What is Bitcoin?
Defining Bitcoin
Defining Bitcoin is incredibly difficult because it represents a seismic shift in what a currency can be. Our definition should be treated as a demonstration of how Bitcoin serves to challenge the common understanding of currency’s place in modern-day financial systems.
Bitcoin is a decentralised digital currency that enables anyone to transfer value to another party without relying on or using traditional banking institutions. Prior to Bitcoin’s creation, the only way that parties could transfer currency without relying at all on banks was by making payments in cash. Naturally, this required all parties to be in the same location at the same time. Bitcoin removes this requirement because it exists exclusively on the internet. This ensures that transactions can occur between people spread all over the world. For the first time in history, a system exists that allows people to send currency to others without having to rely on third-party intermediaries such as banks, or the physical distribution of cash.
There is a lot to unpick here, both in terms of our definition of Bitcoin, and its wider implications. We will attempt to deal with these issues below.
“I think the internet is going to be one of the major forces for reducing the role of the government. The one thing that’s missing but that will soon be developed, is a reliable e-cash”
— Milton Friedman, Noble Prize Winning Economist, 1999
Centralised v Decentralised Finance
The concept of decentralised finance is key to understanding our definition of Bitcoin. It is therefore important that we set out below, in simplified terms, what the differences are between centralised and decentralised finances.
Centralised Finance
Centralised Finance: the expectation that financial activities, for example payments, must go through central financial institutions (banks). Banks will record each transaction they / their customers are involved in, on a private ledger, controlled and owned by the bank.
Banks promise to be a safe haven for their customers’ cash and they pay interest on the money their customers deposit in order to encourage continued use. In return, customers let banks lend the money they have deposited to other customers.
The benefits of this system are clear. Banks provide people with opportunities to purchase things that they may not ordinarily be able to afford, like houses or businesses, when they lend money to their customers.
However, the centralised system does present risks for its customers. The 2008 crash is a clear example and is representative of the fact that banks can lend money to customers without understanding the underlying risks associated with their decisions.
Decentralised Finance
Decentralised Finance: the idea that financial activities can occur without any involvement from centralised institutions. For Bitcoin, this is made possible because all transactions are recorded on a public network that anyone can access. In Bitcoin’s case, that network is the Bitcoin Blockchain.
Decentralisation is possible because the transactions that occur on the Blockchain are validated by computers located all over the world, called nodes. Nodes operate as independent bookkeepers and communicate details about verified Bitcoin transactions to one another. This ensures that each node keeps the same record of transactions that occur on the blockchain.
Decentralised systems like the Bitcoin blockchain document all Bitcoin transactions on an unchangeable and publicly shared database. Simply put, anyone can monitor any and all Bitcoin transactions that have and will ever take place.
The decentralised system, much like the centralised system, is not perfect. If you send Bitcoin to the wrong address, it is very likely that you will be unable to retrieve the sums sent. With there being no central body to monitor the blockchain, there is nobody to raise concerns with if such a mistake is made.
“We have elected to put our money and faith in a mathematical framework that is free of politics and human error.”
— Tyler Winkelvoss, Founder, Gemini Cryptocurrency Exchange
Political Influence
Bitcoin’s decentralised nature has led many to argue that it is free of political influence. Don’t forget, Bitcoin is not run by one organisation. Its network is propped up by anyone who wishes to host the Bitcoin blockchain on their computer. As a result, Bitcoin cannot just be turned off.
The easiest way to demonstrate Bitcoin’s censorship resistance is to compare it to a government backed currency like the US dollar. 1913 saw the inception of the United States Federal Reserve (the “Fed”). The Fed’s main responsibilities included setting interest rates and managing the money supply. Since 1913, some calculate that the United States Dollar has lost 96% of its purchasing power. Put another way, $1 in today’s terms would be worth ¢4 in 1913. This devaluation of the US dollar is largely due to the fact that the Fed can “print” money whenever it deems it necessary to do so. Although printing money can be beneficial, it is undoubtedly a cause of inflation.
When new dollar bills are printed by the Fed, more money suddenly becomes available to those who operate in the US economy. However, the production of goods and services sold to US people does not scale up with the number of new dollars in circulation. As a result, the newly printed dollars enable US citizens and companies to chase the same number of goods and services that existed before the new dollars were printed. In this scenario demand for goods and services outstrips supply because more people have more money than before. This leads to an increase in prices.
In comparison, and at least in theory, Bitcoin cannot suffer the same inflationary fate. Because Bitcoin is not controlled by a central body, no one person or agency is able to print more Bitcoins. In fact, Satoshi Nakamoto limited Bitcoin’s total supply to just 21 million Bitcoins. It is expected that the final Bitcoin will be created, or mined, in 2140.
“Bitcoin is mathematics, mathematical purity. There can never be another Bitcoin created.”
— Steve Wozniak, Co-Founder of Apple, 2021