What is Bitcoin Backed By
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Topics of Discussion
- Development of Bitcoin
- What is Bitcoin
- Mining
- Blockchain
- Total Bitcoins in Circulation
- Transactions
- Transaction Fees
- Bitcoin as an Investment
- Bitcoin Wallets
- Privacy
- Bitcoin As A Potential Currency
- Bitcoin and Financial Institutions
- What is Bitcoin Backed By
Development of Bitcoin
The original creator of Bitcoin Client described their approach to the software as an attempt to prove that a peer-to-peer electronic money system was valid, which begs the question; What is Bitcoin Backed By? There are over a dozen companies and industry groups that fund and grow Bitcoin. The original Bitcoin.org domain name was first registered August 18, 2008 and the bitcoin network was created January 3, 2009 when Nakamoto mined the first block of the chain, known as the genesis block. Nobody really know who Nakamoto is.
Cypeherpunk Hal Finney was the first person to receive a bitcoin transaction, as he was the person who created the first reusable proof of work system. On January 12, 2009 Finney downloaed the bitcoin software on his computer and received ten bitcoins from Nakamoto. The first known commercial transaction took place in 2010 when Laszlo Hanyecz purchased two Papa John’s pizzas for ₿10,000. In 2010 Blockchain analysts estimated that Nakamoto mined around 1 million bitcoin and disappeared handing the reigns over to Gavin Andersen who later became the developer of the Bitcoin Foundation.
What is Bitcoin
Bitcoin is a digital currency that is not backed by any central bank that can be sent peer-to-peer. Transactions are verified by nodes through the process of cryptography and recorded on a public ledger called a blockchain. Bitcoin are created through the process of mining and can be exchanged for products, services and other currencies.
Bitcoin has been both criticized and praised ever since it’s inception. It received a bad name in it’s early years as a way for criminal enterprises to conduct illicit transactions, miners use a large amount of electricity and the price remains to be extremely volatile. There are many that consider Bitcoin to be a speculative bubble. Even though several regulatory agencies have issued many investor alerts about bitcoin, many still use it as an investment.
Mining
Early miners used Graphic Processing Units (GPU’s) for mining as they worked better with the proof of work algorith created by Hal Finney. Later, amateurs adopted the use of Field Programmable Gate Array (FPGA) and Application-Specific Integrated Circuit (ASIC) chips to mine bitcoin. Today bitcoin has become more industrial with companies dedicated to housing and operating high-performance mining hardware.
Miners keep detailed records of the blockchain to make sure the chain is consistent and unbroken. They do this by grouping newly broadcast transaction into a block which is then sent to the network and verified by recipient nodes. Each block consists of a SHA-265 Cryptographic hash linking it to the previous block giving it the name blockchain. In order for a new block to be accepted by the network, a proof-of-work (PoW) is required.
The chaining of blocks, along with the PoW system makes modifying and therefore counterfeiting, extremely difficult. A counterfeiter would need to alter all subsequent blocks in order for changes to one block to be accepted by the network. With new blocks being mined all the time, the difficulty of altering blocks increases with each passing day.
Blockchain
The bitcoin blockchain is a public record of transactions. It consists of a chain of blocks that contains a hash of each previous block, all the way back to the genesis block. The blockchain is maintained by a network of communicating nodes running bitcoin software.
When a transaction occurs, the nodes will validate the transaction, add them to the ledger, and then broadcast the changes to the other nodes on the network. In order to verify transactions, each node on the network stores its own copy of the blockchain. There is a conventional ledger that is used to record transactions that happen outside the blockchain that may consist of bills or promisary notes but the only place a bitcoin can be said to exist in the form of unspent outputs of transactions is the blockchain.
Total Bitcoins In Circulation
Nakamoto set a monetary base to create scarcity at bitcoin’s inception, bitcoin can never exceed 21 million. Roughly every ten minutes new bitcoin are created and the rate they are created halves about every four years. The maximum number of 21 million bitcoin will be reached by the year 2140. As of 2020, roughly 18.5 million bitcoin have been mined.
A successful miner that finds a new block is allowed to reward themselves with 6.25 newly created bitcoins per block added to the blockchain by the rest of the network. In order to claim the reward a transaction called a coinbase is included with the processed payment. Every bitcoin that has been mined thus far has been created with this coinbase system.
Transactions
Transactions consist of inputs and outputs, when users send bitcoins they will designate the amount and the address of the recipient and this is the output. Every input must refer to an unspent output of the blockchain in order to prevent double spending. There may be multiple inputs in a transaction which relates to the number of bitcoin being sent in a cash transaction. Given that a transaction can have multiple outputs, a user can pay multiple recipients in a single transaction.
Just like a cash transaction the sum of the inputs can exceed the sum of the outputs. When this happens, a new output is created returning change back to the payer. If any input satoshis is not accounted for the output then becomes the fee for the transaction.
Transaction fees
With Bitcoin transaction fees are optional, but miners have the option to choose which transactions to prioritize and process based on those that pay higher fees. A Miner may choose to process a transaction relative to their storage size and not necessarily the fee size. Fees are usually paid in satoshis per byte and the size of the transaction is typically measured on the number of inputs and outputs used to create the transaction.
Bitcoin as an Investment
The very first bitcoin fund was established in Jersey, the region of France, in July 2014 and was approved by the Jersey Financial Service Commission. You are able to own individual bitcoin without having to buy into a fund and Forbes named bitcoin the best investment in 2013. Bloomberg pegged bitcoin as one of its worst investment in 2014 and then turned around in 2015 topping their currency table which give further evidence of the volatility with this investment.
According to bitcoinmarketjournal.com, in December 2019, there are currently 42 million bitcoin wallets and 7.1 million active bitcoin users. It is estimated that 5% of Americans own bitcoin and the largest bitcoin exchange is Coinbase which has approximately 13 million users. It is very difficult to tell exactly how many bitcoin users there are as a single user can have multiple wallets.
Bitcoin Wallets
A wallet contains the necessary information a user needs to transact bitcoin. Wallets store the digital information for your bitcoin holdings and allows a user to access and distribute them. Many often describe a wallet as a place to store bitcoin but as we know from above, bitcoins are not separated from the blockchain and are therefore not individual coins like with traditional currency.
Wallets are made up of cryptographic keys, one public and one private, as bitcoin uses public-key cryptography. This adds to the privacy and security aspects of using bitcoin.
There have been several third-party services that have appeared called online wallets, similar to online stock trading accounts. In these cases, access to funds is stored online rather than on the owners own hardware. In this case, users must chose credible online wallet providers as an unscrupulous provider or a security breach of the wallet server may result in the loss or theft of the users bitcoin.
Privacy
Owners of bitcoin addresses are not really identified, but all bitcoin transactions are kept on the public ledger which makes bitcoin pseudonymous. The funds in a bitcoin wallet are not tied to any specific entity or individual but transactions can be tied back to entities by tracing back public transaction data with information of known owners addresses.
With the adoption of more people exchanging bitcoin for other currencies and assets, bitcoin exchanges may be required by law to collect personal information allowing people to trace specific companies or individuals to specific wallets. In order to combat this, new bitcoin addresses can be created for each individual transaction.
Bitcoin as a Potential Currency
Bitcoin has three qualities that potentially make is useful a a currency. They are hard to earn, limited in supply and easy to verify but most people agree that it works best as a payment system rather than a currency.
A currency is generally defined as a medium of exchange for goods and services usually in the form of paper or coins and backed by a government and generally accepted at its face value as a method of payment. In 2018 The Economist stated that cryptocurrencies meet none of these criteria.
There are many out there that believe that bitcoin can be used as a reserve bank currency but most economists believe that with the fixed supply of bitcoin, it makes it impractical as a world reserve currency. Demand would far outreach supply and this would result in permanent deflation which means adopting it as a global reserve currency doesn’t make sense.
Bitcoin and Financial Institutions
Currently, bitcoin can only be bought, sold and transferred on digital currency exchanges. Most financial institutions have given a large amount of push back towards cryptocurrencies. In 2014 the National Australia Bank closed business accounts that had ties to bitcoin and the Hongkong and Shanghai Banking Corporation (HSBC) has refused to serve any hedge fund with ties to bitcoin.
In 2017, the Chicago Board Options Exchange began allowing the trading of bitcoin futures which was soon followed by the Chicago Mercantile Exchange. In 2020 the state of Wyoming gave Kraken a license to establish a special purpose depository making it the first crypto bank. The bank is tentatively known as Kraken Financial and is expected to open in the first quarter of 2021.
What is Bitcoin Backed By
Like the US dollar, bitcoin is not guaranteed by a physical commodity and instead it gets its value in another way. Since bitcoin does not have a centralized entity that regulates its value and is not supported by any commodity, many people mistakenly think that means it has no value. However, the value of an individual unit of bitcoin currently exceeds $ 10,000. The Market Cap of bitcoin is currently around $190 billion which clearly indicates that it is perceived to have value by a large number of people.
Bitcoin is not currently supported by anything physical or backed by any government but the complex mathematics and controlled sourcing behind its blockchain technology gives the public enough confidence for it to maintain its value. This method ensures that bitcoin remains limited in supply and opposes censorship, giving bitcoin its value. The remainder of the value of bitcoin can be attributed to the fact that it was the first monetary system to function without a centralized unit and it cannot be easily seized much like gold was in the 30s.
The utility value of bitcoin is growing as thousands of merchants now accept bitcoin as a means of payment for goods and services. Bitcoin is found to be less correlated with the stock market than many other assets, making it useful as a hedge in the same way people use gold. The level of confidence observed in a currency can be indicated, by its level of use in the world.
While it performs well against other fiat currencies, the US dollar is – and will be for the foreseeable future – a currency that can be spent almost anywhere. As a result, consumers have confidence in the dollar. Purchasing power and convenience are themselves valuable products.
On the other hand, bitcoin is still far from mainstream. The crypto community has come a long way since the first bitcoin transaction was spent on pizza, but until mass adoption, relying on bitcoin will ultimately not be used as much or as widespread as current currencies until it was establishes Confidence as a fiat currency.
Despite their obvious differences, bitcoin is similar to that of fiat currencies which are largely supported by consumer confidence. As the crypto space expands, trust in bitcoin will continue to increase and since the market price of bitcoin is a direct result of fluctuations in supply and demand, it means that it can appreciate significantly when times are good, but it can also drop if it falls out of favor.
Summary
The world seems to be pushing towards a global reserve currency and bitcoin seems to be the first attempt that has gained enough support to make a run at it but from what we have learned, the experts say that it has a long way to go before it can meet the demands necessary to fill that gap. Unlike gold or other precious metals, bitcoin is not backed by anything other than the perceived value of it’s users and is therefore not real money. But unlike fiat currencies, there is not an unlimited supply which puts bitcoin in a very unique space.
