Bitcoin: 1st Generation Crypto, A Revolutionary Currency
July 20, 2021 by Marvin Bertin ‐ 8 min read
Series 1: Cardano The Only True 3rd Generation Crypto
- Introduction to Crypto, A Misunderstood Technology
- Bitcoin: 1st Generation Crypto, A Revolutionary Currency
- Ethereum: 2nd Generation Crypto, Web 3.0
- Cardano: 3rd Generation Crypto, A World Financial Computer
Bitcoin, the largest cryptocurrency by market cap and the first decentralized digital currency to go mainstream. It was introduced to the world in 2009 by an unknown creator under the pseudonym Satoshi Nakamoto in response to the 2008 financial crash and the failure of the world financial system. The blockchain, a breakthrough in technology, demonstrated that a viable “digital money” could be created without the backing of a country or a centralized institution in a way that is fast, cheap, and secure. Over the years, the revolutionary concept gathered a cult-like following and has grown to become a global phenomenon. Its devotees call it the “perfect store of value”, “digital gold”, or the “ideal reserve currency”, while its detractors call it “a Ponzi scheme” , “a fraud” , and “rat poison”. So, which one is it?
To fully understand bitcoin inner mechanics, we would need to learn about cryptography, computer science, distributed computing and mathematics, however these are beyond the scope and objective of this post. Instead, we will focus our attention on learning about the properties that emerge out of Bitcoin and explore its applications and shortcomings.
What are Bitcoin’s Emergent Properties?
Borderless - Like the internet, it runs on a global network that isn’t controlled by any nation or individual.
Portable - Unlike gold, it is a digital store of value that can easily be transferred around the world, rapidly, at almost no cost.
Secure - By leveraging cryptography, financial transactions are secured automatically by the public network.
Scarce - Unlike the US dollar, it has a predetermined fix supply that makes it inflation-proof.
Decentralized - Without a hierarchical power structure, every transaction is validated through a network-based consensus algorithm (i.e., democratic voting).
Censorship Resistant - The lack of a centralized authority prevents a single actor from corrupting or manipulating any transaction recorded on the blockchain.
Permissionless - Like a public good, it is not proprietary but instead open and accessible to anyone that wants to use it.
Bitcoin: A Revolutionary Currency
Bitcoin introduced to the world a new type of currency, one that is intrinsically borderless and digital, yet secure and inclusive. A type of currency with the potential to create a global financial standard on which to build a world financial system. This is a fundamentally new approach to money that has the potential to impact our lives as profoundly as the internet.
It is no secret that current financial systems are deeply flawed. Take SWIFT for instance, the current cross-border payments network is notoriously known for being slow, expensive, and subject to security breaches. Most people would be surprised to know that the payment from the latte they bought at their favorite coffee shop will take days before the merchant gets a single penny from that transaction. International transfers can take even longer to settle. This is because the financial rails that underpin all of our payment infrastructure predates the internet. They were not built for a digitized, connected world and are now simply outdated. Netflix can stream 4K resolution movies across the world within seconds— why can’t a small transaction carrying a few bytes of information do the same? This is the equivalent of riding a donkey while everyone else is driving a Ferrari. At a time where our communication infrastructure is cheap, fast, and global, isn’t it time for our financial systems to catch up?
“At a time where our communication infrastructure is cheap, fast, and global, isn’t it time for our financial systems to catch up?"
Even more interesting to highlight is the effect Bitcoin will have on the economics of currencies themselves. Today, currencies are no longer backed by collateral, like the gold-standard which the USA went off in 1963 due to overspending in the Vietnam War. As a consequence, central banks have full control of the money supply and can print money in exchange for government debt. Take the impact of the COVID-19 pandemic for instance, the US government’s stimulus increased the USD money supply by a whopping 345% in just 12 months and subsequently pushed the national debt to 123% of the U.S. GDP. While in the short term, the stimulus has greatly benefited many American households in need during the pandemic, it is unclear what will be the long-term adverse effects on the economy over the next decade. In fact, this trend is here to stay and marks a turning point in US monetary policy. It even has a name, Modern Monetary Theory (MMT).
"[In 2020] the US government’s stimulus increased the USD money supply by a whopping 345% in just 12 months and subsequently pushed the national debt to 123% of the U.S. GDP”
Unlike the dollar, Bitcoin cannot be debased (devalued) over time through money printing because it has a fixed supply that is encoded into the protocol itself. It therefore has the properties of a scarce asset that is inflation-proof and a reliable store of value, aka digital gold. Moreover, Bitcoin is not controlled by any institution but rather by a network of decentralized computers across the world. The validation of transactions is cryptographically verified through a consensus algorithm called Proof of Work (PoW) (learn more about PoW in a future post). For these reasons, Bitcoin is not just a good solution on which to run a global digital currency, but more importantly, it may come at the right time where global debts are at record highs and world nations are realizing they may be at the brink of another financial crisis similar to 2008 or maybe worse.
"[…] global debts are at record highs and world nations are realizing they may be at the brink of another financial crisis similar to 2008 or maybe worse."
In fact, the transition may happen sooner than we think. The fastest adoption of Bitcoin has been seen in developing nations, such as Venezuela where its citizens are witnessing the collapse of their local currency through hyperinflation. As of June of 2021, El Salvador is the first nation to officially accept Bitcoin as legal tender, with other nations already ready to follow suit. The cat is out of the bag and it is here to stay.
What are Bitcoin’s Shortcomings?
Bitcoin introduced the world to a groundbreaking new approach to money. Fast forward to today, institutional investors are now pouring billions of dollars into it and nations around the world, whether they like it or not, are forced to acknowledge its significance. However, Bitcoin isn’t perfect and suffers from systemic issues that may jeopardize its long term success.
High Volatility - Like most new technologies, investors struggle to agree on how to price cryptocurrencies, which leads to a lot of speculation and greed fueled investing. Moreover, Bitcoin’s growth seems to be rooted in network effects following Metcalfe’s Law, which states that the value of a network grows exponentially with the number of users. That being said, high volatility is common among other breakthrough technologies with exponential potentials (think dot.com bubble) and is likely to resolve itself as adoption increases.
High Energy Consumption - Bitcoin’s Proof of Work consensus algorithm is the bedrock foundation that makes a decentralized currency possible, however it is also a very power-hungry algorithm to run. Bitcoin miners have to provide hash power (solve a cryptographic task) to mint new blocks on the blockchain and earn new Bitcoins (learn more about the blockchain in a future post). The problem is that hash power grows exponentially with the network and so does its energy consumption. Annually, the Bitcoin network consumes around 135 TWh, which is equivalent to the energy consumption of countries like Argentina and Sweden.
Annually, the Bitcoin network consumes […] the energy consumption of countries like Argentina and Sweden"
Some would argue that most of the energy used by Bitcoin primarily comes from renewable energies or from locations where energy is cheap and untapped. Nevertheless, the energy consumption is significant and will only increase with Bitcoin adoption. This is the reason why most cryptocurrencies, such as Cardano, are switching to Proof of Stake as their consensus algorithm, since it completely avoids the computational requirements to validate transactions and is therefore much more energy efficient.
Undefined Governance Framework - Some would argue it is not a bug but a feature, however, to others Bitcoin’s lack of standardized governance is a fundamental flaw that is often overlooked and significantly hinders Bitcoin’s capacity to adapt and improve over time. Bitcoin, like most other cryptocurrencies, is a public and decentralized organization with no owner nor official hierarchical power structure, therefore the lack of a governing body means that any decision comes at the risk of fragmenting the network and its community. Ironically, this lack of adaptability could, over time, render Bitcoin obsolete before it even becomes mainstream. Most improvement proposals get stunted in endless debates between the Bitcoin developers and Bitcoin miners. In 2017, Bitcoin’s community went to war over a seemingly small change to the protocol related to the block size. The disputes escalated and culminated in the eventual split of Bitcoin into three separate cryptocurrencies (Bitcoin, Bitcoin Cash and Bitcoin SV). This event is now referred to as the “Bitcoin Civil War” and since then no other significant changes have been introduced to the network. One way other cryptocurrencies, such as Cardano, handle this limitation is by designing an “on-chain governance” system, in which any protocol decision is made by the community through a secure and democratic voting system.
"[the] lack of adaptability could, over time, render Bitcoin obsolete before it even becomes mainstream."
Despite Bitcoin’s lack of adaptability, the crypto space continues to innovate and grow. In fact, over the past decade, it has been one of the most dynamic industries, which leads us to the second breakthrough in crypto space, smart contracts. Popularized by Ethereum, this second-generation crypto project will be the topic of our next discussion.
Next blog post in the series Ethereum: 2nd Generation Crypto, Web 3.0