Bitcoin in Brief

What are the problems Bitcoin was designed to solve?

Countless examples in human history demonstrate that anytime a central authority is in control of money production and distribution, it results in an inflation of the money supply and erosion of the purchasing power for anyone who puts their savings in the debasing money. Since 1971 government currencies (fiat currencies) are no longer pegged to gold or other scarce assets which means that central banks can create unlimited amounts of money to stimulate growth, finance wars, bail out corporations and fulfil other political or socio-economic goals. Some countries like Venezuela, Zimbabwe, Argentina or Lebanon are currently experiencing extreme forms of monetary debasement and price increases (hyperinflation) while developed economies face a gradual and less visible decline of their currency’s purchasing power. The US dollar has lost 95% of purchasing power since the Federal Reserve was established in 1913. In 2020 alone the US has created 22% of all the dollars issued in the history of the country. Fiat money is inflationary, its buying power declines over time and it enriches the first receivers of new money at the expense of latecomers (Cantillon effect). The constant expansion of the fiat money supply leads to speculative bubbles and capital misallocations which often end in financial crises (boom and bust). Fiat incentivises states, corporations and individuals to take on excessive debt that can often not be paid back or only serviced with the help of ultra-low or negative interest rates, again harming savers on top of the inflation effects.

How were payments done prior to Bitcoin?

Before Bitcoin, payments could essentially be conducted in two different ways. Cash payments, directly carried out in person and without the involvement of a third party like a bank or a payment provider offer immediate and final settlement and do not come with a transaction fee. The main drawback is that both parties have to be physically present at the same place at the same time which makes this option inconvenient. Another problem is that the traders have to physically carry the money which exposes them to risks of theft or loss. The second type is an intermediated payment which requires the involvement of a trusted third party like a bank, credit card company or payment provider like PayPal. Intermediated payments can be done over large distances and users do not have to carry the physical money. A credit card or a smartphone with a payment app suffices. But as transactions run through a centralised party, they can be censored or reversed, hence there is no final settlement as in the case of cash payments.

Who created Bitcoin?

In October 2008, in the midst of the global financial crisis, a person or a group of persons with the pseudonym “Satoshi Nakamoto” published a 9-page paper titled “Bitcoin: A peer-to-peer electronic cash system”. Nobody knows who Satoshi is and even though he/she/they were active in online discussions after the start of Bitcoin, Satoshi disappeared in 2011 and there was no sign of life ever since. In February 2009, Satoshi wrote about Bitcoin in an online forum to describe his motivations: “I’ve developed a new open source P2P e-cash system called Bitcoin. It’s completely decentralised, with no central server or trusted parties, because everything is based on crypto proof instead of trust […]. The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.” With the development of Bitcoin Satoshi wanted to build a trustless system which brings the positive features of physical cash — immediacy & finality of transactions — to the digital world so that two parties can send payments conveniently over distance without having to be at the same place at the same time.

What is Bitcoin?

Bitcoin is essentially two things: It’s a global network for value transfer and settlement — just like PayPal or Swift but based on a drastically different governance structure. And it’s a digital currency that’s native to this network — just like the Dollar, Euro or Yen — but with a drastically different monetary policy. Probably the most important difference between Bitcoin and all other payment systems is that Bitcoin is a decentralised system. That means no organisation and no individual owns or controls Bitcoin. There are no central authorities that can change the rules of Bitcoin. Instead, Bitcoin is run and maintained by a network of computers (nodes) that are distributed all over the world. Every single member of the Bitcoin ecosystem is dispensable. The nodes do not need to trust each other, instead they are independently verifying the information they receive from other nodes, making sure that the ownership of coins, the history of transactions and the rules programmed into the Bitcoin code are valid. There is no barrier to use Bitcoin. An internet access is sufficient to download a wallet and receive Bitcoins. Everybody can run a network node to validate the transaction history and everyone can be a miner to secure the network and get compensated in Bitcoins. It doesn’t require anybody’s approval or permission to interact with Bitcoin. Because of the decentralised set-up and the lack of a single entity, Bitcoin transactions can not be censored and funds cannot be confiscated as long as the owners control their private keys. The most important feature of Bitcoin as a currency is that it’s inflation-resistant. New Bitcoins can only be created every 10 minutes in a process called mining which analogue to the mining of gold is a costly and energy-intensive process. One of the consensus rules of the Bitcoin protocol, enforced by all the nodes, is that only a specific amount of Bitcoins get created and rewarded to the miners. When Bitcoin was launched in 2009 this reward was 50 Bitcoins every 10 minutes, in other words the Bitcoin supply increased by 7200 coins per day. Another rule of the Bitcoin protocol is that roughly every four years the mining reward gets cut in half (halving). Since May 2020 the supply increases by 6.25 Bitcoins every 10 minutes or 900 coins per day. Based on this pre-defined schedule, the overall Bitcoin supply is increasing, but at a decreasing rate until the maximum amount of 21 Mio Bitcoin is reached sometime around the year 2140. There is no possibility that this supply cap will ever change because it would require a network consensus — an agreement by essentially all the nodes who are typically Bitcoin owners and have zero incentive for their wealth to be diluted. Not only the absolute scarcity of Bitcoin’s supply, also other properties make it a superior form of money than fiat currencies and gold: Due it’s its digital composition, Bitcoin has perfect portability features, so that for example 1 Mio $ can be conveniently sent from one end of the world to the other in a matter of minutes at very low transactions costs. Plus Bitcoins can be subdivided into 100 Mio smaller units (Satoshis) which allows for making micropayments. The private keys needed to access the Bitcoin funds can be stored on a mobile phone, a USB-like hardware device or on a sheet of paper making Bitcoin the most secure form of private property that ever existed.

How is Bitcoin’s performance?

As per March 2021, the price of one Bitcoin (BTC) is 54,000 $. Bitcoin’s market cap is over 1 trillion $, making it the fastest asset in history that ever achieved that mark. Since its inception, the BTC price increased by 500 Mio %. The compounded annual growth rate of BTC is 200% per year. Compared with stocks, bonds and commodities, Bitcoin outperformed every other asset class almost every single year over the last decade. Due to its hard money properties, Bitcoin is increasingly used as a store of value and inflation hedge — “digital gold” or “gold 2.0”. Compared with its digital competitor, gold’s value declined by 83% measured in BTC over the past 12 months. Over the past 5 years, gold’s price went down by 99% when measured in BTC. Similarly, the Nasdaq is down 72% while the S&P 500 is down 77% vs. BTC in the last year. Over a 5-year timeframe thedecline of both indices in BTC is 98%.

What are the main price drivers?

Both retail and institutional investors increasingly begin to understand the unique properties of Bitcoin as the hardest money and best possible store of value that ever existed. In an environment of unlimited money printing, negative interest rates and historically high equity valuations, Bitcoin offers an attractive alternative with an asymmetric return profile. If the network fails and Bitcoin goes to zero, an investor would lose all of his/her capital. If Bitcoin reaches parity with the market capitalisation of gold, one Bitcoin would be worth around 580,000 $ — a more than 10x return. If Bitcoin becomes the world’s dominant store of value absorbing capital from real estate, stocks, bonds, gold and other assets, one Bitcoin might be worth several million $. Since last year, Bitcoin is making significant progress in becoming an established asset class as legendary investors like Paul Tudor Jones, Stanley Druckenmiller and Bill Miller disclosed large positions. Companies like Microstrategy, Tesla and Square used their treasury reserves to put significant amounts of Bitcoins on their balance sheets. Fidelity, BlackRock, Morgan Stanley and many other financial heavyweights launched or announced Bitcoin investment vehicles. Such institutions typically invest with a longer time horizon as opposed to retail investors who are more likely to get nervous and sell if there’s a market correction. Moving forward, the massive inflows of smart money should lead to a more stable and continuous price growth than experienced during Bitcoin’s infancy years.

Is Bitcoin a bubble?

It is very popular among mainstream journalists, economists and legacy financial experts to dismiss Bitcoin as a bubble. And looking at the chart in the second half of 2017 Bitcoin behaved like a bubble that grew exponentially and then burst when the price dropped by 80% to 3000 $ in December 2018. Everyone who called it a bubble felt vindicated that Bitcoin was finally dead and their predictions came true. But Bitcoin recovered and the price now is almost three times as high as the peak in 2017. Judging by the long-term logarithmic chart, Bitcoin is a steadily growing asset whose price develops in line with four-year cycles which are initiated with the halving when the new supply of Bitcoins rewarded to miners gets cut in half. The first cycle had a massive gain in percentage terms from zero to over 20 $ per BTC at its peak. Then the price crashed and Bitcoin was proclaimed dead by its critics. The second cycle, from the peak price in cycle one of 20 $ to the peak price in cycle two of over 1000 $, saw an increase of more than 50x. Again the apparent bubble burst and Bitcoin was dead. The third cycle from peak-to-peak had an increase of about 20x, where Bitcoin briefly reached 20,000 $ in December 2017. Afterwards everyone thought once again that Bitcoin is dead and would never come back. Since May last year Bitcoin is in the fourth cycle. If the pattern holds up and if the first peak-to-peak increase was 50x while the second was 20x, then the third might be realistically be between 5x and 10x which would lead to a Bitcoin price of 100,00–200,000 $ at the peak of the current cycle.

Does Bitcoin waste energy?

Another common narrative frequently propagated by Bitcoin critics is the network’s seemingly wasteful use of energy and harmful impact on the environment. It is an indisputable fact that Bitcoin consumes a lot of energy — at the moment approximately as much as a country like Norway. The consumption of electricity is a result of the billions of computations miners have to perform in order to ensure there is one single and truthful version of Bitcoin’s transaction ledger and to protect the network from external attacks. The inevitable real-world cost to the consumption of energy creates an incentive for miners to act honestly and commit valid transactions to the network. The higher the computational power (hash rate) of the Bitcoin network, the more energy would be required to launch a double-spend attack. Therefore, Bitcoins are essentially protected by a gigantic virtual energy wall that an attacker would have to overcome if they wanted to steal any coins or spend the same coins twice. Energy consumption in Bitcoin is a feature, not a bug. And it is not wasted, it is used for an incredibly important purpose: to secure an unconfiscatable, censorship-resistant money with a fixed supply that allows people all over the world to preserve and grow their wealth. Besides, a large share of the energy that miners are using to run their computers is excess energy that would otherwise be wasted. For example, large parts of Bitcoin mining take place in Sichuan province in China which saw a massive overbuild of hydroelectric power in recent years. The installed hydro capacity in Sichuan is double what the local power grid can support creating a lot of excess energy. That’s why lots of miners located around these hydropower plants where they use this otherwise-wasted energy to perform computations and get rewarded in new Bitcoins. Bitcoin mining equipment can be set up relatively quickly anywhere in the world, plus mining is highly competitive where the miners constantly seek the cheapest energy sources in order to maximise their profits. That’s why mining is primed to buy excess energy, whether near hydropower plants in China or stranded oil & gas wells in North America. Based on latest estimations, the share of renewable energies used by miners is over 50%. Excess energy and unsubsidised renewable energy provide the cheapest form of electricity the world can access. Since the incentive for miners to use electricity that is as cheap as possible will always remain, eventually the entire Bitcoin network will be powered to 100% by clean energy and does no harm to the environment.

Will governments ban Bitcoin?

Another repeatedly shared concern is that governments will ban Bitcoin if it becomes too large and successful. After all, Bitcoin was designed to separate money and state and if it ever became the only money in the world of which additional units can’t be created, then governments would lose their most important funding mechanism: unlimited money printing and loans by central banks. There is also a historic precedent for a ban on hard money when gold was confiscated by the US government in 1933. That ban was very hard to enforce because not all the gold owners were known and many people we able to hide it from the authorities. But a large amount of gold that was stored with custodians like banks was very easy to be confiscated. Since Bitcoin uses public/private key encryption, it is not possible for governments to confiscate anyone’s Bitcoins as long as the users control their own private keys. And it’s neither possible for a government to stop any transaction on the Bitcoin network because it’s a decentralised system without any central entity which could be attacked. What governments can do is to regulate or crack down on the exchanges, where fiat money gets converted into Bitcoin and vice versa. In fact, China has banned exchanges since 2017 and India currently discusses a ban, but the trading volume in these countries did not decline significantly as many people turned to peer-to-peer platforms or the black market to exchange fiat currency for Bitcoin. Nevertheless, it would be a big blow for the Bitcoin industry and shy many institutional investors away if the US or EU decided to ban Bitcoin exchanges and make the ownership of Bitcoin illegal. But Bitcoin is a 1 trillion $ market. Several publicly traded companies own Bitcoins, so do a lot of private companies, investment funds and ultrahigh net worth individuals. PayPal, Mastercard, hedge funds, bank — they all started to adopt Bitcoin. These organisations have lobbyists and are influential when it comes to put pressure on US politicians that might harm their business interests. So there is a lot of mainstream momentum happening at the moment. Besides that, the Senator of Wyoming, Cynthia Lummis, is a passionate Bitcoin supporter who made clear in several TV interviews that she is planning to educate her colleagues in the Senate about Bitcoin and to fight for favourable legislations. Plus at least two congressmen from the house of representatives identify as Bitcoiners, and presumably a lot more politicians have invested as well without announcing it publicly. And the more political entrenchment, the more corporations and politicians own Bitcoin, the more unlikely a ban becomes. Trying to ban Bitcoin would be extremely unpopular among millions of voters, it would be an attack on the balance sheets of corporations, funds and banks. Against that background, a ban on Bitcoin becomes more unlikely with every day that passes.

What does the future hold for Bitcoin?

There is no compelling reason to believe that the central bank’s reckless expansion of the money supply and ultra-low interest rate policies will stop anytime soon given the immense debt levels of public and private sectors worldwide. This will uphold and further strengthen the demand for store of value assets which allow people to protect their purchasing power and grow their wealth. With its diminishing and terminally fixed supply as well as its resistance to censorship and confiscation, Bitcoin is predestined to become the world’s dominant non-sovereign digital store of value. If Bitcoin manages to take shares not only from gold but other store of value assets, it might easily become a multitrillion $ asset class, with one Bitcoin being worth hundred thousands if not millions of dollars. Besides that use case, the Bitcoin network might also compete to become the future settlement layer for international payment balances with Bitcoin as the global reserve currency at its core. Compared with alternative systems like Swift or settling in gold, Bitcoin offers relatively cheap, extremely secure and final settlement of large amounts of money. That would allow companies as well as countries to settle their payment balances in a far more advanced way than they do today. As Bitcoin is not tied to the political interests of any nation state, global commerce would not be at the

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