In the late 1950 the first programmable computer was produced. With that, a new era in human history began, the consequences from which have touched every aspect of human life in the form of innovations. Among those who have been improving their businesses are also banks and private companies who utilized a whole new set of technologies to keep records and make payments. Strangely enough, all the new technologies implemented in past decades did not provide us with a new form of money, and the ones who tried to do so, failed. The major problem was the double spending – the risk of digital currency to be spent twice. Nobody had come with a plausible solution. All failed, except one: Bitcoin.
The first time this word started circulating publicly was on October 3, 2008 when a certain Satoshi Nagamoto decided to upload into a cryptography forum a paper called “Bitcoin: A Peer-to-Peer Electronic Cash System”. Today, the true identity of Nagamoto is still unknown, and nobody can say if behind that pseudonym there is a real person, a group of people or a government agency. Anyway, that document explained how to create a payment network with a currency, designed in a way that used the work of some of its members to verify all transactions without having to rely on a third party, like a bank for instance.
This network has operated for more than 10 years without any technical problem, offering individuals sovereignty over their money, while at the same making their money time-resistant to the biggest issue that our currencies cannot overcome – inflation. Everyone, who has a basic financial knowledge, is aware that the purchasing power of savings, for example, if left in a bank account, will inevitably decrease. This assumption became evident after the reform made by American president Nixon in 1971. Before that, the value of the dollar was linked with the value of gold: one ounce of gold was redeemable at a fixed value of thirty-five dollars. Actual existing gold was needed to be owned in order to print more money. That is why, for governments, that hoped to increase money supply for spending, the gold standard was restrictive. Gold is scarce and governments can’t produce more gold just like that and to meet their political goals. As a result, the gold standard was abandoned and the dollar became a fiat currency without a direct peg to gold. The same happened with all the major currencies around the world and nowadays central banks are able to print or digitally produce as much money as they wish.
This mechanism is impossible to implement for bitcoin since its supply is fixed from the first day of the existence of the network. In the distant future the maximum amount will be 21 million units. Analyzing its price, we can see that there is a clear increase in value. The first time when bitcoins were sold to someone through Internet exchange, this value was at $1 for 1,006 units of the currency. The price was calculated by measuring the value of the electricity needed to produce one bitcoin. Today the same amount is traded at $ 39.500. Some predictions, like the one made by the stock to flow model designed by a famous twitter user, known as Plan b, suggest that its price could skyrocket to over 1 million in the next 5 years.
In order to try to understand if such a statement is based upon solid arguments, we need to understand the deflationary nature of this asset. The key words here are scarcity and mining.
The scarcity of bitcoin, as mentioned above, is supported by the fact that the protocol provides a strictly limited supply that is set at 21 million units, whereas the mining process is a mechanism that ensures both the validation of the transactions and the input of new coins on the network.
A bitcoin is extracted from this protocol and put into circulation following the operation of the so-called miners – individuals who obtain as a reward a predefined number of bitcoins with the help of increasingly powerful computers, in exchange for the solution of mathematical equations generated by the protocol itself.
The latter us based upon an innovative technology called blockchain. This is nothing more than an encrypted digital archive, shared by all its users and in which all completed transactions are recorded. This archive is completely transparent, and it is possible for anyone to check what transactions have ever been made and at what time they took place. The users of the bitcoin blockchain are identified through the so-called addresses, which are simply a series of numbers and letters similar to a bank IBAN number. This is why bitcoin transactions are called pseudo-anonymous, in the sense that they are visible to everyone but cannot be linked to the real identity of the person who has made them.
For the validation of a bitcoin transaction, it is necessary for the transaction to be recognized as correct by the majority of the network. This happens through a complex system of control over the blockchain registers, which are updated every time one sends or receives bitcoins. However, this transaction verification requires an enormous amount of calculations, made thanks to an enormous computing power and at very high energy costs. As already mentioned above, these calculations are carried out with the help of some users of the blockchain itself called miners, who, through the use of a special software, make the computing power of their computer available. Since this task requires very high energy costs, the miners are rewarded by the system. In other words, for each block of transactions that is validated, the algorithm generates new bitcoins with which it rewards those who have worked for the network.
The peculiarity of this process can be explained by the fact that the quantity of bitcoins, guaranteed to miners in exchange for the solution of the algorithms, over time will be less and less. To be precise, every four years the number of bitcoins generated at a given period of time is halved (the protocol uses an interval of 10 minutes). This timeline is called halving, and the last time it happened was in May 2020, when miners saw their reward halved from 12.5 bitcoins to 6.25 for every block of solved equation. So far, every time a halving occurs, the price of bitcoin follows a period of very high volatility. After the last one, it went from $4800 to $ 42000.
So, what is the real use of bitcoin? Initially, the majority of those interested in the world of cryptocurrencies were ready to bet that bitcoin would become an alternative currency to the ones we use every day. With time, however, we have come to realize that perhaps this would never happen. The main reason is in its non-scalability: this means that a payment made in bitcoin, due to the complex process explained above, cannot be made immediately, as the majority of the network participants must validate the transition. The duration of this operation can vary between 10 minutes to hours, depending on how many transactions are being processed at that moment. A second obstacle is its high volatility, with price fluctuations which on certain days can even exceed 10%. A third factor is the fact that bitcoin is now seen as an asset that will most likely increase its value in the future. Generally, no one is willing to use a currency destined to increase its value. The case with a US citizen, who in 2010 bought two pizzas at the equivalent of 10,000 bitcoins, is quite famous.
Seen from another perspective, however, the supposed weaknesses turned out to be its unexpected strengths: first of all, the fact that it is not suitable for immediate payments, in the long run could prove to be an advantage – this means that bitcoin does not compete with traditional money printed by governments and central banks. In other words, the lack of such a conflict can, as it has so far, result in central authorities ignoring bitcoin, not considering the fact that it is capable of replacing traditional payment methods. The fact that the latter has a deflationary quality, on the other hand, means that it is used by many as a store of value, thus assuming the function of digital gold rather than digital currency.
–By Daniel De Luise
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