Understanding Bitcoin requires understanding that the term "Bitcoin" refers to at least four different things all at once.
Similar to the 4 Phases of Matter
The reason many people struggle to understand Bitcoin is because they skip straight to its fourth form... Bitcoin (BTC) The Asset. You cannot skip over the first three forms: The Protocol, The Network, The Community and expect to understand The Asset.
Skipping straight to BTC The Asset is like trying to learn about the phases of matter and starting with Plasma (skipping Solid, Liquid, and Gas) § When you understand that the term bitcoin refers to several different things all at once, you can begin to see its value and utility. I also urge people to adopt a posture similar to the one they implicitly adopt when they use Netflix. You don’t have to understand how TCP/IP works in order to utilize the Netflix service or buy NFLX stock. There are certain elements that you take at face value when you utilize the internet. Regarding bitcoin, you need to take at face value:
- Bitcoin is scarce - there are 18.7mm BTC at present
- In the year 2140, the final fraction of a bitcoin will be produced – resulting in 21mm BTC
Protocol + Network + Community + Asset
These four forms each contribute to Bitcoin having both value and utility.
The Protocol is a set of unchangeable rules that provides certainty and clarity. Governance in Bitcoin yesterday, today, and tomorrow is clearly defined and locked into place (more on why later).
The Network is a group of participants that provides computer processing power and the electricity required to power that processing power. As the size of the network grows so too does its defense mechanism against attack.
The Community is a pool of participants that provides adoption and growth. As more people adopt the Bitcoin standard, network effects create more value and utility for those inside the community.
The Asset is a commodity that provides an incentive
- Incentive for the protocol to remain unchanged
- Incentive for computers to contribute processing power to the network
- Incentive for people (natural and corporate) to join the community
Results In A Better Monetary System
Put all of that together and you have the makings of a nascent monetary system that is attracting more and more participation every day. Take a monetary system with rapidly expanding participation, a fixed and inelastic supply, and you get exponential growth.
The Bitcoin monetary system is controlled by neither central bankers nor politicians. This makes it an ideal store-of-value.
The First Form: The Protocol
Internet Protocol (IP)
The Internet, in the most basic sense, refers to a vast network of computers that are connected to one another via TCP/IP (Transmission Control Protocol / Internet Protocol). The Internet Protocol is an open standard that governs how entities on the internet interoperate with one another.
The Bitcoin Protocol
The set of rules that governs how entities on the Bitcoin Network interoperate with one another. This protocol was first outlined in a whitepaper entitled: Bitcoin: A Peer-to-Peer Electronic Cash System that was published on October 31, 2008 by an unknown person using the pseudonym Satoshi Nakamoto.
Whereas the Internet protocol is more than 40 years old, the Bitcoin Protocol is only 12 years old.
Features of Protocols
The internet protocol is neither perfect nor without competitor technologies. Better solutions for packet switching and routing have been invented. since the internet protocols founding. Despite newer and better solutions, it faces zero threat of displacement as the root of networked computing. This is because protocols only need to be good enough; soon enough.
The Bitcoin Protocol is not the best blockchain technology. There have been many technological advances in this domain over the past 12 years. But just like the internet protocol, it too was good enough; soon enough.
Protocols like the internet and Bitcoin can be updated and modified at their edges; indeed, both have been. But they both maintain backwards compatibility and they conform to their core principles.
The core principles of these protocols do not change, they remain consistent across both time and space.
China’s tool of censorship, The Great Firewall illustrates this concept perfectly. Even though The Great Firewall blocks certain internet traffic, it is still based on TCP/IP.
A Protocol For What?
The internet protocol governs the ruleset for how digital packets of information travel around the world. The Bitcoin protocol governs the ruleset for how digital stores-of-value travel around the Bitcoin Network.
Bitcoin is the value protocol; just like the internet is the information protocol.
Bitcoin mimics the internet protocol – It has a clearly defined ruleset, which cannot be changed, it is controlled by no single entity, and it is rapidly establishing itself as the most dominant value protocol on earth.
Second Form: The Network
The Network is the Computers Connected Via The Bitcoin Protocol
The Bitcoin Network refers to the global network of computers that run software conforming to the Bitcoin Protocol. Just in the same way that the internet also refers to the network of information and software that sits atop the internet protocol.
The Bitcoin Network began operation on January 3, 2009. With the message “Chancellor on Brink of Second Bailout for Banks” embedded as a message in it’s first block, which gives a not-so-subtle hint at the aspirations the creator had for their project.
Blockchain = Chain of Blocks
The Bitcoin Network is the first instantiation of blockchain technology. Bitcoin is the first blockchain, the invention itself spawning the category. Blockchain is just: “distributed ledger technology” – it combines peer-to-peer networking, proof-of-work, and public key cryptography.
Who and What Constitute the Bitcoin Network?
Miners – Entities that contribute computer processing power and the electricity required to run those computers in exchange for their pro-rata share of the newly minted bitcoin.
Transactions – This is the flow of funds / transactional activity that happens within the bitcoin ecosystem. When someone sends BTC from one wallet to another they have created a bitcoin transaction. Much in the way that when you send a wire transaction, you are creating a transaction within the Fed Wire system. § These transactions are batched in blocks (every 10 minutes) and added to Bitcoin’s blockchain (chain of blocks).
Node Operators – People who store constantly updating copies of the bitcoin blockchain (the ledger). Some choose to do this for political / ideological reasons, others for the analytics / data, and still others as a way of ensuring security over their self-custodied BTC assets.
What Does the Network Do?
- The miners direct their processing power at a cryptographic puzzle (hashing) – hoping to find the solution to that puzzle before their competitors. A solution to this puzzle is found (approximately) every 10 minutes. This remains true, even as more computers join the hunt, because the protocol contains a rule whereby the difficulty of the problem self-adjusts based on how much power is being directed at the problem.
- When a solution is found, the miner is said to have discovered or found a block. That miner is granted the the right to add the newest block to the chain of past blocks. In exchange for doing so, they receive a reward of BTC the asset - 6.25 BTC at present. The block they add to the chain contains the record of all transactions that took place over the intervening 10 minutes.
- All copies of the blockchain (the copies of the ledger distributed around the world) update their ledger (chain) with the new block of transactions.
- And the process starts over, with miners racing to find the next block.
Third Form: The Community
Bring Your Own Rationale
As knowledge of the protocol and the network have spread, people have created, joined, and cultivated a thriving community. People find and join the Bitcoin community for all kinds of different reasons.
Some arrive on Bitcoin’s doorstep due to politics. Others for financial speculation. Still more for entrepreneurial opportunity. More recently people have been finding their way to Bitcoin as a hedge against inflation.
Technologists
People with technological expertise who might help maintain the outer edges of the protocol, hardening it against emergent threats, addressing bugs, and adding new functionality while maintaining backwards compatibility. While some contribute to the maintenance of the protocol, others will develop new products and services on top of the protocol.
Traders, Investors, Speculators, Holders
These community members primarily serve as a mechanism for price discovery. Bitcoin trades 24/7 365 in dozens of different exchange venues, against every major currency. Derivatives markets, along with lending and interest earning facilities have emerged.
Journalists & Bloggers
Provide coverage of new developments in the space, whether about upgrades to the protocol itself. Or about the businesses building out new products and services in the community.
Entrepreneurs
Build new products and services on top of the Bitcoin Network. E.g. Strike – Enabling instantaneous, final settlement remittances to every corner of the globe.
Exchanges
Provide the on-ramp for people who have some amount of wealth looking to convert that value into Bitcoin. E.g. Coinbase – The largest crypto exchange in the United States (debuted on NASDAQ today).
Net Effect = More Participants By The Day
With more and more people and businesses joining the community each day, the community benefits from network effects. Adoption drives adoption resulting in a flowering of new products and services which serves to attract ever more participants into the fold.
Fourth Form: The Asset
A Digital Commodity
The proper functioning of the Bitcoin Network, when it adheres to the Bitcoin Protocol, emits a known amount of BTC every ten minutes. The Bitcoin Protocol contains the rules governing BTC’s issuance rate, roughly speaking these are (from the beginning):
- When the network turned on in 2009 – 50 new BTC being mined into existence every ten minutes
- With that quantity (50) being cut in half every 4 years.
- 2009—2012 (50 BTC) THEN 2012—2016 (25 BTC) THEN 2016—2020 (12.5 BTC) THEN 2020—2023 (6.25 BTC)
- At present, we are in the fourth epoch with 6.25BTC every ten minutes
- This creates an exponentially decreasing issuance schedule – The first 18mm were mined over 11 years, the next (final) 3mm coins will take another 120 years. Unlike all other commodities, the supply is impervious to demand considerations.
With A Purpose
BTC’s primary function and first responsibility is to serve as an incentive for people to run software that is based on the bitcoin protocol. But it also functions as a hard asset / commodity money for anyone who wishes to use it as a store of value.
The Bitcoin Network is responsible for implementing and enforcing the protocols rules. Mining is the act of using computer processing power to create more Bitcoin according to the rules set out by the protocol. It also serves as an enforcement mechanism, because as the computational power of the network grows, the amount of effort (resources) required to attack the Network grows.
Why Though?
Because in the bitcoin monetary network, no one can change the rules, including you. Whereas in every other monetary system available today, someone CAN change the rules, just not you.
Conclusion
Bitcoin is a new monetary system that combines several technological breakthroughs to deliberately engineer a digitally scarce ideal money. Bitcoin is the hardest money on earth, governed by rules but no rule maker, and this makes it the best place to store your wealth. It has spent the last 12 years appreciating roughly 200% per year and will continue to gain in value so long as there remain people who do not yet understand it’s simple elegance.
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