Disclaimer: This is not financial advice. I am not a financial advisor. What follows is my personal, subjective, biased opinion.
Three years ago, Jack Gavigan shared a Dilbert cartoon on his blog:
Like most Dilbert strips, it’s funny because it’s true. We don’t want the condescending simple version. Regardless if we’re managers or not. There’s only one problem: the full, technical explanation is complicated. Welcome back to Bitcoin for Beginners!
Bitcoin for Beginners
1. Why Should You Care About Bitcoin?
2. 7 Ways Bitcoin Will Make You Rethink Money Forever
3. How Does Bitcoin Work?
4. Why Is Everyone Investing in Bitcoin?
5. Why Market Predictions Are Almost Always Wrong
6. Where Is Bitcoin in the History of the World’s Greatest Bubbles?
7. 7 Big Obstacles to Mass Adoption of Blockchain Technology
8. 3 Potential Paths Cryptocurrency Regulations Could Take (and Which One’s Most Likely)
9. The 15 Best Resources To Learn More About Bitcoin
10. Granny’s Bitcoin Cheat Sheet
So far in this series, we’ve learned that Bitcoin is interesting because its underlying technology, the blockchain, has the power to change many aspects of our lives. It’s a way to enforce decentralization, transparency, security, and meritocracy, among other things. But in order to believe it can do those things, we must now understand how the tech actually works.
That’s a challenge, because if you’re not a technical person, you can neither tell if whoever explains Bitcoin to you is an expert, nor if they’re good at explaining. As a result, you only ever get two variants of the story:
- The true complicated version.
- The condescending simple version.
Faced with this problem, most people, both the experts and the intrigued, go with the third option: not explaining anything at all. Geoffrey A. Moore described this phenomenon way back in 1991 in Crossing the Chasm:
“First there is a market…
Then, there is no market…
Then, there is.”
It’s the famous cliff between the early adopters and early majority in the life cycle of a new technology. It’s not a gap in usage. It’s a gap in communication.
If we, the innovators, the early adopters, the first movers, can’t close this gap, we’ll never see our new tech reach full dissemination. With blockchain it feels extra complicated, but it’s always been this way. Case in point: That Dilbert cartoon was modified. Scott Adams drew the original in 2003.
Back then, blockchain didn’t exist. But the internet did, and at that point, it was still complicated. Somehow, we made it through. So, at the risk of sounding condescending, here’s my version of how Bitcoin works.
It may be simple, but I hope it’ll help bridge the chasm.
The Underlying Architecture of Bitcoin
With the internet, we had to wrap our heads around every computer being hooked up to every other computer in the world. That’s a network. If building the internet was shaping a flower, building blockchains is the flower unfolding. They are networks on top of networks, and there are several layers to each one.
Each layer adds a different feature, but here are the main three of the Bitcoin network in particular.
- Decentralization. There is no central entity governing the system. Every participant of the network contributes to keeping it alive. This removes security holes, because even if a single, big party gets hacked, the other members of the network aren’t affected and the overall system recovers.
- Shared memory. A record of all transactions between all parties on the blockchain is stored on every computer in the network. Forever. And everyone can see it. This makes the network secure against fraud and data loss.
- Cryptography. Through a set of complex algorithms and math problems, all transactions and participants are protected by encryption.
There are tradeoffs between these features and different projects interpret them in different ways, but in the end, these three elements are what defines not just Bitcoin, but all blockchains.
When it comes to Bitcoin in particular, the combination of these blockchain features serves two core functions: storing value and enabling direct, financial transactions from one user to another. These functions are part of any working currency, Bitcoin just aims to make them better.
1. Trustless Transactions
In a government-issued currency, the trust that enables you and me to exchange $1 bills at constant value is delegated to the government. We hope no matter what happens, the government will make sure we get our $1 worth of goods. Whether that’s an apple today or a car in 50 years, no one knows. When we process money through banks, we trust that the government has trusted in them to extend that guarantee, and so on.
The Bitcoin network enables that same 1-on-1 transaction power at constant unit value, minus the governments and the banks.
Every user has an individual address, like a bank account you use today. It keeps a balance of how much value in Bitcoin you have and enables users to send money from one address to another. What’s different is that users don’t need the bank and can still expect the transaction to be secure. They don’t even need to know each other. Hence the ‘trustless’ part. You don’t need to delegate trust to any third party in order to exchange value for currency and vice versa.
2. Storing Value
The way a government can guarantee a dollar will always be interchangeable for another dollar is by backing the sum of all dollars with a massive amount of assets. While governments do own a lot of those — land, real estate, landmarks, national treasure, and tons of commodities, like gold — their number one asset is that they can print the currency at will. It’s called inflation.
This is a tool that can both help and hurt the value of one dollar, but since 2008, governments have been using it a lot, which has led the purchasing power of a dollar to decline. If you’ve kept a dollar, or lots of them, under your pillow since then, each one would now only get you the equivalent of $0.84. That’s 3.5 beers less in a 24-pack, just for diligently holding on to your money, which makes the dollar a not so great way to store value.
Bitcoin tackles this problem by more directly copying the economic model which has evolved around gold. The two are often compared because both have a limited supply. As with gold, it gets harder to create, that is mine, new Bitcoins over time. While nobody knows exactly how much gold is still to be discovered, the maximum supply of Bitcoin is detained in the open source code: 21 million coins, over 17 million of which have already been mined. The last Bitcoin will be created around the year 2140.
With a fixed supply of money, but an infinitely growing population of humans, demand is bound to outpace supply sooner or later. In fact, it already has, which is why the price of Bitcoin has exploded so much. If population growth stagnates at some point and everyone uses Bitcoin, the price might stagnate too. But as long as it doesn’t and more people keep joining the currency network, the price goes up. That makes holding Bitcoin a great store of value for those, who have some.
The whole point is to make sure what you have today won’t be worth less ten years from now. It doesn’t need to grow like crazy, which it won’t forever, as long as you don’t lose value.
Now those are great ways to tackle those two functions, but who implements them? Who makes sure the network is decentralized? Who keeps the record of transactions? Who encrypts them? And where do the coins come from?
A Network by the People, for the People
Bitcoin was born in 2009, when the consequences of the world financial crisis still affected lots of people. Since the invention of money, kings and emperors have always had the power to control the supply of money, to print and press coins as they pleased. Nowadays, this power lies in hands of governments and federal banks they control, at least in most countries.
So when those banks failed the people they should serve, a money system that doesn’t require them felt like a revolution that was long overdue. A new way to transact and store value without having to delegate trust. But the only way to make sure we finally ended up with something better, something that wouldn’t end up putting all the power in the hands of a few people, was to get everyone involved. Force everyone to contribute to play.
For Bitcoin, this contribution comes in form of computing power, which is required to guarantee security, stability and scalability of the network. The people dedicating their computers to encrypting, processing, cross-checking and storing transactions are rewarded with new Bitcoins. They are called miners and they keep the network running.
By putting the various functions of the system on two sides of an incentive scheme, Bitcoin makes the right thing to do, which is contribute, the thing that also makes economic sense.
Once we run out of new coins to give them, miners keeping the network running will be paid from transaction fees, keeping this incentive scheme alive even after 2140. Not that you and I need to worry about that.
Conclusion
Bitcoin is a network run by the people, for the people. Because all transactions are encrypted and stored on a public record, the system is safe, transparent and doesn’t require banks or governments to function. Due to its limited supply, the currency is a good store of value too.
Everyone is encouraged to support the network, and those who keep it running, the miners, are rewarded with new coins and transaction fees so that what’s right is also what’s profitable.
Now if Scott Adams could wrap that into one single Dilbert comic, I’d be more than happy to read it. Even if it’s the condescending simple version.
