Bitcoin’s relentless rise in value over the course of 2017 thrust the world’s first cryptocurrency firmly into the public’s consciousness. It also raised general interest and awareness around all things cryptocurrency. The value of many smaller cryptocurrencies (Ethereum, Ripple, Litecoin etc.) also got a massive boost, riding the coattails of the wave of interest and investment Bitcoin’s surge resulted in. Before last year, interest in Bitcoin and other cryptocurrencies was largely confined to a relatively small group of enthusiasts. Many of those with a good general knowledge of how Bitcoin worked came from a tech background or at least had an interest in tech or Fintech.
That has changed significantly over the past several months. Now almost everyone has heard of Bitcoin and cryptocurrencies. Many may also have considered a small, speculative investment in Bitcoin, just in case. However, there is a great deal of sense in the Warren Buffet maxim: only invest in things you understand. Even those with no intention of buying any Bitcoin often still have a strong curiosity and would like to understand the concept and technology behind it better. So with that in mind, we will address some of the most commonly asked questions about Bitcoin.
Where Do Bitcoins Come From?
This question has two possible answers depending upon whether it is posed with regard to Bitcoin’s history or how it works. So we’ll address both here!
Bitcoin was created and launched back in 2009 by an individual or individuals going by the pseudonym of “Satoshi Nakamoto”. There are several theories as to who is behind the pseudonym, ranging from California and Australia-based computer scientists Hal Finney and Craig Wright to Elon Musk – who recently categorically denied any links through a blog post. None have been proven, though it is thought the USA’s National Security Agency (NSA) may be aware of Nakamoto’s secret identity(s).
In 2008, a year before Bitcoin was launched, a white paper explaining the concept and technology behind what was to become the original cryptocurrency was published on the P2P Foundation’s website. The white paper explained that Nakamoto’s “new open source P2P e-cash system called Bitcoin”, was intended to address what the author considered to be fundamental flaws in the incumbent fiat monetary system.
Nakamoto argued that the fiat system was both inefficient and designed to perpetuate societal and global inequalities in wealth. The fact that central banks are able to print new fiat money at will benefits financial institutions at the top of the chain while gradually eroding the wealth of the salaried masses at the bottom. Additionally, money printing ordered by the government-controlled central banks that control the handful of dominant global currencies (eg. USD, EUR), maintains their position of wealth and economic power in the international financial hierarchy.
The fact that central authorities in the form of big banks and other financial institutions are also required to verify ownership and transfers of fiat money was another perceived flaw the white paper argued Bitcoin would solve. Nakamoto posited that this placed disproportionate power and influence, open to corruption, in the hands of these financial institutions. Electronic money transfers are also slow and expensive. Bitcoin’s decentralized P2P character removed the need for central authorities, which in theory neutralizes concentrated economic power and improves efficiency.
Enough people agreed with Nakamoto’s Bitcoin philosophy for it to gather a cult following and get it off the ground, albeit initially within a narrow circle of enthusiastic early-adopters. Over the years since, Bitcoin has slowly gathered traction despite price volatility, with 2017 marking what looks to have been a breakthrough into the financial mainstream.
How Bitcoin Works
So, that’s where Bitcoin comes from if we address the question from the angle of its origins. But where do actual Bitcoin units come from if not created by a central bank in the same way as fiat currencies? Bitcoin is a ‘digital’ currency, so it only exists as lines of code rather than in any physical form. The cryptocurrency is based on a P2P digital ledger run on blockchain technology. When Bitcoin was created by Satoshi Nakamoto, a capped total number of Bitcoin units was set. A first “Genesis Block” of 50 Bitcoin was “mined” by Nakamoto and released into circulation.
New Bitcoins are created through a process called mining. The Blockchain technology upon which Bitcoin is based means ownership and transfer records are held on a public ledger. These are verified without the need of a central authority by members of the P2P network all maintaining a copy of the ledger. The system’s security is maintained through complex cryptography and Bitcoin ‘”miners” provide the computing power to maintain the cryptographic verification of transactions and record of ownership.
They are incentivized to do so by being awarded newly created Bitcoin units every time they create a verified “block” of Bitcoin transactions and add it to the ledger blockchain. This process is designed to slowly release new Bitcoin into circulation in a way that prevents inflation. Miners are also paid a small transaction fee by those transferring Bitcoin. Once all the pre-set volume of Bitcoin (21 million) enter circulation, miners will no longer receive new Bitcoin as a reward for contributing to the P2P system and only the transfer fee. So, Bitcoins come from the digital mining process that enables the blockchain decentralized public ledger system.
How Many Bitcoins Are There?
The total number of possible Bitcoin was capped by Nakamoto at 21 million. Once all 21 million have been mined, there will never be any new coins. Due to the fixed supply, as demand grows, so will the value of one Bitcoin. Smaller and smaller denominations will then be increasingly used. This system is designed to circumvent Bitcoin devaluation through inflation, as happens with fiat currencies.
There are again different theories as to why exactly 21 million Bitcoin was the number chosen by Nakamoto as the final number that would ever come into existence. But essentially, the exact number is not important. Rather, the fact that there is an absolute and irrevocable limit is crucial to Bitcoin avoiding inflation-based devaluation.
As of January 2018, there are a little under 16,800,000 of the total 21 million Bitcoin already in circulation. The pace at which new Bitcoins are mined varies through time, with the reward halved every four years to maintain a steady flow that won’t lead to inflation. It is estimated that all 21 million Bitcoin will have been mined and in circulation by 2040.
How Does Bitcoin Have Value?
Another common question asked about Bitcoin is how a currency system and units thought up a decade ago, based entirely on computer code and not officially endorsed by any government or international body can have real value. The answer is rather simple and the same reason as any other asset has value – supply, and demand. The demand for Bitcoin comes from the fact that people believe in it as a medium of exchange (a currency) and in its intrinsic value as a finite commodity (like gold).
A working currency needs to be scarce, divisible, portable, durable, fungible and easy to verify. The value of fiat currencies, which are also not backed by any physical asset, is in the fact that they are accepted as a representation of value and means of exchange. The only real difference is Bitcoin’s status as a currency is not endorsed by any government or central bank but simply by user-generated demand.
While a growing network of merchants do now accept Bitcoin as a means of value exchange to pay for goods and services, this quality is still very much in the early stages of development. Currently, Bitcoin’s value is derived from the fact that there is demand for it based on its prospective future exchange value and potential to become a universally accepted means of value exchange.
Its value is also considered ‘intrinsic’ in a similar way to gold because, unlike fiat currencies, supply is limited. More Bitcoin cannot be created out of thin air in the same way fiat currencies are through monetary policy.