1. Bitcoin's origin, early growth, and evolution
Bitcoin is based on the ideas laid out in a 2008 whitepaper titled Bitcoin: A Peer-to-Peer Electronic Cash System.
The paper detailed methods for "allowing any two willing parties to transact directly with each other without the need for a trusted third party." The technologies deployed solved the 'double spend' problem, enabling scarcity in the digital environment for the first time.
The listed author of the paper is Satoshi Nakamoto, a presumed pseudonym for a person or group whose true identity remains a mystery. Nakamoto released the first open-source Bitcoin software client on January 9th, 2009, and anyone who installed the client could begin using Bitcoin.
Initial growth of the Bitcoin network was driven primarily by its utility as a novel method for transacting value in the digital world. Early proponents were, by and large, 'cypherpunks' - individuals who advocated the use of strong cryptography and privacy-enhancing technologies as a route to social and political change. However, speculation as to the future value of Bitcoin soon became a significant driver of adoption.
The price of bitcoin and the number of Bitcoin users rose in waves over the following decade. As regulators in major economies provided clarity on the legality of Bitcoin and other cryptocurrencies, a large number of Bitcoin exchanges established banking connections, making it easy to convert local currency to and from bitcoin. Other businesses established robust custodial services, making it easier for institutional investors to gain exposure to the asset as a growing number of high-profile investors signaled their interest.
2. What is Bitcoin used for?
At its most basic level, Bitcoin is useful for transacting value outside of the traditional financial system. People use Bitcoin to, for example, make international payments that are settled faster, more securely, and at lower transactional fees than through legacy settlement methods such as the SWIFT or ACH networks.
In the early years, when network adoption was sparse, Bitcoin could be used to settle even small-value transactions, and do so competitively with payment networks like Visa and Mastercard (which, in fact, settle transactions long after point of sale). However, as Bitcoin became more widely used, scaling issues made it less competitive as a medium of exchange for small-value items. In short, it became prohibitively expensive to settle small-value transactions due to limited throughput on the ledger and the lack of availability of second-layer solutions. This supported the narrative that Bitcoin's primary value is less as a payment network and more as an alternative to gold, or 'digital gold.' Here, the argument is that Bitcoin derives value from a combination of the technological breakthroughs it integrates, its capped supply with 'built-into-the-code' monetary policy, and its powerful network effects. In this regard, the investment thesis is that Bitcoin could replace gold and potentially become a form of 'pristine collateral' for the global economy.
Another popular narrative is that Bitcoin supports economic freedom. It is said to do this by providing, on an opt-in basis, an alternative form of money that integrates strong protection against (1) monetary confiscation, (2) censorship, and (3) devaluation through uncapped inflation. Note that this narrative is not mutually exclusive from the 'digital gold' narrative.
3. Bitcoin’s basic features
- Decentralized: Nobody controls or owns the Bitcoin network, and there is no CEO. Instead, the network consists of willing participants who agree to the rules of a protocol (which takes the form of an open-source software client). Changes to the protocol must be made by the consensus of its users and there is a wide array of contributing voices including 'nodes,' end users, developers, 'miners,' and adjacent industry participants like exchanges, wallet providers, and custodians. This makes Bitcoin a quasi-political system. Of the thousands of cryptocurrencies in existence, Bitcoin is arguably the most decentralized, an attribute that is considered to strengthen its position as pristine collateral for the global economy.
Read more: How does governance work in Bitcoin?
- Distributed: All Bitcoin transactions are recorded on a public ledger that has come to be known as the 'blockchain.' The network relies on people voluntarily storing copies of the ledger and running the Bitcoin protocol software. These 'nodes' contribute to the correct propagation of transactions across the network by following the rules of the protocol as defined by the software client. There are currently more than 80,000 nodes distributed globally, making it next to impossible for the network to suffer downtime or lost information.
- Transparent: The addition of new transactions to the blockchain ledger and the state of the Bitcoin network at any given time (in other words, the 'truth' of who owns how much bitcoin) is arrived upon by consensus and in a transparent manner according to the rules of the protocol.
- Peer-to-peer: Although nodes store and propagate the state of the network (the 'truth'), payments effectively go directly from one person or business to another. This means there’s no need for any ‘trusted third party’ to act as an intermediary.
- Permissionless: Anyone can use Bitcoin, there are no gatekeepers, and there is no need to create a 'Bitcoin account.' Any and all transactions that follow the rules of the protocol will be confirmed by the network along the defined consensus mechanisms.
- Pseudo-anonymous. Identity information isn't inherently tied to Bitcoin transactions. Instead, transactions are tied to addresses that take the form of randomly generated alphanumeric strings.
- Censorship resistant: Since all Bitcoin transactions that follow the rules of the protocol are valid, since transactions are pseudo-anonymous, and since users themselves possess the 'key' to their bitcoin holdings, it is difficult for authorities to ban individuals from using it or to seize their assets. This carries important implications for economic freedom, and may even act as a counteracting force to authoritarianism globally.
- Public: All Bitcoin transactions are recorded and publicly available for anyone to see. While this virtually eliminates the possibility of fraudulent transactions, it also makes it possible to, in some cases, tie by deduction individual identities to specific Bitcoin addresses. A number of efforts to enhance Bitcoin's privacy are underway, but their integration into the protocol is ultimately subject to Bitcoin's quasi-political governance process.
4. Bitcoin's economic features
- Fixed supply: One of the key parameters in the Bitcoin protocol is that the supply will expand over time to a final tally of 21 million coins. This fixed and known total supply, it is argued, makes Bitcoin a 'hard asset,' one of several characteristics that has contributed to its perceived value from an investment perspective.
- Disinflationary: The rate that new bitcoins are added to the circulating supply gradually decreases along a defined schedule that is built into the code. Starting at 50 bitcoins per block (a new block is added approximately every 10 minutes), the issuance rate is cut in half approximately every four years. In May 2020, the third halving reduced the issuance rate from 12.5 to 6.25 bitcoins per block. At that point 18,375,000 of the 21 million coins (87.5% of the total) had been 'mined.' The fourth halving, in 2024, will reduce the issuance to 3.125 BTC, and so on until approximately the year 2136, when the final halving will decrease the block reward to just 0.00000168 BTC.
- Incentive driven: A core set of participants, known as miners, are driven by profit to contribute the resources needed to maintain and secure the network. Through a process known as Proof-of-Work (PoW), miners compete to add new blocks to the chain that constitutes the ledger (the blockchain). The hardware and energy costs associated with PoW mining contribute to the security of the network in a decentralized fashion along game-theory driven principles. The profit motive is considered important in this regard. Further, since miners tend to sell their earned bitcoin to cover their significant mining-related costs, the mining process is seen as a fair mechanism for widely distributing bitcoin.
Read more: What is Bitcoin mining?
5. Who decides what Bitcoin is?
Bitcoin is not a static protocol. It can and has integrated changes throughout its lifetime, and it will continue to evolve. While there are a number of formalized procedures for upgrading Bitcoin (see "How does Bitcoin governance work?"), governance of the protocol is ultimately based on deliberation, persuasion, and volition. In other words, people decide what Bitcoin is.
In several instances, there have been significant disagreements amongst the community as to the direction that Bitcoin should take. When such disagreements cannot be resolved through deliberation and persuasion, a portion of users may - of their own volition - choose to acknowledge a different version of Bitcoin.
The alternative version of Bitcoin with the greatest number of adherents has come to be known as Bitcoin Cash (BCH). It arose out of a proposal aiming to solve scaling problems that had resulted in rising transaction costs and increasing transaction confirmation times. This version of Bitcoin began on August 1st, 2017.