Friendly Beginner’s guide to Bitcoins

Unless you live in a Bubble, Its impossible that you already haven’t seen the headlines about Bitcoin or Bitcoin Bubble. Bitcoin continues to garner the attention(both positive and negative) of the mainstream media especially this year. If you are unaware of the intricacies of the world of Bitcoin, this post will help you understand few fundamentals.

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What is a Bitcoin?

Before we begin, we need to understand that there is Bitcoin and there is bitcoin. Bitcoin is the software protocol and bitcoin is the your distributed decentralised peer to peer crypto-currency. Both are often used interchangeably, here we shall focus on the currency angle.

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  1. Distributed: Bitcoin ledger is shared and consensus driven ledger which can be synchronised and replicated by anyone in the globe. The earliest example of distributed ledger can be found in Yap island in Micronesia. People, in Yap island, use ‘Rai stone‘ as store of value and currency. Since the stone is too large to carry around, the ownership of the stone was recorded by consensus-driven oral verification.800px-Yap_Stone_Money.jpg
    a.Rai Stone
    Bitcoiners believe whoever holds the ledger holds the power. (Typically Bankers who own the ledger can potentially falsify ledger or deny service.) By distributing the ledger, Bitcoin guarantees transparency and distributes the power of governance.
  2. Decentralised: When it comes to Bitcoin there is no central bank or reserve bank to issue currency. So where does the money come from? Bitcoin software protocol issues new bitcoins based on mining and totally there can only be 21 million Bitcoins available by 2140. Bitcoin is designed as a deflationary currency as opposed to fiat currency issued by central banks which can be inflated.
  3. Peer-to-peer: Bitcoin is paid peer-to-peer like cash. You may not appreciate this design unless you are aware that every time you swipe your debit/credit card you pay a tiny amount to visa/master-card and your bank .(Usually the merchant will bear the cost . The duopoly(visa/master-card) earns more than 40 billion USD as interchange fees.)
  4. Crypto-currency: Anything digital(images, audios, videos) can be copied or multiplied. Unlike other digital stuff, Bitcoin is scarce and prevents double spending. This is achieved by miners who put every transaction through hashing algorithm when adding it to the blockchain.

Where do I hold Bitcoins?

“If you don’t own your private keys, you don’t own your Bitcoin”

You hold your Bitcoins in your Bitcoin wallet. Technically, you hold your private keys in your wallet which will digitally sign your transaction. Some prefer to hold their Bitcoin in exchanges. However it is prudent to hold your bitcoins in your wallet rather than exchanges because it gives control over your private keys.

Is Bitcoin a digital gold?

“Bitcoin is scarcer than Gold”

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Because of the demand and supply dynamics in the pricing of Bitcoin, many compare Bitcoin to gold. But its important to notice that Bitcoin is scarcer than Gold. Each year more gold is is pulled out of the ground than the year before. [1]

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b. Inflationary Gold production
Bitcoin provides for a maximum of 21 million units by 2140 and cuts the supply (called Halving) every four years. Currently the supply is 4% annually and in 2020 that will be cut to 2% annually.

But…but…What is the intrinsic value of Bitcoin?

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Many incumbents of Financial industry have decried Bitcoin as “Ponzi scheme” or “Fraud”. Others have questioned the intrinsic value of Bitcoin. Where does Bitcoin get its value? What is its utility?

Bitcoin pricing may resemble the Paradox of utility. (Although water is useful for survival, it is valued less than diamond). Bitcoin’s value comes from its intrinsic scarcity, immutability and security. (There can only be 21 million Bitcoins and no-one can print more bitcoins like fiat-currency. Bitcoins cannot be double spent as all transactions are recorded and verified across the blockchain)

Bitcoin is closer to commodities like gold when examining the price from a demand and supply perspective. As many Bitcoiners hold bitcoin as a store of values and others hold it in the hopes that it will appreciate in time(to speculate).

What’s with the Volatility bruh?

Bitcoin price tend to be extremely volatile and easily swing 20-30% in a trading day. If you ask a Bitcoiner, they would recommend to HoDL(hold) your coins irrespective of the price swing. This volatility can be attributed to its thinly traded market. Bitcoin total market capitalisation is only 2% of global gold market capitalisation.

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If you examine Bitcoin market closer, you will notice the volatility in Bitcoin has reduced considerably over the years.

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c. Bitcoin Daily Percent Price change in 2013 Vs 2017

As Bitcoin gains more mainstream adaption, the market will become more liquid. Therefore the market capital will increase as more the people will chose to buy and sell, many Bitcoiners expect volatility to reduce over time.

Should I buy in an All-time high Bull market?

“The best time to plant a tree is 20 years ago. The second best time is now.”

At the time of writing, Bitcoin was trading at $16000. (I can’t help posting DBZ Vegeta meme 🙂 ).

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Should I buy a full bitcoin? Answer is NO! Even though Gold bars are priced at $13,862, you can still buy gold as small coins. Like wise You don’t have to buy a full Bitcoin. You can buy a fraction of it.

So does that mean I should invest in Bitcoins? Maybe. Maybe not. Bitcoin was name the worst investment in 2014. Following this year’s rally, Bitcoin is named as the best bet for the year 2018. Let us see some of Bear and Bull Scenarios. (I will discuss this in detail in later posts)

Bear Scenario:

  1. Gresham’s Law: “Bad money drives out good”. ICO (Initial Coin offering) will drive investors away from Bitcoin.
  2. Its not a bullet proof investment even for Bitcoin maximalists. Bitcoin advocates like Wences Casares argue that you should not invest more than 1% of your portfolio in Bitcoins as there is a 20% chance it could be a failure.
  3. Speculation supersedes utility which may lead to Bitcoin to crash.

Bull Scenario:

  1. More Mainstream investors are coming.
  2. Lightning Network.
  3. Schnorr Signature .
  4. Metcalfe’s Law: Value of a network is equal to the square of the number of connected users of the system (n2). Don’t underestimate network effect and Bitcoin’s network effect in particular.

    It would be Stupid to invest in an All-Time high volatile market like Bitcoin. And it would be equally Stupid to stay away from possibly the best performing asset of the decade. So choose your stupidity wisely.

Recommended Reading:

The Denationalization of Money – F.A. Hayek (1976)
The Age of Cryptocurrency – Paul Vigna and Michael J . Casey (2015)
Digital Gold – Nathaniel Popper (2015)

Bitcoin donations are accepted.

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