Blockchains and Bitcoins

How did we get here and where are we going? 🚀

Bitcoin is up 843% in the last year, and you still don’t know what a blockchain is.

There’s a lot of noise when it comes to learning about cryptocurrency. Put simply, a blockchain is a decentralised solution to a problem — the double-spending problem. This occurred in early cryptocurrencies where two people would exchange a digital token. Issues arose regarding which person is now holding the original asset, as opposed to a copy. Exhibiting behaviour as the name suggests.

A blockchain as a digital distributed ledger solves the double-spending problem. It consists of records called blocks, storing transactions that take place on a peer-to-peer network. Each block has an associated hash which is basically a reference number for a block in the blockchain. They are computed using cryptographic hashing functions that take block data as input and return a fixed length, encrypted output.

Blocks are chained together by using the hash of the previous block along with the unencrypted data of the new block as input to the hash function. This makes blockchains immutable (unchangeable) data structures as changing previous blocks is impossible without the alteration of subsequent blocks, which everyone else on the network has access to. Everyone is able to validate every transaction for themselves.

That’s all well and good, but who gets to decide which blocks are added to the blockchain? This is where Bitcoin amongst other cryptocurrencies comes in.

Consensus is reached on the Bitcoin network using a system called Hashcash proof of work. These proofs are used at the block generation stage and is a cryptographic problem that ‘miners’ on the network compete to solve first.

All Bitcoin clients share an extremely large number called the target. For a new block to be valid, it must hash to a value less than or equal the target. The first miner to find a hash that meets this constraint is the one who gets to add the new block onto the chain and is compensated for their work with Bitcoin.

The important thing regarding proof of work is that the problem it presents is sufficiently difficult to solve, so much so that a new block is added to the blockchain every ten minutes. This ensures the node on the network that finds a solution is chosen almost completely at random. Moreover, it is incredibly easy for other nodes on the network to verify a solution using the target and therefore agree on the new block.

This provides security on the Bitcoin network due to the sheer amount of work it takes to recompute block hashes if an earlier one is changed. By which time the rest of the network would have left a bad actor in the dust by reaching consensus on new blocks in the meantime. Someone with malicious intent would require compute power equivalent to at least 51% of the whole network, an impossible feat.

A number of other cryptocurrencies have emerged since the birth of Bitcoin in 2009, the most notable being Ethereum. Ethereum uses a different system called proof of stake to reach network consensus. This alongside other blockchains and digital currencies deserve articles all to themselves.

So, why invent cryptocurrency in the first place?

The Case for Crypto: So much of the economic world does not recognise currency other than the US dollar as money. Some currencies are pegged to the dollar meanwhile other governments copycat American monetary policy. Oil, for example, that isn’t priced and purchased in dollars simply does not exist. Some would argue it is these commodities that ‘make the world go around’. And so, it seems logical to talk about the increasingly popular viewpoint that US dollar is somewhat a doomed illusion of money.

It is important to separate currency and money. Currency is a medium of exchange — people believe it has value so we can pay for goods and services. It acts as a store of value meaning we can save in it and it’s not going to disappear overnight.

Historically, money has been sound money. This means it exists outside of the system, cannot be created by any group of people and isn’t liable to sudden appreciation or depreciation. An example of sound money would be a currency based on or redeemable in gold. Gold is a great store of value but a terrible medium of exchange. As a result, we created paper claims on top of gold which lead to the paper money we know and use today. Much more convenient.

In 1971 under President Nixon, the US abandoned the gold standard which meant the dollar was no longer backed by gold. This gave the government the power to print [fiat] currency boundlessly. What this does is manipulate the ‘free’ market and causes inflation.

During the Coronavirus pandemic, we have observed the dollars reliance on the ‘velocity of money’ or volume being exchanged. This is what keeps an economy growing, the same way a shark must swim to breathe. This lack of consumption and velocity has exposed some dire problems with the financial system. To combat this, the US government flooded the market with liquidity and cut interest rates to 0%, leading to higher rates of inflation.

Another way in which they did this was riddled with hypocrisy — by bailing out large corporations in a midst of panic. Take the airline companies for example, which have been profitable for decades. Instead of saving or investing profits, they were taking 80–90% of free cash flow and buying back their own stock, making executives rich. The second the pandemic started, they realised they were going to go bankrupt.

They chose not to raise equity capital where someone invests in the business to pay bills and employees. They chose not to raise debt. They ran to the government begging for a bailout. The US government is the idiot in the room here as no investor would give these companies the terms that they did. These bailouts consisted of hundreds of billions of dollars, a third of which they agreed, minimum, they did not have to pay back. Free money.

The reason this is hypocritical is because if you’re a business owner and you make bad decisions or investments, the government won’t come and help you. The US saw historic numbers of unemployment in the first week of March last year. No one even knows the real figure as they couldn’t process all the claims, but it is in excess of 6.6 million. This is the case for cryptocurrency, it holds people and organisations accountable for their actions and no one can devalue your hard-earned cash.

It’s not the government’s job to take care of you, it’s the government’s job to ensure you have the freedoms to take care of yourself.

Recent estimates state around 40% of dollars in existence were created in the last 12 months. This raises questions over the official inflation statistics quoted as 1.7%. If we look at the US stock market and denominate it in dollars, we observe an almost straight line increasing linearly at around forty-five degrees. When we choose to do so in gold (sound money) instead, we see a line with negative gradient.

This begs the question, is the stock market and other investable assets accruing value or is the dollar being devalued? A financial incentive has been created to not hold cash and lose purchasing power as a result. It seems those airline companies were on the right track.

So, What Now? By this point, it should be clear to you Bitcoin is sound money. Not only is this the case because no one can create, destroy or alter the supply, but also because of proof of work. Bitcoin, in essence, is backed by the computations necessary to mine it. Although belief in any currency is important, they represent something more than that.

No statistic captures the belief people have in decentralised finance quite like this one: of all Bitcoins in circulation, 60% of them have not moved in the last twelve months. Bitcoiners have iron-clad fists of belief.

Security also leads to belief in the system which has been paramount to Bitcoin’s success. More transactions took place on-chain last year than with Apple Pay, Venmo and Paypal; the network handled this just fine.

If the Bitcoin network was somehow in some way compromised by a nefarious organisation, its value would decrease. Although this is highly unlikely, there is no financial incentive to do so. Even if someone were to steal all the Bitcoins, this act would render them worthless. The ‘someone’ in this scenario would have to be a non-economic actor.

There is a trade-off between security and ease of use, however. This is shown in Bitcoin transaction speeds as mentioned earlier, it takes ten minutes on average to mine a block. The Bitcoin community and blockchain companies will continue to grow, eventually adding new layers on top of Bitcoin to remove such limitations. This will happen in a similar way to how second layer paper money was created on top of gold. Followed by credit and electronic payments on top of that, and so on.

Ethereum already acts as a platform to build such services on top of using smart contracts as tools for automation. No one really knows what the future global reserve currency is going to be. With Bitcoin already being an ideal store of value and a multitude of companies working on new layer blockchain technology, nations across the globe will have to create ‘digital dollars’ which will flow to Bitcoin or risk being left behind.

This is a real possibility national governments have to consider. Any country who wants to be ahead of the curve should participate in Bitcoin. At its core, it is an open, decentralised protocol, much like the internet. It hasn’t worked out so well for nations that failed to adopt new technology in the past.

As a result, there will be little to no competition at the core technology layer we have talked about — blockchains, peer-to-peer networks and the protocols that govern them are here to stay. The competition will be at the monetary policy layer. But it is also our job as developers and engineers to decide. The technologies we choose to work on will be where the bulk of innovation and economic activity takes place.

The market will decide which cryptocurrencies are adopted, but adoption is indeed inevitable.

I am a keen writer, aspiring young professional and computer science student. Connect with me on LinkedIn or View my Portfolio