What is Bitcoin and why do people use it?

What is Bitcoin and why do people use it?
Justin Searway
September 20, 2022

Follow along with Justin as he becomes crypto-literate. This blog is part 1 of 6 in this crypto education series.

I'm new to the world of crypto. 

Over the last few weeks, since being hired at Engiven, I've been feeling like a novice. "It's not that I'm ignorant," I tell myself. I mean, I studied Business & Economics in college, so I do have a general understanding of economics and finance. 

It's just that I've spent the last nine years of my life working with various nonprofit organizations in southern California and northern Mexico. So those are the waters I've been swimming in (like many of you, I'm sure). Meanwhile, the world of crypto has been rapidly growing in the background.

Well, the background is now the foreground, and I have some catching up to do. Want to join me?

When I first heard about Bitcoin, it sounded like some kind of a magical internet money. As I think back to those days––sixteen days ago, to be precise––I realize that the largest gap in my knowledge was in understanding how Bitcoin could hold value.

I mean, I use online banking, and I understand that my account reflects "digital dollars" rather than actual money. I know my money probably isn't locked in a vault somewhere. Rather, those "digital dollars" represent Bank of America's promise to give me cash when I request it. And it's because I've been able to do that at countless ATMs that I trust in my bank's "digital dollars". That's how "digital dollars" work.

But how does Bitcoin work?

In order to answer this question, I'll explain three general concepts in the blog post below: 

•What Bitcoin is

•How it holds value

•Why people use it

I'll be doing the hard work so that you don't have to. And as I begin to dip my toes into the waters of crypto, I'll be blogging and sharing my findings with you. Join me on this journey of discovery, as we grow in knowledge together and I prove to myself that dropping out of Dr. Dave Newton's Corporate Finance class back in 2012 wasn't a huge mistake (🙃).

1. What is Bitcoin?

I watched this really great video of Peter Van Valkenburgh explaining what Bitcoin is and how it (and other cryptocurrencies) work. It's six minutes long, and totally worth your time.

Bitcoin is the first cryptocurrency that was ever created, and "it lets you send and receive value to anyone in the world using nothing other than a computer and an internet connection," says Mr. Van Valkenburgh. 

Bitcoin lets you send and receive value to anyone in the world using nothing other than a computer and an internet connection.

To do this, it utilizes blockchain technology to record, distribute and secure transactions. The blockchain is the form of coding, and it works like this:

Picture a page of an excel spreadsheet as a digital ledger. This digital ledger is encrypted, and it records information and Bitcoin transactions. There are people and organizations all over the world using computing power to solve incredibly complex algorithms pertaining to the blockchain. Once an algorithm is solved, the current page of this digital ledger is secured. That process completes the creation of a “block,” which is then added to the blockchain. Each block for Bitcoin has been recorded and secured using this process.

Blockchain technology is revolutionary because each block is publicly visible and available to anyone, and it is impossible to alter information on a secured block by any outside source. Why? Because the entire blockchain is distributed worldwide and completely decentralized, meaning no one person or organization has authority or control over Bitcoin. Every Bitcoin transaction since its inception in 2009 can be viewed publicly by anyone. Click HERE to view the first Bitcoin transaction ever, when Laszlo Hanyecz paid 10,000 Bitcoin for two large pizzas at Papa Johns.

Anyone trying to change anything on the blockchain would instantly be identified as fraudulent and denied, assuming they could even break through the cryptography securing it.

That is what Bitcoin is.

2. How is Bitcoin valuable?

This was the biggest hurdle for me, because payment infrastructures (like cash or Bitcoin) are only valuable if people value them

And for any payment infrastructure to be valued by people, it must meet six different criteria:

  1. Durability: Does it stay the same over time? Carrots don't, but diamonds do.
  2. Portability: Can it be easily transported or exchanged? Imagine carrying silver to the store to buy your groceries (😱). 
  3. Divisibility: The US dollar, for example, can be broken down into cents.
  4. Fungibility: All Bitcoins are equal, whereas some radishes are better than others.
  5. Scarcity: There needs to be a limited supply of it for it to hold its value over time.
  6. Acceptability: How easy is it to find someone who will accept this payment infrastructure?

The better a payment infrastructure is at criteria 1-5, the more it will be accepted.

So why are people accepting Bitcoin as a payment infrastructure (and we know they are)? Because it kills at criteria 1-5.

Bitcoin is durable, because it is a digital asset and is electronically stored. It's portable in the most modern sense possible, because all you need in order to send and receive Bitcoin is a computer (or smart device) and an internet connection.

It's highly divisible. Currently, Bitcoin can be divided into a one-hundred-millionth (which is called a "satoshi" after Satoshi Nakamoto, the creator of Bitcoin). And if someday that isn't enough, it can be modified to handle even smaller units.

Being a digital asset, it is fungible: all Bitcoins are equal.

And it's scarce, as there will only ever be 21 million Bitcoins in existence. Compare that to the US dollar, or even gold and silver. More money can and will be printed, and more gold and silver can and will be mined, which will increase the supply and decrease the value. The supply of Bitcoin on the other hand will never exceed 21 million, meaning that the price of Bitcoin will only increase as demand increases.

Because all of this is true of Bitcoin, people are adopting Bitcoin as a payment infrastructure, which makes it valuable. 

That's why Bitcoin has value.

3. Why do people use Bitcoin?

People are using Bitcoin more and more as a payment infrastructure. Why is that? There are many reasons, but I'll highlight three: 

• It's decentralized
• It has low fees
• It is secure

It's decentralized, which means it has no central authority. It is controlled by the majority of its network participants who, being Bitcoin holders, are highly motivated to act in the best interest of their Bitcoin investment. Cash, on the other hand, is controlled by a central government agency that is susceptible to conflicts of interest.

Because Bitcoin is decentralized, it can always be exchanged without a "middle man". 

Because Bitcoin is decentralized, it can always be exchanged without a "middle man". 

The same is true of cash, but only in face-to-face transactions. When the two parties are in different places, they must use a private payment infrastructure (like a bank transfer or a cash app like PayPal or Venmo) to exchange the cash.

These are private payment infrastructures, each create their own ledger entries for the transaction. In order to complete the exchange, the parties will likely go back and forth until we settle on a private payment solution we both trusted. 

But not with Bitcoin!

Because it's decentralized, it's "trustless"––which means it doesn't require trust, not that it's "untrustworthy" (I know, that got me). Bitcoin can be sent directly from one party to the other from anywhere in the world. It goes straight from one wallet to the next, with no "middle man".

Another draw to using Bitcoin is that it has lower fees than other (more traditional) methods of sending and receiving money. 

And finally, Bitcoin is secure

When it's being stored, it traditionally resides on a digital wallet completely unique to the owner. The key to this wallet is only known by the owner, and as long as they don't share their information, they have no reason to worry about someone gaining access to their Bitcoin. 

And when Bitcoin is exchanged, it happens on the blockchain (which deserves a whole blogpost just to itself––it's on my list!). 

As opposed to electronic cash transactions, which will be recorded on a centralized ledger at a bank, the Bitcoin ledger is public, being shared and stored on thousands of computers worldwide. It is encrypted and virtually unhackable. Even if any single block in the blockchain were to be corrupted, the thousands of copies around the world would quickly identify the issue and correct it.

Conclusion

So in conclusion, Bitcoin is a public payment infrastructure that lets you send or receive value to or from anyone from anywhere in the world. It's valuable because it's secure and trustless, and the more people use it, the more valuable it becomes.

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