A gentle introduction to bitcoin
Posted on September 1, 2015 by antonylewis2015
This article is a gentle introduction to bitcoin and assumes minimal technical knowledge.
Shorter companion pieces to this are:
Bitcoin’s network in one infographic
Inside bitcoin’s blockchain (infographic)
A gentle introduction to bitcoin mining
In the popular media, you will often read comments like “Bitcoins are stored in a digital wallet”, or “You can send money using blockchain technology”. These comments can be misleading and can confuse. By the end of this you should understand enough to participate in a dinnertime conversation about bitcoin, and not be mystified by the topic.
Bitcoin
Although people refer to bitcoin as a decentralised digital currency, I prefer to think of it as an electronic asset, to sidestep questions around which government backs it and who sets the interest rate, which are often a mental block in understanding bitcoin.
As an electronic asset, you can buy bitcoins, own them, and send them to someone else. Currently (Sep 2015) there are around 14 million bitcoins that have been created, increasing by 25 bitcoins every 10 minutes or so, with an agreed limit of 21 million, the last of which should be created a little before the year 2140.
Cumulative BTC in circulation
Transactions of bitcoins from account to account are recognised globally in a matter of seconds, and can be considered securely settled within an hour, usually. They have a price (usually in USD, but can be against any currency, as with anything else), and the price is set by normal supply and demand market forces in marketplaces where traders come to trade, just like with oil or gold.
What is bitcoin designed for?
A 2008 whitepaper written by the pseudonymous Satoshi Nakamoto introduced the concept of bitcoin, and the design principle behind bitcoin is:
A purely peer-to-peer version of electronic cash [which] would allow online payments to be sent directly from one party to another without going through a financial institution.
So, there is the concept of electronic cash: cash being a bearer asset, like the cash in your pocket which you can spend at will without asking permission from a third party.
Before Bitcoin there was never electronic cash; we had numbers being stored in the database of a financial institution like a bank or Paypal, whose rules you had to comply with in order to open an account and use, and whose permission you had to seek before being able to move the money.
Why use Bitcoin?
I think of bitcoin like just another international currency whose ‘home ground’ is the internet, as opposed to any geographical location. Put another way: if the internet were a country, bitcoin would be its currency. For the first time we have an entirely digital asset which can be controlled by the end user, without requiring signup with an institution.
Bitcoin payments. Payments of bitcoins can be made from one person to another, irrespective of geographical location or jurisdiction. Payments are relatively fast – the initial notification is within seconds, and it ‘settles’ in about an hour. In situations where the normal financial system is inadequate, it can be a useful way of transferring value to anyone who has access to the internet.
Potential users. Some communities are underserved by banks due to the cost/benefit of the brick & mortar banking model and regulatory cost; some international transfers are unreliable, or can take many days, with manual processes and faxes being used as part of the plumbing; some people may want to accept digital money for selling digital goods; there may be use cases where small payments, in the order of pennies, may be useful, which is currently difficult with existing fee structures with credit cards. There may be other uses which we haven’t discovered yet…
Price volatility. Just like other currencies, bitcoin’s price fluctuates. Bitcoin’s price is more volatile than a lot of currencies (though the volatility is decreasing), so if you account for your wealth in your local currency, then owning bitcoin is essentially a bet on bitcoin’s future exchange rate price. You can see historical price volatility on Tradeblock’s website.
Conversion. Just like other currencies, if you have one currency (say, Pound Sterling), and you want to convert it to bitcoin, you need to find someone to exchange it with. This necessarily has some friction and fees: either dressed up as commissions; or built into the spreads (the conversion price). With time, conversion is getting easier and cheaper as more exchanges are springing up in more countries.
Maintain cynicism. You may hear of bitcoin being ‘fast’ and ‘free’ or ‘low cost’. While that is true when you are strictly in bitcoin, it’s worth maintaining some cynicism and thinking about the costs involved in the ‘on’ and ‘off’ ramp getting from sovereign currencies into bitcoin and back.
While I can’t imagine “mass consumer adoption” of bitcoin, I can imagine a group of freelancer developers or graphic designers in an emerging economy, who may not have access to banks or Paypal. With bitcoin, for the first time, they can do ‘digital’ work and be paid digitally. Of course, there is still the question of how they can convert bitcoin back into local currency, but that’s an easier problem to solve then receiving the money in the first place.
It’s worth noting that while bitcoin has spawned many other similar cryptocurrencies such as litecoin, dogecoin, bitcoin is still the most widely used and traded due to its network effect and relatively higher levels of security and robustness.