Cryptocurrency - The Fundamental

Chapter 2

Disclaimer: Nothing in this article shall be construed as financial advice. This article is purely for expressing the author’s opinions and observation regarding Bitcoin and cryptocurrency in general. Author’s view might not necessarily reflect company’s view.

Now this chapter might be important if you want to invest (buy and hold for the long term). Cryptocurrency is a very controversial subject. There are champions of Bitcoin who tells people to mortgage their house and buy Bitcoin. Seriously, give this video a spin.

There are others who believe Bitcoin will be useless and will not have a price. So I think it is worthwhile for us to take a look at Bitcoin as is.

If you want to trade, this chapter might not be important because you’d probably be focusing on sell pressure from Mt. Gox or FTX etc etc. Be sure to keep a close eye on those big whales so that you can conduct your flow analysis properly. Or maybe use a technical indicator like RSI? I don’t know. But just remember that trading is a zero sum game.

Hopefully, if the chart is like below, you know what to do or what not to do.

Chapter 2: What is a cryptocurrency? Or Bitcoin?

In its purest form, it is software that is run by people. In fact you can take a look at Bitcoin’s codebase if you fancy. This is the most popular bitcoin implementation that is contributed by 900+ developers as of 2024. There are alternative Bitcoin implementations such as btcd (one that is written in Go programming language) but its not popular.

And what software is this? Is it a software that runs a ride hailing app? Or is it a software that runs a B2B market place?

Let’s take a look:

What is Bitcoin Core?

Now that’s a mouthful. From peer-to-peer network to blocks. If you are the nerd-type, you can take a look at the Bitcoin white paper for more details. If you are just a normal human being, let me try to explain those g1bb3r1sh in the most intuitive way possible.

Essentially Bitcoin is an accounting software. It is a really special accounting software because it has the following features: (i) it accounts for all public transactions (ii) it is publicly available and (iii) it requires little trust. Toby please write in english.

It means that any recipient of my Bitcoins knows that I have the amount of Bitcoin spendable to make a transaction. If I want to spend 100BTC for example and I don’t have it, I cannot do so. Hmm, how is this significant?

Traditionally the flow is as follows:

1. Alex owns $100 in the bank
2. Alex wants to send $50 to Bob via bank transfer
3. The bank approves the transfer to Bob because Alex has $100
4. Bob receives $50 and his bank account increases by $50

Now let’s say we have Charlie who wants to send Alex some money:

1. Charlie owns $10 in the bank
2. Charlie wants to send $50 to Alex via bank transfers
3. The bank declines the transfer to Alex because Charlie has $10
4. Alex never receives $50 from Charlie and his bank account remains unchanged

Notice point where the bank is a middleman verifying transactions between Alex, Bob and Charlie. Banks would reject invalid transactions because it has a ledger (or bookkeeping) of all transactions of their customers. Of course you cannot make up money out of thin air, otherwise that money is meaningless.

Now Bitcoin is special because it does verification of transactions without banks. Banks do not have to have a role in verifying transaction of bitcoins between two parties (they are irrelevant). In fact, the motive of creation of Bitcoin in the wake of Global Financial Crisis is to make banks irrelevant.

but but banks are buying bitcoin, ethereum and {insert your favourite cryptocurrency here} and the price is going up! ??

Yeah funny that these financial institutions buy assets that’s purpose is to make them irrelevant.

So who verifies my Bitcoin transaction? And how is it done?

Anyone who can run the software I shared above. Remember that it is a public bookkeeping of all transactions that happen in the network. That’s why people call it a decentralised network. People from all walks of life, age, background, ethnicity, you name it can run a bitcoin software and start verifying transaction. For example, if Alex runs the bitcoin software using his computer, he is deemed as a node. A collection of these nodes (let’s say run by Alex, Bob and Charlie) is called the bitcoin network.

Now, if Alex wants to transfer 1 BTC to Bob, how does Alex’s transaction gets verified? Remember, this is the public and you cannot expect public to act honestly without a well-defined protocol. Dishonest activities include:

• How does one prevent others from forging transactions on behalf of others?
• How does one prevent from spending more than one owns?
• How does one know that all transactions in the network are not fraudulent?

In a very simple and intuitive way, we have a well-defined protocol. What do you mean by well-defined protocol? It is a set of rules that are obeyed by participants. If the rules are obeyed, the system (game) works.

For example, the rules of playing football or soccer. There are simple rules like only the keeper can use their hands to guard the goal, others must only use their feet (duh football). But there are more edge cases rule like during a goalkick, a striker from the opponent team cannot “steal” the ball from the keeper. Everybody who plays football, needs to adhere to that rule, otherwise you don’t participate.

Now Bitcoin, or the accounting software, has those rules as well. Put simply here are the rules:

• Each person is assigned with 2 keys. Private and public. Private keys are the keys you keep secret and they are unique. Public keys are keys that others know.
• If you want to make a transaction, you have to digitally sign that transaction using your private key and then publicly broadcast that transaction to the network.
• Others can verify that it is a transaction you made using your public key to know that transaction is valid
• All transactions that occur in one epoch (period of time) are then collated together and grouped together forming a “block” of transactions
• For a network participant to verify the block of transactions, they need to solve a complex mathematical problem (cryptographic hash function to be precise) that can only be solved by brute force or trial and error.
• But once it is solved, it is very easy to verify that the person (also known as miners) has done the correct work. And obtaining an answer to that math puzzle is a hard proof that you have done the work.
• For the reward, you will get an unspent currency that can be spent (because it is unspent) and people refer that to Bitcoin.

Eittss, we are not done.

• After getting the reward, to mine the next block, you need to take into account the hash (or result) of the previous block.
• So the current block of transactions will always be connected to previous one. Forming a chain. Hence, blockhain.

And how do we trust the blockchain? We trust the longest one. Why the longest one? Because it has the most work that is put into it to verify the transactions. Makes sense? That way, you don’t need a single entity to decide whether this transaction is valid or not.

Now if you don’t understand still, that’s alright. There is a great video by Grant Anderson in explaining how this is done in technical terms. He explains it super clearly that involves very minimal math.

Okay, so we have managed to breakdown what Bitcoin is in its purest form, which is the longest public ledger (transaction records) that has the most work on it.

So what? Why do people buy if it is just a collection of transaction records?

If you have managed to read this far, your prefrontal cortex (rational brain) must be screaming. How is bitcoin this simple? Will it go down to zero then? Well, no one knows. But let’s begin by enumerating reasons why people buy bitcoin.

Number go up

“Bitcoin is going to hit ${insert_target_price} in 2024!” - {insert_finance_influencer}

It is really obvious that people want to be rich or make money. So they buy an asset that would go up in price. And this is not new. For those old enough to experience the commodity boom in the 2010s, you’d also often hear people congregating, saying that oil is going to $150 or $200 or whatever. Then shale happened in 2014 and oil prices tanked.

This is fine, if people buy Bitcoin because of this reason, but perhaps it is wise to acknowledge that they are not investing but are speculating or gambling. And it is probably wiser not to use a disproportionate amount of your material wealth to speculate or gamble.

Limited 21 million supply

There will only be 21 million Bitcoin mined in this world. With this limited (scarce) supply and increasing demand, the price of the asset must surely go up.

Always remember that a scarce asset does not always mean it is a valuable asset. Especially if that asset does not have an intrinsic value. Furthermore, the fact that other people value an asset, does not mean it is really valuable. Remember in 2005-2008 in America? People value Mortgage Backed Securities at sky high valuations even though the underlying asset is people’s pets getting mortgages? Do you really think that a dog will pay their owners’ home loans?

The limited 21 million supply is thus only valid if there is going to be an increasing demand for Bitcoin, because of its intrinsic value. If you believe that there is surely going to be an increasing demand because of Bitcoin’s intrinsic value, then it might make a good long term investment. Otherwise, if you believe that demand comes from participants who speculate, you might want to be careful.

Bitcoin halving

Despite people (my circle) telling me to buy more Bitcoin because of halving, surprising how many people don’t know what Bitcoin halving is.

#1 common misconception:

Bitcoin is cut in half, so there’s going to be a supply shock because Bitcoin becomes more scarce.

The latter is correct Bitcoin becomes more scarce after a halving, but not because the circulating supply is cut in half. But the mining reward is cut in half. So if you are miner that used to earn 1 BTC after you successfully mine a block, you will get 0.5 BTC now after halving.

Escape from fiat

I love this reasoning the most. People buy bitcoin because they want to escape fiat currencies. But paradoxically, they get super happy when Bitcoin value goes up in fiat terms. Then when crypto bear market comes, they turn silent somehow. This is because they also get upset about crypto when value goes down in fiat terms.

If you really want to escape from fiat, here are some things you should do:

• Make money and only accept money in cryptocurrency
• Only buy products (clothes, food, etc) and services (medical, travel, etc) that accept cryptocurrencies as payment
• Pay your mortgages in cryptocurrencies
• Pressure your government to accept bitcoin or other crypto to receive taxes in those currencies

There are people who legitimately do this btw. To some degree they are admirable for standing by the values envisioned by those who built cryptocurrencies back in the day.

But for you folks who keep your bitcoin under the custody of your favourite centralised exchanges and are looking to profit from your crypto in fiat, please please don’t tell me that you are escaping from fiat.

Closing Remarks

Thank you for reading thus far! So what do you think is Bitcoin’s intrinsic value?

Is it a store of value, medium of exchange or unit of account? Who do you think will be able to use Bitcoin in a meaningful way in the future and for what purpose?

Will Bitcoin be able to withstand technological changes that breaks its current protocol? Hint: quantum computing that can break SHA-256 would render the “work” done in Bitcoin meaningless.

Once you have come up with the answers to the above, you can come up with a total value (in dollar terms). The price will be value / number of bitcoin. Simple ya?

Until then, do you think its wise to mortgage your house, family businesses and put all your savings into a single asset? You decide.