the block is successfully confirmed, these blocks are added to the blockchain record which in turn make them irreversible. The minors are then rewarded with a small amount of Bitcoin for this process. This provides incentives


Miners who secure the Bitcoin blockchain get incentivized to do so, but there will come a time that the miners will no longer be able to be paid in new bitcoin. A set amount of 21 million Bitcoin will ever be produced. Once the 21 millionth bitcoin is produced the miners will no longer be getting paid in new bitcoin, but will be incentivized via the transaction fees attached to the transfers of bitcoin from wallet to wallet. Now this is good for two things. Number one the miners will be paid to continue being rewarded for validating transactions (this allows for indefinite securitization) after the mining is done which in turn secures the network indefinitely. Secondly we have the scarcity component. In the case of Satoshi’s vision for bitcoin, the scarcity aspect of bitcoin has no advantages hence why in the original white paper, there is no mention of scarcity or total mention of bitcoins. In my opinion, I think particularly because the fact that there are 21 million bitcoins is the reason why there will not be mass adoption of the crypto. If you’ve ever bought fragments of a bitcoin you’d know that it is very complicated to calculate your exchange only in Bitcoin. That's why most apps or websites of exchanges have it pre-set in fiat so it is easier/clearer to perform a bitcoin exchange. But now, if you were to look at bitcoin as a storage of value (SoV), the scarcity aspect can help induce people to buy the coin; rarity which drives human desire and psychology. Beauty is something that respects the law of scarcity. A purely psychological benefit if bitcoin we’re to be used as a storage of value instead of a means of exchange.


This Bitcoin network runs on something called the blockchain. The blockchain is a protocol that consists of a single chain of discrete blocks of information, arranged chronologically. The information stored on the blocks are irreversible and can be any string of 1’s and 0’s, meaning it could include emails, contracts, land titles, marriage certificates, or bond trades. In theory, any type of contract between two parties can be established on a blockchain as long as both parties agree on the contract, but for now the most common use of the blockchain is as a ledger (a list of transactions). So no one should be able to deny the future power of this innovative ecosystem, for this has given us a stepping stone on which to begin the optimization of contract and payment dynamics.


Since bitcoin is decentralized, in the sense it simply needs the peers who seek to exchange and the blockchain to validate the transactions. There are no central banks to govern the currency. It would help stop artificial inflation and allow for a slow organic inflation (assuming forking and other cryptos do not get bundled up which creates an expanding and diluting basket of cryptos).

Original White Paper Thesis

Let us now bring it back to its origins to contextualize its original thesis. Bitcoin was created by some character named Satoshi Nakamoto. Back in 2008 Satoshi published something called the Bitcoin White paper - https://bitcoin.org/bitcoin.pdf . This white paper explains what bitcoin's original thesis by its creator is, how it works and what its main uses are to be. This gives us the starting point of our journey into understanding bitcoin. “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” That is the first sentence of the paper, which means that Mr. Nakamoto intended Bitcoin to be used as some sort of global currency, to provide a simpler and more efficient and trusted means of exchange. This is where we can conclude that a lot of people get confused with the original value of bitcoin. If bitcoin was intended to be used as a currency, why is the motto in the crypto world HODL? And why do people expect crazy price targets of 100’s of thousands of dollars which is the desire of an asset price inflation, not a currency? Bitcoin may reach those prices because anything is possible in these new markets, but is that really sustainable for the actual job it was intended to do? In my opinion, I think not. This negative analysis will be narrowed in more depth with PART 2 of this Bitcoin piece.


Looking at bitcoin and its innovative solution is not something anyone should toss aside, for it is a significant value proposal. But how we choose to approach that proposal is up to us based on how we interact with it, within our collective ecosystem.


Another benefit of bitcoin being used within the perspective of a currency is if you try to compare it to the euro, you see the euro unites a singular geographical location with many intersecting trade interests. This currency unification lowers barriers to trade amongst its members but also allows for the sharing of social/economic/political risk. For example one EU member nation is experiencing deflationary house prices and the neighbor country’s house prices are skyrocketing. The euro helps dampen the burden on the member nations affected. The pioneer of this theory, Robert Mundell explains it brilliantly in this quote,“ A harvest failure, strikes, or war, in one of the countries causes a loss of real income, but the use of a common currency (or foreign exchange reserves) allows the country to run down its currency holdings and cushion the impact of the loss, drawing on the resources of the other country until the cost of the adjustment has been efficiently spread over the future. If, on the other hand, the two countries use separate monies with flexible exchange rates, the whole loss has to be borne alone; the common currency cannot serve as a shock absorber for the nation as a whole.``

-https://cs.stanford.edu/people/eroberts/cs201/projects/2010-11/DigitalCurrencies/economics/index.html


“First, Bitcoin at its most fundamental level is a breakthrough in computer science – one that builds on 20 years of research into cryptographic currency, and 40 years of research in cryptography, by thousands of researchers around the world.

Bitcoin is the first practical solution to a longstanding problem in computer science called the Byzantine Generals Problem. To quote from the original paper defining the B.G.P.: “[Imagine] a group of generals of the Byzantine army camped with their troops around an enemy city. Communicating only by messenger, the generals must agree upon a common battle plan. However, one or more of them may be traitors who will try to confuse the others. The problem is to find an algorithm to ensure that the loyal generals will reach agreement.”

More generally, the B.G.P. poses the question of how to establish trust between otherwise unrelated parties over an untrusted network like the Internet.

The practical consequence of solving this problem is that Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.”

- https://dealbook.nytimes.com/2014/01/21/why-bitcoin-matters/


"The scripting language can also unlock transactions based on other parameters. Unlocking them over time can enable automatic mortgage, trust, and allowance payouts. Unlocking them on guessable numbers creates a lottery auditable by third parties."

- https://nav.al/bitcoin-the-internet-of-money

Extra Reading Sources


https://dealbook.nytimes.com/2014/01/21/why-bitcoin-matters/


Original White Paper PDF - https://bitcoin.org/bitcoin.pdf


www.bitcoin.com


https://sevenfigurepublishing.com/2014/02/11/bitcoin-the-whole-story/

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