Bitcoin

Introduction

It was on the 31st of October, 2008 that the Bitcoin Whitepaper was first presented to the world by Satoshi Nakamoto. Back then, only a handful of people expressed their support for this new concept. Most people active in the financial sector or related fields were sceptic about bitcoin, while most of the general public had no idea what exactly it entailed. Over the recent years, both bitcoin’s popularity and opinions on the subject of cryptocurrency have changed dramatically. Making use of decentralised blockchain technology, it provides a method of payment away from third parties. Many other currencies have been developed since the birth of Bitcoin, but none have surpassed Bitcoin’s success yet. 

With Bitcoin rapidly fulfilling its promise of a more reliable and more transparent system of payment, an increasing number of experts believe that it could one day replace the world’s current, traditional payment systems. However, there are also plenty of critics that do not share the same optimistic future perspective for Bitcoin. So, to what extent could Bitcoin actually function as a global payment system? Does it fulfil the promises it makes, embedded in the ideology of a ‘free money’ world? And what are possible obstacles on its way to revolutionising the financial system?

In this article, we seek to answer these questions by exploring Bitcoins history, its core concepts, and how it compares to the world’s traditional payment systems in both its advantages and disadvantages. 

A short history of Bitcoin

Before Bitcoin

Before the birth of Bitcoin (BTC), people from different sectors and backgrounds, from academics to hobbyists, were already working on attempts to create a payment method similar to what Bitcoin eventually became. The idea of a decentralized payment method especially aligned with people that held anarcho-capitalist and libertarian values, of which freedom from centralized states and the maximalization of autonomy are key concepts.

In 1983, David Chaum was the first person to publish about an early form of cryptocurrency. Key features of his concept for this currency were untraceability and the lack of need for a centralized entity such as a bank. A little more than ten years later, in 1995, he developed a cryptocurrency concept called DigiCash. Unfortunately, DigiCash did not catch on to the public and the corporation behind it went bankrupt in 1998, only three years later. Efforts to develop a currency similar to DigiCahs, however, continued to exist. 

When the global financial crisis hit in 2008, the desire for a currency or market seperate from central authorities grew further. It was in October of this year that the Bitcoin Whitepaper was first released by Satoshi Nakamoto, the pseudonym of the developer or group of developers behind Bitcoin whose identity is still unsure/unknown. This whitepaper was titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. It proposed a new system of electronic cash transfers that would make it possible to carry out online payments between two parties without needing the involvement of a third, trusted party, as is the case in traditional banking.

The start of Bitcoin and the first transactions

Not long after releasing the Bitcoin whitepaper, Satoshi provided the software for this new currency as an open-source code. He himself then mined the first block of Bitcoin in January 2009, with this creating bringing the Bitcoin network into existence. With this very first block of Bitcoin, referred to as the genesis block, the first decentralized, digital money system was brought into existence. At this time, the reward for mining one block of Bitcoin was 50 BTC.

The first transaction of Bitcoin was received by Hal Finney, the inventor of the first reusable proof-of-work system, also in January 2009. After this, in 2010, the first commercial transaction was made by Laszlo Hanyecz when he bought to pizzas for the total price of 10,000 bitcoins. This was also the first time that a tangible item was bought with Bitcoins. 

Early use of Bitcoin

In the early years of Bitcoin, one of the most well known and notorious ways in which this currency was used, was by the Silk Road. The Silk Road was a marketplace on the darkweb, where users could sell and buy a whole range of, usually illegal, goods. It was especially popular as an online place for the sale and acquisition of illegal drugs. Bitcoin provided a payment method for transactions under pseudonyms that was also censorship-resistant. This of course was a very useful payment method for the acquisition and sale of illegal goods. In 2013 the Silk Road website was shut down by the FBI, with that also ending its use of Bitcoin.

The first halving of Bitcoin

By November 28, 2012 a total amount of 10,500,000 Bitcoin had been mined. On this day, the first Bitcoin halving took place. With a halving, the amount of Bitcoin that can be received for mining one block is halved. So in 2012, the reward for mining one block of Bitcoin changed from 50 BTC to 25 BTC. These halvings reduce the number of Bitcoin that come into circulation to induce inflation and thus keep up Bitcoin prices. A halving happens after every 210,000 BTC mined, which turned out to be roughly every 4 years, until the proposed limit of 21 million bitcoin is reached somewhere in the year 2140. However, before this last halving, Bitcoin still has a long way to go.

Rise in popularity

By November 2013, the price of a Bitcoin broke through the $1,000 ceiling, only to drop back to around $530 a month later. It wasn’t until January 2017 that Bitcoin finally hit the $1,000 again. This, for that time, relatively high price was the start of a bull run phase for Bitcoin. During 2017 alone, the price of Bitcoin rose over 1900%, from a little under $1,000 in January to almost $20,000 in December, when it hit its peak. The enormous profits made with Bitcoin during this period is one of the main drivers behind cryptocurrency entering a more mainstream popularity.

The SegWit update

However, Bitcoin also experienced trouble with malleability of the transactions. This refers to the possibility that parts of the transaction data could be manipulated, resulting in invalidation of new Bitcoin blocks. On top of this, there were struggles with increasing transaction times as well. 

To resolve these problems, a major update called Segregated Witness was implemented in the summer of 2017.  Segregated Witness, better known as SegWit, was a soft fork change to improve the classification of transactions within one block on Bitcoin’s blockchain. It was aimed at increasing the processing speed of transactions by separating transaction data from the signature data.

Crash of the cryptocurrency market

After Bitcoin hit its peak in December 2017, the cryptocurrency market crashed in 2018. Bitcoin dropped to levels as low as $3,200 and it took several years for the price to recover to the peak levels of 2017.

Institutionalization of Bitcoin

Even though the prices of Bitcoin remained relatively low after the levels of 2017, more and more traditional institutions on Wall Street started to pick up on cryptocurrency, launching offerings of cryptocurrency to institutional investors. This has created regulated exchanges for Bitcoin and other cryptocurrencies.

More recently, governments and multinationals from around the globe have taken a more serious interest in cryptocurrencies. One example of this was the plan of Meta, the mother company of Facebook, to develop its own cryptocurrency, Libra. However, a major obstacle for many institutions to start investing in bitcoin is the lack of regulation and supervision for cryptocurrency. The downfall of some major cryptocurrencies exchanges, such as Mount Gox in 2014 and FTX in 2022, due to security breaches and financial mismanagement, illustrate the problems that could occure due to lack of regulation. As of 2022, regulation of cryptocurrencies is a hot topic, but there is still a lot of uncertainty. The so called MiCAR legislation of the European Union should bring about improvement of cryptocurrency regulation. Its expected starting date is 2024.

Explosive rise of Bitcoin price and popularity

With the outbreak of the COVID-19 pandemic in the early months of 2020, markets around the world suffered from major dips. Bitcoin was no exception to this drastic fall on the markets. Within only two days, the coin halved in value to below $4,000. However, whereas the pandemic kept weighing most global markets down, Bitcoin started to rise again by fall 2020. In December of that same year, the price rose to $20,000 for the first time in the history of Bitcoin − and it did not stop there. Bitcoin kept rising, hitting $28,000 by the end of December and a whopping $63,000 in April 2021. After this all time high, the price fell back for a few months, until a new peak of $68,000 in November of 2021. However, after this latest record breaking level, the price of Bitcoin has decreased again to around $20,000 at the time of writing this article (July 2022). 

The rise of Bitcoin prices while other markets lagged behind, and the record breaking peaks of 2021 drew renewed interest from media, institutions and, consequently, the broader public. From insurance companies to entrepreneurs such as Elon Musk and the everyday person − Bitcoin’s popularity skyrocketed around the world. 

Taproot: Bitcoin’s latest major upgrade

Although Bitcoin has firmly established itself as one of the biggest and most popular cryptocurrencies, this hasn’t stopped users from proposing improvements and updates to the network. Implemented very recently, the 2021 Taproot upgrade was the most important upgrade of the Bitcoin network since SegWit in 2017. The main focus of this upgrade was to further improve the processing of transactions, and to increase efficiency of transactions in terms of both cost and speed.

Before the implementation of Taproot, signatures used for transactions in the Bitcoin network were validated by matching them with a public key. This way of validating signatures is relatively slow, especially for complex multi-signature transactions. With the implementation of Taproot, the processing of multi-signature transactions happens through the accumulation of the signatures in batches, which are then validated. Single-signature and multi-signature transactions can also be combined into one verification with the Taproot upgrade. Aside from benefits in terms of speed Taproot also comes with improved privacy for users of Bitcoin, since the upgrade makes it harder to distinguish between single-signature and multi-signature transactions and, consequently, to distinguish participants of the blockchain.

Bitcoin anno 2022

In 2022, Bitcoin still hasn’t recovered to the record breaking level of $68,000 from November 2021. So far, 2022 has not been Bitcoin’s best year. One of the main reasons is the current global economic climate, with banks increasing interest rates to combat inflation. Another major hit for Bitcoin – and other cryptocurrencies – was the downfall of crypto-exchange FTX due to mismanagement and the resulting loss of crypto for many FTX clients. However, this does illustrate the urgency for regulation of cryptocurrency exchanges and the European Union is one of the major players developing legislation. With more regulation in place, the main point of hesitation for many large institutions will be addressed, which might open the way to more acceptance of Bitcoin and a wider use of cryptocurrency.

The Bitcoin Core 24.0 update

At the end of November 2022 another major update to Bitcoin Core was released. Bitcoin Core 24.0 was developed to improve privacy, security and usability of the Bitcoin network by paving the way for Miniscript, by enabling changeless transactions, making Replace by Fee the default setting, and expanding descriptor wallet migration. Miniscript should eventually result in a simpler and safer way of conducting complex scripting for Bitcoin by decreasing the risk of human error. The implementation of changeless transactions is a way to improve privacy of users, by making it harder for blockchain analysts to track UTXO’s throughout the blockchain. Bitcoin Core 24.0 also makes Replace by Fee (RBF) the default setting, which should decrease waiting time for transactions in the mempool. Finally, descriptor wallet migration is meant to increase usability by providing an easier way to retrieve the derivation path of backed-up wallets.

Bitcoin timeline

An non-exhaustive overview of some of the most important developments and events in the history of Bitcoin.

• Oktober 2008: The Bitcoin whitepaper was published by Satoshi Nakamoto
• January 3, 2009: The very first block of Bitcoin is mined: the genesis block
• January 9, 2009: Release of the first version of the Bitcoin software
• January 12, 2009: The very first Bitcoin transaction occurred
• October 2009: the first Bitcoin exchange rate was published and $1 was worth 1,309.03 Bitcoin
• February 2011: For the first time, 1 Bitcoin was worth $1
• October 2011: M-of-N Standard Transactions was implemented, enabling escrow transactions, secured wallets and other features that require more than one signature
• January 2012: Introduction of Pay to Script Hash address types, which meant a new standard transaction type used by the Bitcoin scripting system
• February 2012: Introduction of HD Wallets; Hierarchical Deterministic Wallets, allowing multiple cryptocurrency wallets to be generated from a single seed phrase.
• April 2012: Bitcoin’s price passed the $100 threshold for the first time.
• November 28, 2012: First halving of Bitcoin, from 50 to 25 BTC.
• February 2014: Downfall of Mt. Gox.
• April 2014: Developers introduced a hard cap for Bitcoin, preventing the supply of the currency to grow indefinitely, which until that time was possible through a bug in the software.
• October 2014: A new opcode was introduced for the Bitcoin scripting system, named OP_CHECKLOCKTIMEVERIFY. With this update, a transaction output can be made unspendable until a certain point in the future. 
• August 2015: The new opcode CHECKSEQUENCEVERIFY was introduced to the scripting system, which allowed restriction of execution pathways of a script “based on the age of the output being spent”
• July 9, 2016: Second halving of Bitcoin, from 25 to 12,5 BTC.
• August 2017: SegWit, a User Activated Soft Fork. This major update was aimed at protection against transaction malleability and decreasing transaction times by separating transaction data from signature data, thus creating more space in a single block.
• May 12, 2020: Third halving of Bitcoin, from 12,5 to 6,25 BTC.
• November 2021: Bitcoin reaches a record breaking level of $68,000
• November 2021: Bitcoin’s Taproot update was launched, introducing several new features aimed at improving Bitcoin’s privacy and to lower the transaction fees.
• November 2022: Downfall of FTX.
• November 2022: Release of Bitcoin Core 24.0
• 2024: Expected fourth halving of Bitcoin, from 6,25 to 3,125 BTC.
• 2024: Expected release of miCAR legislation from the European Union.

Core values of Bitcoin

With the major fluctuations in Bitcoin prices and its ever rising popularity also come negative notions about the world’s first successful cryptocurrency. Warnings about its volatile nature are often heard, with some going as far as to compare investing in Bitcoin with investing in high risk assets. However, tales about Bitcoin being little more than a shortcut to acquiring vast amounts of money completely miss the true intention behind the development of Bitcoin: to create a new type of currency resistant to interference from third parties and authorities.

Why was Bitcoin developed?

The main reason behind the development of Bitcoin is the wish to create a decentralized payment method operating outside of traditional institutions such as banks or governments, and without needing a third party at all. Bitcoin was developed as a payment method meant for sending money over the internet free of central control. There are several reasons behind the desire to create such a currency.

Firstly, the world’s traditional currencies, such as the US dollar and the euro, are controlled by national banks and governments. Their influence over their citizens’ money only increases with the current increase in digital payments and the reduced role of cash money. Cash money was a way for people to pay peer-to-peer without needing the bridging facilities of a bank, as is the case with payments by card and digital transferring of money. We trust banks to handle the money of their clients with care, but more often than not, they take risks that could result in them losing their client’s money. Since the central bank of a country often jumps in to prevent a bank’s collapse in case of problems, banks have little incentive to do better.

Secondly, when someone has an account at a government controlled bank, their money is vulnerable to seizure by authorities. For law abiding citizens in a democratic country this might not be a significant problem, but it is for citizens of countries with corrupt and dictatorial regimes. They might not be free to spend their money as they see fit, as it might induce a hostile response from the government or police authorities. Bitcoin operates similar to cash money, without the need for a third party, such as a bank, to facilitate the transaction, and without the government tracking these transactions.

A third reason behind the development of Bitcoin as an alternative for other currencies is its reliability and, consequently, its suitability to fulfill a role as sound money. Sound money is necessary to ensure trade, investments and entrepreneurship in an environment of reliable information. In addition to this, sound money is seen as a cornerstone of a free society, because it cannot easily be misused by (corrupt) governments. One of the most important characteristics of sound moneys is a high stock-flow ratio. The stock-flow ratio is determined by dividing the the amount of a material or resource in reserves by the annual amount that is added to this reserve. A resource with a high stock-flow ratio has a low annual production in comparison to the reserve. This is true for bitcoin, since there is a limit on the amount of new bitcoins that enters into circulation through mining, and because bitcoin has a hard cap, a maximum amount of bitcoin that will eventually be in circulation. This creates scarcity, an important driver behind a resource’s value.

Many traditional currencies do not have a high stock-flow ratio, because banks can print extra bills as they and the government see fit, under the guise of regulating the economy. The printing of extra money is a way to induce inflation, which lowers the value of a currency. Due to inflation, people can suddenly buy less with their savings than before the inflation. Because new bitcoins are released only sparsely, the inflation is steady and not as sudden or severe. At the same time, the limit on bitcoin production should ensure that bitcoin prices will keep rising over a longer period of time, because its scarcity drives the value up.

Bitcoin currency vs. bitcoin technology

The name “Bitcoin” is used to refer with to both the currency and the underlying protocol that holds the ledger. The bitcoin protocol is the layer 1 foundation where full nodes process transactions and where new blocks are added to the blockchain by miners through proof-of-work. It is on top of this layer 1 protocol that the currency of Bitcoin is built. The currency consists of data that is not restricted to the rules of the protocol, but instead operates on top of the protocol using layer 2 solutions such as Lightning Network.

The advantages of Bitcoin

High stock-flow ratio

Bitcoin has several advantages over traditional currencies. The first one, as was briefly discussed already, is its high stock-flow ratio. Bitcoin’s proof-of-work technology ensures that the production of new bitcoin is a time and energy consuming process. The minimum time of mining a new block to the bitcoin blockchain and receiving new bitcoin as reward will always be roughly 10 minutes. If the calculating power of the miners increases, so does the difficulty of the mathematical calculations the minders have to solve, hence requiring more calculating power. This creates a high stock-flow ratio for bitcoin, as only a small amount of it can be produced every year compared to the total amount in circulation.

Protection from fraud

Additionally, the proof-of-work technology creates a solid layer of protection from fraud with or attacks on the transactions registered on the bitcoin blockchain. Attempts to add fraudulent transactions to the blockchain are not rewarding because it requires an enormous amount of calculating capacity and, hence, energy to add a fraudulent block, while the verification of the correctness of the block by the nodes is fairly easy. As long as more than half of the nodes discards the block as being incorrect, the attempt at fraud is averted and the culprit will have lost a lot of money in the proof-of-work process. And since there are millions of nodes in the bitcoin network, it is highly unlikely, if not impossible, to corrupt enough (owners of) nodes to vote for approval of the fraudulent block.

Resistant to change

Besides bitcoin’s resistance against fraud and attacks, the network is also incredibly resistant to change. The core of the Bitcoin network is formed by the consensus rules, which dictate the processing and validating of transactions. All nodes in the network are obliged to follow this set of rules. Any other attempt at processing or validating transactions will be rendered invalid. This is an additional layer of protection against fraud with the blockchain. In addition to this, the consensus rules have an essentially unchangeable character, which serves as protection against changes from individual entities. As a result, no one can control bitcoin, because no one can change this fundamental set of rules. Any serious proposal to change (part of) the consensus rules can only result in a split off of a new coin to which the new set of rules applies. Improvements and changes outside of the consensus rules can be implemented, if accepted by enough nodes, but the consensus rules themselves have to be the same on every node. Bitcoin’s ability to remain unchanged at its core is one of its most important characteristics and a main advantage compared to all other cryptocurrencies that were developed after Bitcoin.

Individual property and transparency

Another advantage of Bitcoin over traditional currency is that Bitcoins are property of the person who bought them only. They are not stored at a financial institution or other third party that might have fraudulent intentions or where they can be confiscated. Bitcoin grants people economic freedom to an extent that is not possible with traditional currencies. It is money for the people and for what society deems important, not a tool for governments to do as they please. Bitcoin also has a high degree of transparency; everyone can take a look at Bitcoin’s ledger to view the transactions that have been made. User’s privacy is protected by the network’s use of encryption.

International use

Furthermore, bitcoins can easily be send all over the world without the obstacles. Traditional currencies often differ between countries and transferring money from a country with currency A to a country that uses currency B, often comes with a conversion fee. Being able to easily send money between countries is not only favorable for people that might have family living abroad, but also for the many companies that trade internationally in today’s highly globalized world. Bitcoin’s independence from third parties in combination with its avoidance of problems with exchange rates also makes it particularly suitable for settlements of large amounts of money between national banks and big financial institutions.

High divisibility

Finally, bitcoin is easily divisible into smaller units. This is a crucial characteristic of a good unit of account, one of the main functions of money besides being a method of payment. It can be used to express prices worldwide, which facilitates cross-boundary calculations. However, before bitcoin can fulfill its potential as a global unit of account, it needs to be adopted to a great extent worldwide.

Units of Bitcoin

Similar to any other currency such as dollars and euros, Bitcoin knows denominations as well, ranging from the algorithmic maximum of nearly 21 million BTC to the smallest unit of 0,00000001 BTC, also known as a satoshi. The table below gives an overview of the denominations of Bitcoin and their values:

Challenges of formatting Bitcoin amounts

Bitcoin values in the range of the smaller units, such as the satoshi, can easily be smaller than the smallest unit of fiat money, such as dollars, posing a challenge for expressing bitcoin values in fiat units, especially when institutions use a rounded formatting. For example, the current (September 19, 2022) value of 1 satoshi equals $0.0001879 USD, but dollars are often rounded to a format that would express this amount as $0.00 USD.

Another format for displaying small amounts of bitcoin proposes the modification of digit group separators for improved readability. Starting the grouping of digits from the right instead of from the left would further increase the ease with which the satoshi value can be identified. This method of displaying bitcoin values would look like this:

• 0.000 830 00 Bitcoin
• 0.00 083 000 Bitcoin

The amount of Bitcoin is the same, but the latter makes it easier to identify the satoshi value at a single glance. In this example, the satoshi value is 83 000. However, there is no standardized way of displaying Bitcoin values yet, so the decision about formatting depends on what is most appropriate for the intended audience or purpose.

Disadvantages of Bitcoin

In addition to the many advantages of Bitcoin, there are also some disadvantages of this new form of currency.

High volatility

An often heard argument against Bitcoin is that its value has been incredibly volatile ever since its creation, especially when compared to other resources used as payment, such as gold and prominent currencies of fiat money (e.g. US dollar). However, it is expected that the volatility of Bitcoin will decrease and its value will stabilize as its market grows and institutions associated with it will become more sophisticated. This stabilization will be reached when a large amount of people procures bitcoins with the intention of saving them for a longer period of time.

Criminal use of Bitcoin

Another downside to bitcoin is that the high degree of individual freedom of the currency also makes it appealing to criminals to use as a payment method. On the other hand, since everyone can view Bitcoin’s ledger, criminal transactions can be traced back by authorities if they figure out the encrypted identity of the criminals in question.

Scalability problem: transaction fees and processing time

Bitcoins main disadvantage and its most significant obstacle on the path towards becoming a global payment method are the transaction fees. Blocks on the Bitcoin blockchain have a maximum size of 1 megabyte and take at least roughly 10 minutes to mine. With this size limit, one block can process a maximum of 4 transactions every second, about 350,000 every day, or 120 million every year. This is not nearly enough to handle even a fraction of the more than 1 billion non-cash transactions that are being made worldwide every day. Therefore, if more and more people want to use Bitcoin as a payment method, the transaction fee will increase significantly. This makes it unsuitable to handle everyday transactions, such as the transferring of small amounts of money between people or paying for groceries in the supermarket.

Simply increasing the size of blocks on the blockchain may seem like the solution to this problem, but a larger block size requires more calculating power and thus more energy and more expensive equipment. This would in turn decrease the amount of people that maintain a full node in the Bitcoin network, which undermines the decentralized character that is so fundamental for bitcoin. So far, all proposals to increase the block size of Bitcoin have either been denied or have lead to a split off of bitcoin, such as Bitcoin Cash, which has not gotten anywhere near bitcoin’s success. However, the problem with bitcoin’s scalability makes it unlikely that it will ever be able to process transactions at the same scale as centralized systems, such as Visa or Mastercard.

Bitcoin as a reserve

Bitcoin’s scalability problem does not mean that bitcoin cannot be a valuable solution for other purposes. Due to its favorable stock-flow ratio it is incredibly suitable as a store of value for longer periods of time, worthy of the higher transaction fees. For people or institutions that wish to make important transactions without supervision or interference from a third party, a higher transaction fee would also be worth it.

It is expected that bitcoin, when widely adopted, could become to the world what gold is nowadays; a reserve that covers the value of a form of money that is built upon bitcoin as a second layer. Smaller, day-to-day transactions will then be facilitated by these second layer solutions. For people that specifically value the individuality of Bitcoin and the freedom from third parties, a second layer solution would be a major drawback, because it often involves a third party institution that facilitates the second layer solution. However, for people that simply want to carry out small purchases this would not be that much of an obstacle. The second layer solution will then fulfill a similar function for Bitcoin users as a bank does for digital money today. The blockchain itself will then only be used for the definitive settlement of (large) transactions. One of the most well-known second layer solutions for bitcoin today is the Lightning Network.

Governance of Bitcoin

Bitcoin is praised for its decentralized character and for operating outside of third parties’ control. As explained before, there is not a select group, institution or government that controls the network and can impose changes and rules on the users. This does not mean that there is no governance of the network at all – it simply isn’t in the hands of a small group. Bitcoin’s network is governed by a social contract: changes can only be legitimized when enough users agree to the new protocol.

Suggestions for changes to the network come in the form of Bitcoin Improvement Proposals, abbreviated to BIPs. These proposals can be submitted by anyone in the open-source community of Bitcoin. After submittal of the proposal, the community will debate on the suggested changes until a consensus emerges. The maintainers of the Bitcoin Core network then implement the code changes into Bitcoin Core’s GitHub Repository. Once this implementation is finished, the owners of the full nodes in the network must adopt the changes. Only when a majority of the users on the Bitcoin network adopts the changes, is the proposal officially ratified. Full nodes will only validate the transactions and block proposals that are in line with the rules of the Bitcoin protocol, so once a BIP is implemented, every miner has to abide by its rules.

Since the favour of the majority of users is necessary for protocol changes to be accepted and there are millions of users, it is unlikely that a small group of people can control the network and implement changes to their liking.

How to acquire bitcoin

Bitcoins can be bought with traditional valuta, like dollars or euros, or be payed for with other crypto currencies. There are many exchanges suitable for trading in Bitcoin, but transactions can also be made in person over a communication platform. With the increasing popularity of Bitcoin and other crypto coins, formal institutions such as banks are increasingly offering possibilities for transactions in cryptocurrency as well. 

Bitcoin as a currency

To fully understand Bitcoins suitability as a new global payment system, it is important to understand what a currency excatly is and what characteristics it entails.

In general, a currency is considered to be an instrument that can be utilised as a medium of exchange, a store of value, and a unit of account. To what extent does bitcoin as a currency align with these three characteristics? 

Medium of exchange

The most well-known use of a currency is its function as a medium of exchange: an instrument that facilitates trade of goods between two or more parties. A currency is a more convenient alternative to a barter system in which the actual goods themselves are exchanged between people, which comes with all sorts of impracticalities. 

Before a currency can be used as a medium of exchange it must first be accepted as such by all the parties involved in the trade. Bitcoin has yet to be widely adapted by merchants, institutions and the general public, but there is an increase in merchants that accept payment in bitcoin. However, the rise of bitcoin transaction fees due to the block size limitation might become an obstacle for the acceptance of payment in bitcoin in the future. In addition to this, the average waiting time of 10 minutes for approval of a transaction is impractical for day-to-day transactions. Second-layer solutions might facilitate swifter transactions and could be the solution to the problems of both the rising transaction fees and the waiting time. 

Another often heard hesitation regarding a widespread acceptance of bitcoin is the current lack of regulation of cryptocurrency, especially when it comes to the use and acceptance of bitcoin by large scale institutions. The formulation of clear regulations aimed at protecting investors and safeguarding financial stability while also allowing for development and innovation can lead the way to widespread acceptance of bitcoin. 

An second essential condition of a currency suitable to be a medium of exchange is a relatively constant intrinsic value, which guarantees a more or less stable purchasing power on average. Bitcoin has a long history of an unfavourably high volatility, but as we pointed out earlier, it is expected to become more stable when the bitcoin market matures. 

In conclusion, bitcoin could definitely fulfil the function of a medium of exchange when all parties involved in a trade accept bitcoin for their negotiations, rather than simply using bitcoin as an intermediary and converting it back to fiat currencies as soon as the trade is done. 

Store of value

A currency can also function as a store of value. For something to fulfil the role of store of value it is important that it does not perish or depreciate over time. It must maintain its purchasing power into the future without too much depreciation of its value. Whether bitcoin maintains its store of value into the future depends on the expected future acceptance of bitcoin as a medium of exchange. After all, if no one accepts bitcoin as a payment anymore, it will hold very little value because bitcoin owners will not be able to purchase anything with it. At this moment, bitcoin is especially an attractive store of value for people that prefer to store their wealth in a relatively anonymous way, outside the reach of authority and without the need to trust third parties. 

Unit of account

We already touched upon Bitcoin’s suitability for the function of a unit of account, but we will elaborate a little more on this topic in this paragraph.

A unit of account is a numerical unit that provides a measurement for the market value of goods, services and other trades. It can be used to express the value of something, and to make calculations with. A unit of account must be countable and divisible into smaller units. As explained before, bitcoin meets both these requirements. However, in order to be able to express market value with bitcoin in a reliable and stable way, its volatility must be reduced. A second obstacle for using bitcoin as a global unit of account, is the price fragmentation that occurs across different exchanges that facilitate trading in bitcoin. Bitcoin does not have the exact same value across all exchanges – so which of those values do you follow if you want to express value in bitcoin? This problem needs to be addressed before bitcoin can function as a reliable global unit of account. 

Bitcoin’s volatility

Currently, one of the biggest challenges and an often heard concern from critics is Bitcoin’s volatility, which has been relatively high ever since its development. Due to Bitcoin’s decentralized character, its price is determined by supply and demand only. There are no financial institutions, such as national banks, that can manipulate its price by printing more money or changing interest rates. However, Cermak (2017) identified other external forces that generally affect the price of Bitcoin: regulations, security breaches, and changes in the value of fiat currencies. 

Government regulations

The implementation of government regulations or changes thereof can lead to a drastic increase in the supply of Bitcoin. Especially when a government or national bank imposes a stricter set of rules, people from that country might want to sell their Bitcoin because of the reduced freedom, resulting in an increase in the supply. When the demand stays the same, the price of Bitcoin will drop. 

On the long term, however, government regulations could also lead to more stability and trust regarding cryptocurrencies, and might incentivize larger institutions that are still hesitant due to lack of regulation to join in as well. 

Security breaches

The bitcoin protocol itself is deemed unhackable by experts, due to its decentralized nature and use of proof-of-work. At the very least it is not profitable for anyone to try and hack the bitcoin network. However, second layer solutions build on top of the bitcoin protocol are more vulnerable to an attack, this includes elements such as third party wallets and cryptocurrency exchanges. One of the most notorious security breaches in bitcoin’s history was the theft, fraud or mismanagement of bitcoin exchange Mt. Gox, which collapsed in february 2014. 

Over time, platforms operated by third parties and build as second layer solutions have become more transparent, and their safety measures have been improved. Yet, there are always risks of new breaches and financial scandals, as is painfully illustrated by the downfall of cryptocurrency exchange FTX in november 2022. 

More and better regulation and supervision can contribute to a decrease of fraud and mismanagement in the future.

Depreciation of fiat currencies

The effects of changes in the value of fiat currencies ripple through to the cryptocurrency dimension. Investors turn to bitcoin to minimize the effects of inflation and economic uncertainty. Due to this tendency, sudden inflation of a fiat currency can lead to an increase in the demand for bitcoin, resulting in a fluctuation of its price. The current amount of bitcoin in existence is not very big yet (compared to, for example, gold), so it does not take an exceptionally large change in the supply or demand to cause price fluctuations. When more bitcoin comes into existence, this effect will wane.

Conclusion

In this article, we discussed Bitcoin’s history, elaborated on the ideology and core values behind its development, and how it might just change the world as a possible new global payment system. As is the case with most new and revolutionary inventions, Bitcoin has had a bumpy history so far, with great price fluctuations and lots of scepticism, but also with conquering these challenges and negative publicity. It is safe to say that Bitcoin fulfils the promises of the core values behind its development: it is a currency free from authority, resistant to government manipulation, and reliable due to its high stock-flow ratio. Bitcoin’s unique characteristics and the inventive processes of blockchain technology and a consensus mechanism make it resistant to both change and attacks. On the other side, the scalability issue and the high volatility of Bitcoin can obstruct it from becoming a globally adopted currency. Second-layer developments offer a solution, but at the cost of safety and decentralisation. Furtermore, lack of regulation makes many institutions and investors hesitant to venture into the world of cryptocurrency.

However, while there are some obstacles on Bitcoin’s way to becoming a global currency, it is very suitable as a store of value away from third parties, especially for large transactions that are worth the transaction fees. Bitcoin’s true value might be in its suitability for a role as reserve for banks and financial institutions, fulfilling the role that gold did before most countries let go of the golden standard.

Despite the challenges and criticism, Bitcoin has proven itself as reliable, safe and fulfilling the values behind its development for more than 10 years already. Time will tell if it will continue to do so for many more decades, possibly revolutionizing the global financial system and handing more power back to the general public.