Guide 2020: What is Bitcoin, and How does Bitcoin work?
Why you should care about Bitcoin and Monero! Protect and grow your money
Interest in cryptocurrencies like Bitcoin and co has only been growing. Having personally spent more than five years in the crypto sphere, I am a firm believer this is the future of money. At least the version of future I want to support! Many approach Bitcoin as a “get rich quick” scheme. This is not me. I do not gamble, and I do not care about any cryptocurrency which does not offer rock solid fundamentals. I do not attempt to promote or sell anything, I only attempt to share as much information as possible in this newsletter. Be sure to subscribe!
But before we understand What is Bitcoin? and How does it work? We need to understand from a high level, how banks work and what is wrong about them! You see, Bitcoin is designed to be the better alternative to banking. Bitcoin is money you control, not some politicians!
How does banking work?
Most people do not understand how banks work even on the most basic level. You see, we do not “deposit” money into our banking accounts. Instead we “lend” money to the bank, and naturally we expect to get paid for that (interest on savings). People who want to take loans, go to the bank and apply for a loan. The bank loans them the money that we just “deposited”. The bank charges them a higher interest rate (interest on loans) than the interest rates they are paying us (the depositors). From that difference, the bank makes its cut!
The above is a vastly simplified version of reality. And of-course banks have other sources of revenue. Here we are only focusing on the main activity of lending. For our purposes, this is enough. The act of taking loans from banks, creates money out of thin air and someone has to pay interest for that. You see, in the end banks are money pumping machines. They suck money from the poor and pump it to the rich. I won’t spend much time on this, but if you need more convincing, the below video just might do that
You don’t control/own your bank money
Let’s say you’re buying a house from a friend. You sign all the paperwork and you pay them through a bank transfer. Note that this operation is vastly different from handing them a large bag of cash. The difference might not be apparent from a first glance but bear with me.
Your money at the bank, is not really yours. You are holding an IOU which only has value because you believe the bank will pay you back your money when you ask for it. Banks usually do! except in cases of a bank run!
And when you perform the money transfer. You are trusting both banks, to perform this operation on your behalf. If the bank decides you should not be doing this transaction, they can simply censor it! Money in increasingly becoming a system-of-control. Money is no longer becoming a neutral medium. It is becoming a tool for the rich and powerful to enforce their point of view on the poor
Bitcoin and Monero solve bank problems
What banking problems do cryptocurrencies solve?
Fiat money is inflated away by governments at an unknown rate. See wtf happened in 1971
You are not in control of your own money. You are only holding an IOU. Banks may only restrict you to withdrawing $100 weekly, or even confiscate the money altogether.
Even the banks are not really holding your money. In many cases they already lent 90% of it (multiple times!). Because banks operate on the border-line criminal fractional reserve system.
Banks and the government control how you may (or may not) spend your money
The current banking system is a mass surveillance system. It is also used for enforcing global sanctions which might not be in your best interest
What is Bitcoin?
Bitcoin is meant to be “money for the people”. Bitcoin is money that no government controls. Bitcoin is money that you hold directly, not through a custodian bank. No one can inflate your Bitcoins away. Bitcoin is meant to be Internet money. Borderless, Censorship resistant, distributed. Bitcoin and Monero, are our best change of achieving that vision!
Bitcoin represents the start of the age where money and state are divorced. No longer can the state print as much money as they need to satisfy their greed or fund wars! You, the individual become finally empowered to hold your own money. No one is able to take away your Bitcoin from you. No crazy inflation, no QE, no fractional reserve banking nonsense.
Bitcoin allows you to transact directly. When you buy a house or a car, and pay with Bitcoin, you are NOT trusting a couple of banks to exchange funds. Instead you are directly transferring the possession of Bitcoins from your hand to the counter-party.
This direct control of funds means better privacy (somewhat! see below). Banks do not know that you did this transaction. No bank will ask you to fill a form, and write a reason for this transfer. No bank is able to “stop” this transaction if they don’t like you or your counter-party! You no longer are a slave to the banks, you are in-control
Properties Of True Money. And How Bitcoin Fares
Let’s go through the properties deemed essential for proper “Money” and how well Bitcoin fares
Durable: An item must withstand being used repeatedly. Bitcoin and other cryptocurrencies score perfectly here. Bitcoin does not have any physical properties. It is as digital as this text you’re reading. So repeated use, does not in any way affect it
Portable: Individuals can carry money with them and transfer it to others. Again Bitcoin and other cryptocurrencies score perfectly on this one. In fact the digital nature of Bitcoin make it super portable. I can take a plan, fly around the globe and still have my Bitcoins accessible to me. Transferring it to others will also be completed in a matter of minutes, vs days for banks.
Uniform: All versions of the same denomination must have the same purchasing power. This overlaps a bit with fungibility and Bitcoin does not score very well here
Limited in Supply: The supply of money in circulation ensures values remain relatively constant. Again, Bitcoin is able to score very well here. Bitcoin’s supply is limited to a total of 21 million Bitcoins. Those are all the Bitcoins that will ever be created! Bitcoin fanatics like to say Bitcoin is the “hardest money”. Other cryptocurrency communities think Bitcoin might be “too hard” for its own good. Having a low and known inflation rate is certainly good. But having it exactly zero, might de-incentivize miners and cause trouble down the line. Even gold, the oldest and possibly best money humans ever had has some limited natural inflation. Bitcoin scores high here with some risk
Acceptable: Everyone must be able to use the money for transactions. Bitcoin and other cryptocurrencies score low on this one. Acceptability is still on the low side. Very rarely will you find merchants willing to accept Bitcoin directly. This is however part of the growing pains and IMO is acceptable for a young currency.
Divisible: Can be divided into smaller units of value. Bitcoin scores perfectly here. A Bitcoin can be split into 100 million pieces, each called a “satoshi”. You can think of a satoshi as a cent, except in that analogy Bitcoin would be one million dollars.
Fungible: One unit is viewed as interchangeable with another. This is one of the most important features of money and unfortunately one where Bitcoin fails. This means that a coin needs to be indistinguishable from any other coin. The coin should not have a history attached to it. Unfortunately because Bitcoin is based on a clear ledger, makes it possible to trace every single Bitcoin from the moment a miner received it (more below), through everyone who ever owned it prior to you, and finally to you. This means that if a Bitcoin you own was previously used in illegal activity, or owned by the mafia, it is less desirable than a squeaky clean Bitcoin. This is problematic for Bitcoin, and although Bitcoin maximalists insist “everything is fine”, we are starting to see Binance Blockade of Wasabi Wallet hinting that a clear cryptocurrency has severe issues with being fungible. This makes fungibility the achilles heel of Bitcoin
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While Bitcoin has proven it to be possible to have decentralized digital money, in no way was the very first design perfect. As discussed above, fungibility (and privacy) are largely non-existent in the Bitcoin world. In this newsletter we focus on perfect digital money “digital cash”, which needs to be fungible and private. A very strong contender in the digital cash world is Monero. We’ll discuss Monero in future articles but for now, let’s answer the question of: How does Bitcoin Work? But before we do, let your friends know you’re enjoying this article
How does Bitcoin Work?
Many articles that attempt to describe how Bitcoin works, tend to dive into deep technical details that only computer programmers understand. This is not the goal of this section. We will attempt to describe in plain English how Bitcoin works, while keeping factually correct. The important part is understanding the ethos of how the Bitcoin network was designed, how it works, and why it works the way it does.
Bitcoin Mining! Where Does Bitcoin Come From?
Where does all the Bitcoin in the world come from? Bitcoin creator, Satoshi Nakamoto (an anonymous person/group) designed the Bitcoin network to mimic gold! At least we can think of it that way. Just as gold is mined from the ground, Bitcoin is mined from the “math” ground. Bitcoin is a virtual currency, that has no physical presence. It only exists in the form of maths and numbers!
Now just as gold miners do a lot of work to dig up gold from the ground, Bitcoin miners do similar work to dig up Bitcoin from this maths ground! At least it’s a good enough analogy. What is Bitcoin mining actually doing? I hear you ask! Miners take the important responsibility of recording all Bitcoin transactions. Those transactions are recorded in the “blockchain”, which you can think of as a database, or simply a file! Except this file is replicated to millions of computers around the globe in realtime!
You’re probably wondering now, who are those miners and who gave them the authority to bless transactions and record them in the blockchain for all eternity! This is a tricky one, and this is one of the main genius points that Bitcoin brought to the state of the art. You see, no one is in charge, and yet everyone is! The genius is to allow a free market competition. Literally any and every person could become a miner. All miners compete on solving difficult maths problems. Problems that take computers many minutes to solve. Every few minutes, a certain miner gets “lucky” and beats everyone else into solving that maths problem. This makes him, and for that moment of time, the miner that blesses a part of the blockchain. He won’t get that lucky anytime soon! So better make sure he doesn’t try to cheat.
You see, miners get paid, in Bitcoin of-course, for all their hard work and electricity! But if a miner tries to cheat, they do not get their payment. Let’s revisit what we just said, “no one is in charge”, because you cannot point at any single person or entity who is in charge of Bitcoin. If such an entity existed, it would be trivial for any government to stop it, kill it, or at least coerce it. And that is against the ethos of Bitcoin. And yet, “everyone is in charge”, because anyone could become a miner. Practically, millions of specialized machines (called ASICs) are competing all over the globe for mining Bitcoin. You too could become a miner if you really want.
What we just described above is called decentralization. It is very important for any cryptocurrency to be decentralized. History has shown that if a cryptocurrency is centralized, governments crush it because they really want that privilege of being able to control money for themselves. If a cryptocurrency is not decentralized, it is no longer important or valuable. It becomes a money transfer company similar to Paypal, Transferwise and others. The level of decentralization, is a good litmus test to judge whether a currency is genuine, or a scam (hint: 99.9% are scams!)
While we used Bitcoin to explain how mining, and recording transactions work. All other cryptocurrencies work in roughly the same way. For example, Monero, a privacy preserving cryptocurrency works the same from a high level. With the added benefit of not needing specialized computers for mining. You can become a Monero miner using any computer you currently own.
Again Monero fixes or improves upon critical features of Bitcoin. In this case, Monero improves mining decentralization. Because not everyone can or wants to buy those specialized ASICs, but roughly everyone on the Internet has access to a computer they can mine on. Interested in learning how to mine Monero on your own computers? Be sure to subscribe and we will share detailed steps in future articles
How to Buy Bitcoins? And How to Spend Them?
Here’s the short version! I want to keep this post from becoming epic. Future articles will delve in more depth
Miners sell the Bitcoins they mined to cover their electricity cost
They usually sell on websites called exchanges. You need to choose a reputable one. I use BitStamp. Kraken is another good one that lists Monero as well as Bitcoin!
You will need to open an account on an exchange. And you will need to show them personal documents (passport, bank statements …etc)
You then transfer money to the exchange (ex: wire transfer). Once your money arrives a few days later (grin), you buy Bitcoin
You will need to very carefully install a trusted Bitcoin wallet. For newcomers I can recommend Green Bitcoin Wallet for Android or Apple iOS. Then you withdraw your Bitcoins from the Exchange to your wallet. Your Bitcoins are now under your control. Do not loose your wallet keys, and do not forget your passwords! There are no backdoors
I hope this was fun for your to read, as it was fun for me to write. I am focusing 100% of keeping a high signal to noise ratio and providing as much value as possible.
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