What is Bitcoin?

Real Vision
Pascal Hügli
March 26, 2021
7:09 PM

Bitcoin is a decentralized internet protocol giving rise to a peer-to-peer monetary network that includes its own asset. Bitcoin (with an uppercase letter B) refers to the protocol, software, and network, while bitcoin (with a lowercase b) is used to describe the native monetary asset itself.

How does Bitcoin make money?

There is no company behind Bitcoin. Bitcoin itself is more like a synthetic commodity similar to gold. Asking the question of how Bitcoin makes money is just as nonsensical as asking how gold makes money. Bitcoin, as a network, functions and operates according to well-designed incentives. As such Bitcoin is metaphorically described as a living organism that pays people i.e., miners) to keep it alive. Bitcoin truly is the first decentralized autonomous organization (DAO) mimicking the functions and operations of a central bank.

Who owns Bitcoin?

Because Bitcoin is composed of a loose and decentralized community, it is owned by everybody and nobody at the same time. Just like nobody owns email technology, no one owns the Bitcoin network, but everyone can use it. There is no CEO, no sales force, no marketing department, or no emergency hotline.

Bitcoin was launched as a peer-to-peer electronic cash system by its pseudonymous creator, Satoshi Nakamoto. As of this day, Bitcoin’s true creator is unknown. All that is known is that Satoshi built on various cryptographic and computer-technology-related breakthroughs to come up with what today comprises Bitcoin. There’s an entire prehistory to Bitcoin, with many smart solutions that ultimately failed for various reasons.

What is its purpose?

Bitcoin was created to provide for a new global settlement system that is wholly independent from today’s financial apparatus. It is a novel economic institution that is trust-minimizing. Because of its non-centralized setup, Bitcoin offers a tamper-proof algorithmically predictable monetary policy that is verifiable at all times. Bitcoin’s asset can be self-sovereignly owned by a single individual because of its embedded independent property system. Users can send and receive any amount of value anytime to and from anyone anywhere. It’s a censorship-resistant network for global value transfer. By design, Bitcoin was created to respect human rights and be out of the reach of governments and national policies. Bitcoin is money of the people, by the people, for the people.

Why is it Revolutionary?

Bitcoin has solved the double-spend problem (a.k.a. the Byzantine Generals Problem) without relying on any third party. This has made digital scarcity possible, a thing unachieved prior to Bitcoin. But Bitcoin is not only absolutely scarce, it is completely divorced from any governmental entity. As such Bitcoin embodies the separation of money and state. It’s a non-governmental, spontaneously emerging blending of digital gold as well as the digital dollar. Bitcoin is digital (that is, informational) scarcity, the first of its kind, while maintaining the quasi-instant portability of email with no trust, just verification. Unlike every other tool for sending money over the internet, Bitcoin works without the need to trust a middleman, a bank, a broker. The lack of any company in between means that Bitcoin is the world’s first neutral digital payments infrastructure, available to all and not owned by any single entity. This represents a major breakthrough when it comes to technology as well as money itself.

How many Bitcoin are there?

Enshrined in the protocol itself is the definite number of 21 million bitcoin. As long as the entire community won’t agree to change this, there will only ever be 21 million bitcoin. So, it’s a fact of life that bitcoin’s supply cannot be inflated, no matter how big an effort one is expending towards creating more. Although the bitcoin supply is a hard-coded fact, each bitcoin is divisible into 100 million satoshis, or sats. This is the smallest unit within the Bitcoin system.

What on earth is Bitcoin mining?

This fixed supply of 21 million bitcoin needs to be created and distributed. For this to happen, bitcoin must be mined. Millions of computers spread around the world compete to solve cryptographic puzzles in order to verify transactions that, once verified, will be added to the blockchain. Any miner that successfully solves the puzzle first in this global competition is being rewarded with some additional bitcoin (called the block reward). Currently the mining reward is 6.25 bitcoin. This rate of newly created bitcoin happening approximately every 10 minutes is cut in half every 4 years. While we started at 50 bitcoin every 10 minutes, the rate was cut to 25, then to 12.5, having reached 6.25 by now. It’s estimated that by the year 2140, every single bitcoin will be mined. As of March 2021 — a little more than 18.6 million bitcoin are already in circulation, leaving about 2.4 million coins available to be mined.

Ok, so Bitcoin is like gold?

Because of its mining capability, bitcoin is often compared to gold. Just as with gold, the production of new bitcoin exhibits what can be called rising marginal costs. The more any single party wants to mine, the more difficult mining becomes. So mining is an expense that cannot be forged (known as unforgeable costliness). With bitcoin, computers are used to do the mining instead of real mining machines such as excavators, explosives, and trucks.

Bitcoin is indeed usually referred to as being the digital version of gold. Just like gold, bitcoin is nobody’s liability. It’s a non-centralized money that can be held independently from any third party. Furthermore, scarcity applies to both, although bitcoin can be considered to be absolutely scarce, which might not be true for gold. As a matter of fact, nobody knows the true supply of gold, while bitcoin’s supply schedule can be perfectly assessed.

At the same time, bitcoin is also considered to be more easily verifiable and auditable than gold itself, since the Bitcoin network with all its monetary rules can be audited by noting more than simple computer software running on a raspberry pi, a single-board computer. As bitcoin is innately digital, it avoids the problems of assayability and verifiability that physical commodities like gold suffer from.

When it comes to the similar properties bitcoin and gold have, one particular property speaks in favor of the cryptoasset. While the last 5,000 years have proven gold to be highly salable across time, because of its physical mass, gold is rather unsalable across space. Bitcoin on the other hand is highly salable across space because of its much greater portability. This is also why the cryptoasset is sometimes called gold with wings. Although bitcoin is rather young, should its digital scarcity hold, the cryptoasset would also be highly salable across time.

As time passes, bitcoin could really be regarded as the better gold. Nevertheless, it is important to keep in mind though: Bitcoin units exist as entries on a distributed ledger maintained by miners. If incentives to uphold Bitcoin would break down, miners would no longer mine and therefore maintain Bitcoin’s blockchain. Bitcoin units would then cease to exist. The same is not true for gold, which exists due to its physical nature that is upheld by the laws of nature.

Is Bitcoin money?

To answer this question, let’s first take a look at the characteristics of money. As a means of exchange and store of value, money unites the following characteristics: durability, portability, fungibility, scarcity, divisibility, and recognizability. Looking at bitcoin through this lens, one sees that it almost perfectly unites these 6 characteristics. Therefore, the answer to this question has to be ‘yes, bitcoin is money.’

But, and that is currently one of the main issues with bitcoin as money, money should also provide its holders with price stability with regards to other currencies and to real goods. Bitcoin has been extremely volatile over the last decade. Its purchasing power has increased over 10,000 fold but not without going through phases of severe price swings. So far, bitcoin has clearly failed to provide its holders with stability and security over short periods of time.

But, is there a chance that bitcoin will improve in terms of price volatility? Speaking against price stability is the fixed supply of 21 million bitcoin, of which close to 19 million are already in circulation. This always leaves room for demand-induced volatility. In favor of future price stability is the fact that bitcoin is still in its early lifecycle and the adoption process has just started to speed up. The further bitcoin progresses in this monetization phase, the more volatility is expected to decrease. Once the monetization phase is completed, bitcoin is anticipated to have a similar volatility as gold. Therefore, to provide more stable prices, bitcoin has more growing up to do.

Another argument that underlines Bitcoin’s characteristics as money is the Lindy effect. This effect states that the future life expectancy of a technology or an idea is proportional to its age. Bitcoin has been around for 12 years, meaning it can be expected to exist for at least another 12 years. And with each additional year it lives on it is expected to exist even longer. This means that the longer Bitcoin has been around, the more likely it is to do so in the years to come.

How much is it worth?

The value of an object is often determined by its scarcity. The rarer an object the more valuable it is. Bitcoin is the first scarce digital object, as there will never be more than 21 million bitcoin.

But how much is a bitcoin really worth?

The easy answer is: whatever the market is willing to pay for it. But this simplified explanation doesn’t do justice to the Bitcoin phenomenon. Bitcoiners, therefore, started applying a method also used for precious metals, the stock-to-flow ratio (s2f). This ratio tells us how many new bitcoin are issued each year relative to the coins already in circulation. The smaller the percentage of the flow coming to the markets, the more valuable (scarce) the respective good. As the supply of bitcoin decreases every four years (halving), this ratio will go to zero in the distant future. However, until the next halving in 2024, bitcoin has a similar s2f ratio as gold.

This low s2f ratio, combined with the knowledge of a capped bitcoin supply, helps to understand that bitcoin is scarce and has an inherent value. But it doesn’t answer the question how much a bitcoin will eventually be worth in US dollars.

For this purpose, a Dutch investor going by the pseudonym of PlanB, developed the s2f cross-asset (S2FX) model. It states that bitcoin went through six different phases, namely 1) proof of concept, 2) payments, 3) e-gold, 4) financial asset, 5) silver, 6) gold (current phase).

As the bitcoin s2f ratio decreased with each halving, the market capitalization of bitcoin increased to an asset with a similar s2f ratio (very high correlation in the past), after which each phase is named. Currently, bitcoin has a similar s2f ratio as gold (years 2020-2024), therefore a similar market capitalization as gold can be expected, so the predication.

Furthermore, on a 2019 call, Real Vision’s Raoul Pal and PlanB discussed the idea that the stock-to-flow model can be applied to multiple different asset classes. The discussion ultimately led to the creation of the Stock-to-Flow Cross-Asset Model.

Should this relationship hold true, then an average price of 288k US$ per bitcoin can be expected by 2024, 1million US$ by 2028 and 10million US$ per bitcoin in 2032. Explained in more qualitative terms, this relationship can be explained as follows: Bitcoin is scarce, fiat money is not. Therefore, bitcoin is expected to draw liquidity from fiat currencies, hence the price must increase (black-hole-effect).

Surely it’s too expensive now to buy?

With an asset increasing in value as fast as bitcoin, such a question is unavoidable. Looking at bitcoin’s price development one sees that there were several severe bubble phases with subsequently massive price drops, the best documented being in 2017-18 from a price of $20,000 US down to $3,300 US one year later.

By the end of 2018, many investors regretted buying into the bitcoin hype of 2017. But three years later, the same investors wished they had bought even more at the very peak of 2017 and the trough that followed, as the bitcoin value had almost tripled by then.

Looking at the price predictions in the previous paragraph, the best time to invest in bitcoin was 12 years ago. The second-best time is now. Should bitcoin ever reach 100k or 1 million USD, then hardly anyone will care if you bought bitcoin at 20k, 40k, or even 60k. The important point is that you purchased bitcoin and participated in the capital gain.

Will volatility hit the Bitcoin market? For sure. Will you get the lowest price possible when buying today? Probably not. Will you have to wait for 3 years to see significant profits as some investors had to between 2017 and 2020? Maybe. But the highest risk is not to get the timing wrong but to not get into the market at all.

What about these other (cheaper) coins?

The current crypto and blockchain movement is often compared with the dot-com boom in the late 1990s. When a new technology called the internet came to the market, thousands of new companies were founded, billions of dollars were invested, and many investors barely understood what they were investing in. Therefore, a large number of investors lost big sums of money in a booming market, as they invested in projects doomed to fail, such as Pets.com, Beenz, and Boo.com. Then there were others who truly shaped the world we live in today, such as Amazon and Google.

Today, similar trends are visible with cryptocurrency-, token-, and blockchain-technology investors. As an investor, it is important to have an extensive understanding of the crypto/blockchain project you’re investing in. Each project has a unique value proposition, specific features, and a peculiar founder team.

Cheaper coins often represent projects which aren’t far developed yet or that the market doesn’t believe in. Many of these projects will never reach maturity or mass adoption. As seen in the internet space, only a few companies will emerge successfully from this phase and dominate the market while many others will fade into oblivion. The challenge, therefore, is to distinguish cheap coins issued by promising projects from ‘shit coins’ that will never deliver a useful product or service.

Bitcoin’s “service” is a revolution of money. It’s a new base asset for a new decentralized world, a world where state and money are separate. As such, bitcoin is a once-in-a-lifetime opportunity and for this very “use case” it has already won its place and defeated everyone else. With other coins, the “revolution” might not be as big and it’s more difficult to know what they will be worth and what use cases they will serve, meaning the investment risk is much higher.

Remember, cheap ≠ better value.

Is it easy to buy Bitcoin?

Yes, it is very easy. All you need is a smartphone and a credit card. You can download popular apps like Kraken, Binance, Bitstamp, or Coinbase, open an account and purchase bitcoin directly with your credit card. For larger transactions, it is recommended to compare the fees on exchanges as they can differ significantly. After the purchase, you should transfer your bitcoin from the exchange to a personal wallet, e.g., Trust Wallet, Trezor or Ledger Nano for security reasons.

Can I easily convert my Bitcoin to cash?

Yes. Bitcoin is a very liquid asset. Dozens of exchanges worldwide offer bitcoin to fiat conversions at fair rates. For the withdrawal of fiat money from an exchange to a bank account a small fee is often charged.

Usually, the process of conversion and withdrawal goes as follows. Bitcoin are sent from a personal wallet to a personal Bitcoin address at an exchange. There, bitcoin are converted into fiat currency, often euro or US dollars, at the current exchange rate. Markets are open 24/7. Once the assets are converted, a bank transfer can be initiated to wire the funds into a personal bank account.

Another way to cash out your bitcoin is Bitcoin ATMs. These machines allow users to anonymously purchase and sell bitcoin. By sending your bitcoin to the ATM’s public address, you will receive the corresponding amount in local currency in cash.

Ok, how much money should I invest in Bitcoin?

Some might say that you could treat bitcoin like a savings account. Whatever money you don’t need for your daily living or other investments and want to save long term, you could invest in bitcoin.

Bitcoin can go through very volatile phases but long term a significant value increase is expected because of its absolute supply limitation. Purchasing bitcoin on a regular basis (monthly) averages costs and makes you less dependent on price swings.

But as with all investments, the golden rule is to never invest more than you are willing to lose. Bitcoin so far has proven to be super trustworthy but there is no absolute guarantee that it remains that way (also, the same is true for fiat currencies). Further, following the wisdom of Warren Buffett, one should only ever invest after having done proper research and gained a fundamental understanding of the investment. This guide is certainly a good starting point to get to know Bitcoin, but there is more of the rabbit hole to fall into.

Ideologically, there are people who believe that the banking and financial system is unstable, centralized, and therefore risky. As a consequence, they hold as much of their assets outside of the traditional financial system. Liquidity is held in bitcoin and other cryptocurrencies and only converted into fiat when needed to pay for goods and services.

When is the best time to buy?

Bitcoin has been tested and proven for more than 10 years now and is accepted as a new form of money in most jurisdictions. Looking at the s2f/s2fx models and the therein contained price predictions helps investors to understand what long-term cycle bitcoin is currently in and what inherent price potential bitcoin still has in the future should these models prove accurate.

But, as learned from traditional stock markets, timing the market right is very difficult. With this in mind, it may be better to ask yourself a different set of questions, namely:

Do I understand what Bitcoin is, how it works, and why many people see a revolutionary potential in this cryptoasset?
And if so, do I agree with these thesis and predictions?

If you don’t agree, which is totally fine, then it is best to not buy bitcoin at all. It doesn’t make sense to invest in a technology you don’t believe in and pay for priced-in predictions you don’t agree with. But if you do agree and see the revolutionary potential of the technology then the time to invest is always today.

Technical investors will also find the Mayer Multiple and the Puell Multiple helpful to understand Bitcoin’s short- and mid-term price developments. The Mayer Multiple equals the Bitcoin market price/200-day Moving Average (MA). If current prices are above the 200-day MA (>1), it is considered a bull market, otherwise a bear market (<1). But any multiple above 2.4 has historically been a strong indicator for a speculative bubble, a multiple below 0.5 was an indicator for an upcoming price increase.

The Puell Multiple looks at the supply side. It equals the daily issuance of bitcoin (in USD)/the 365-day moving average of daily issuance (in USD). The multiple shows if the value of new bitcoin entering the system is too great or too little relative to historical norms.

A Puell Multiple above 4 indicates that too much new bitcoin is entering the system (selling opportunity), a multiple below 0.5 is an indicator for too little bitcoin flowing into the system (buying opportunity).

GET RAOUL PAL'S FREE BITCOIN REPORT

Raoul Pal has written a full research report on Bitcoin to give you a better understanding of this incredible trade. Grab your free report today, by entering your email address.

RELATED CATEGORIES: Bitcoin, Crypto