Bitcoin Explained: Simple Answers to Common Questions

Every month I have multiple conversations with people who do not understand Bitcoin.?

It can be a confusing topic, so in this post I’ve attempted to catalog my thoughts about Bitcoin in a Q&A format based on the questions I'm asked. I’m fascinated by the topic because it has such world-changing potential.

This is not investment advice. There are both positives and negatives to Bitcoin (BTC), but it's important to understand what it is and isn't.

I think Bitcoin can greatly benefit human rights and is likely to increase in value over time. However, it could also challenge the global power structure, especially affecting the United States.

This post will concentrate on explaining Bitcoin's nature, its operational mechanics, and why I think it will have a growing impact on the world.

TL;DR Number go up

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What is Bitcoin?

It is a digital currency, created in 2009, by an unknown person(s) using the alias Satoshi Nakamoto. It operates on a decentralized network of computers using blockchain technology to manage transactions and record keeping.?

The blockchain, at its core, is an accounting ledger (think Accounting 101, credits vs debits) that tracks every time someone sends or receives Bitcoin. There are copies of that ledger all over the world. If someone tries to cheat and insert a transaction into the ledger (for example, to give themselves free Bitcoin), the computers securing the ledger (which are called Miners and nodes) will reject that transaction. 51% of the nodes around the world must agree a transaction is legitimate for it to be transcribed onto the permanent ledger.

One of the technological breakthroughs of Bitcoin is that no one has to trust anyone else to make a transaction. It is “trustless”. It uses advanced encryption, and the nodes/Miners secure the system to guarantee transactions are valid.

Unlike traditional currencies, it has no central authority, operates independently of governments.

What’s so special about Bitcoin?

1. It’s a Scarce Asset: There will be a maximum of 21M Bitcoin "tokens" ever. There are currently 19.7M. This means it is a “scarce asset” and cannot be inflated away as has happened to the US dollar. ($1 from 1900 has lost 97.3% of it's purchasing power over time.)Why won’t there ever be more? Because it is pre-programmed into the code (anyone can read the code to verify this)Why can’t someone just change that number? Because it requires 51% of the nodes (computers verifying the ledger) around the globe to agree to make any changes to the code, and they have no incentive to agree to change it, as that would immediately destroy the value of Bitcoin.Who determines when the remaining (21M - 19.7M) = 1.3M Bitcoin will be issued? It is already programmed into the code. These will be paid to Miners over time for securing the network. (see “What are Miners”)
2. It is Trustless and highly secure: Anyone around the world can exchange Bitcoin with anyone else and be confident the transaction is legitimate, without having to go through an intermediary or verify anything about the other person.
3. It is Decentralized: No government or entity can change it, inflate it, cheat it, etc. It requires consensus (51% of nodes around the world) to make any changes - so it is very stable and protective of the value of Bitcoin for all holders regardless of how much they own.
4. It is the first truly global scarce asset: Anyone anywhere with a smartphone can transact with. This gives power to people all over the world who have been cut off from traditional banking and/or who risk seizure of their home or other assets by the government. This also dramatically saps the power of dictators to control their citizens.
5. Financial Sovereignty: In other words, it allows individuals to hold and exchange value without intermediaries, and no one can take your Bitcoin without your permission. (Unlike cash, or money in a bank or stock market, all of which can be seized by the government)

What is Bitcoin good for?

1. Store of value: Similar to what gold has been used for millennia, but much easier to transact with, and less inflationary (gold will continue to be mined so long as it has more value than it costs to mine it, while there will never be more than 21M Bitcoin)
2. Protection from inflation: When governments print money, it hurts the lowest wage earners the most (as they spend the highest percent of their income on essentials). Countries such as Turkey, Zimbabwe, Argentina etc. have such high inflation that wages quickly lose their value. When citizens can convert their currency into Bitcoin, the money they save is protected from additional debasement of their currency. (i.e. they should be able to convert their Bitcoin back for more of their local currency in the future, because their local currency has lost value due to debasement).? This provides those citizens unprecedented freedom.
3. International Transactions: Workers who send US dollars back to their home country have historically been charged upwards of 8% to 10% by money transfer services. Sending Bitcoin costs a small fraction of that.
4. Autonomy/Protection from seizure:? Bank accounts and earnings are subject to seizure for a variety of reasons around the world - this can be a powerful threat by some governments to keep their citizens in line. Bitcoin cannot be seized or stolen by anyone who does not have access to your private key (a long string of numbers or words)
5. Inclusivity: ?Everyone, everywhere can hold bitcoin so long as they have a smartphone and/or access to the internet. Even those who have traditionally been excluded from the banking system.
6. Forcing governments to stop increasing debt / debasing currency: The US has issued so much debt there is virtually no way to pay it off. Currently 60% of US taxpayer income tax receipts go to pay just the interest on the national debt(!!) So, the US never actually pays off the debt, but simply rolls it forward (i.e. reissues it for a later due date) and then prints more dollars to pay the interest. That means more dollars are inserted into the economy, which means inflation (i.e. it costs more dollars for the same item). In particular, most of those dollars eventually go to the holders of scarce assets (e.g. real estate, S&P500, Bitcoin).Practically, that means home prices get more and more out of reach for young people and people who do not own scarce assets. i.e. the rich get richer, and the poor get poorer.?

Bitcoin changes all of that:

1. Anyone can buy Bitcoin: Each Bitcoin is divisible into 100,000,000 “satoshis”... which as of today is about $0.00067. Thus, everyone can own a “scarce asset” as a hedge to protect themselves against currency debasement.
2. Bitcoin is a threat to the US Dollar as the Global Reserve Currency. Today, the US dollar is used as the Global Reserve Currency (think of it as the currency by which everyone compares the value of the items that they are trading). Today a barrel of oil is worth roughly $80… so when the US prints more dollars there is little downside to the US, in fact, we can use those dollars to buy even more from the rest of the world.? That’s a huge benefit to the US. But, if Bitcoin becomes the Global Reserve Currency, then the cost of a barrel of oil will be measured as X number of Bitcoin. Then, if the US prints more dollars, the number of dollars per Bitcoin goes up, and thus the cost of a barrel of oil to the US goes up… which creates pain for US consumers, and an incentive for the US to stop printing so many dollars. So Bitcoin should force the US (and other governments) to stop devaluing their currency through money printing.

But I can’t buy a cup of coffee with Bitcoin??

No, but you can’t buy a cup of coffee with a US Treasury Bill either. When you use a credit card your transaction is recorded on a ledger several layers above the Federal Reserve. You can think of Bitcoin as an alternative to the US dollar base layer, which records the big transactions. There are other layers (such as the “Lightning Network”) being built on top of that Bitcoin base layer, but whether or not those are used in the future, Bitcoin can be thought of as a way to record large value transactions.?

Isn’t Bitcoin inherently worthless?

While it’s true that you can’t go to a bank and exchange it for a gold brick, the same is true of the US dollar. The US fully abandoned the “Gold Standard”? in 1971, which means there is nothing tangible backing the dollar. Like Bitcoin, the US Dollar has value because other people/countries agree it has value. Obviously, the US dollar has been around longer than Bitcoin, but per the aforementioned, there are also many benefits of Bitcoin that the dollar does not enjoy.?

What are Miners?

Bitcoin “Miners” do work (i.e. run millions of calculations to answer a mathematical puzzle) for the potential to earn a reward (newly issued Bitcoin "tokens"). These new Bitcoins are issued roughly every ten minutes. Simultaneously, Miners are updating the ledger with all of the new transactions. If they update the ledger with an incorrect version of the ledger, they will not receive the Bitcoin reward, so there is a strong incentive to be truthful when updating the ledger.

What’s “The Halving”??

You may have heard this term related to Bitcoin miners. Roughly every four years the number of Bitcoin paid as rewards to Miners is cut in half. This is important because it forces the Miners to get ever more efficient, and it reduces the native selling pressure in the market. Why? Bitcoin Miners need to sell some of their rewards to pay for their servers and energy use, so when rewards are cut in half it means they have fewer Bitcoin to sell (which is a positive for the price of Bitcoin, because selling creates downward pressure on the price)

The price of BTC has traditionally followed 4 year cycles of booms and busts, which correspond to the Halvings. The theory is that as the supply of new Bitcoin earned and sold by Miners decreases, it causes upward pressure on the price, which then turns into a hype cycle before things calm down again. Note: this four year cycle also corresponds to global liquidity levels (the total amount of money in the world) which may also explain the cycles.

Isn’t crypto full of scams?

There are a lot of scams in crypto, however, Bitcoin is different from all other crypto currencies (e.g. Dogecoin, Eth, Tron, Link, etc.) and blockchains (e.g. Ethereum, Solana, etc.). Almost everyone I talk to is confused by this point and bundles them all together. Yes, they have similar backend technologies (blockchains), but they are conceptually very different. The easiest way to think of the difference today is that Bitcoin is a “store of value” (e.g. a digital version of gold) while Ethereum, Solana and other blockchains are used for transactions, decentralized finance (e.g. buying/selling assets), issuing tokens, smart contracts and NFTs, etc.

Also, note that as these technologies and regulations mature, the bad actors are getting removed (e.g. many of the scams from the 2020/21 cycle went bankrupt and the perpetrators have been jailed)... but there is still lots of very dubious activity in meme coins and other parts of crypto.

Plus, the Jan 2024 approval of Bitcoin ETFs in the US was a major stamp of legitimacy that significantly reduces the risk of the US government trying to stop Bitcoin.

Isn’t Bitcoin used for terrorists and illicit transactions?

Most likely, but almost assuredly a lot less than the US dollar. Also, unlike dollars (and other traditional currencies) the Bitcoin ledger (blockchain) indelibly records every single transaction, providing unprecedented transparency.? If a user transfers their Bitcoin into another crypto currency, those transactions are also recorded, and authorities are getting very sophisticated in tracking transactions across multiple chains.?

Isn’t Bitcoin too volatile to be a good store of value?

It’s true that Bitcoin has been highly volatile, though over time as more people own it, and the market cap increases, it will almost inevitably become less volatile (like a big ocean liner vs a kayak in the ocean). While it will likely continue to have large swings (historically 30% to 70%), over time it has had higher lows and higher highs.

Won’t the US Government just ban Bitcoin if it thinks it is a threat?

Theoretically, they can try to “ban” it, but they can’t stop it. Bitcoin is decentralized and governed through consensus by individuals and companies all over the world. i.e. there is no company, no CEO, and no way for a government to stop it. The government could slow it down by massively taxing it and penalizing people who try to avoid the taxes. But, especially now that the Bitcoin ETFs have been approved, there are enough citizens and government officials benefiting from owning it that it will be very hard for Congress to agree to extreme measures to try to stop it.

Isn’t Bitcoin horribly energy intensive and destructive for the environment??

Bitcoin mining deliberately consumes a significant amount of energy. This high energy cost acts as a deterrent against fraudulent activities by miners. The principle is that any Miner attempting to add a fraudulent transaction to the blockchain would incur substantial energy costs without success, as other Miners would reject the falsified transaction, leading to a financial loss for the dishonest Miner. This mechanism, known as "Proof of Work" (PoW), ensures that Miners can only secure and add legitimate transactions to the blockchain if they demonstrate actual expenditure of resources, or "work."

• Isn’t this a terrible waste of energy? Bitcoin mining uses a tremendous amount of energy. I do find this very concerning. However, whether or not it’s a “waste” is a separate question from whether I think Bitcoin will continue to grow in value. I’m very sympathetic to the concern about energy use, particularly given our current reliance on fossil fuels. And, while it’s a valid philosophical debate, I think it is a bit of a moot point because Bitcoin cannot be stopped even if we wanted to stop it. (see discussion re distributed network)
• What many Bitcoiners say to push back against the energy use concerns: Miners always seek the lowest cost energy sources (because energy is the main drain on their profits). This means they prefer to locate next to renewable energy sources (e.g. hydro, geothermal, solar, wind).?These energy sources are often far away from urban centers, so Miners can help these energy providers scale up / increase economies of scale / increase demand to invest in more renewable energies. Miners can be turned off during peak demand periods to help flatten energy demand (a big issue for energy grids / energy generators)Miners can be powered by burning methane emissions that are released by oil and natural gas extraction, reducing greenhouse gasses (of course, many environmentalists would like this entire sector to go away)It’s better than the alternative: The cost of the Petro-Dollar and the US military dwarfs the energy and any negative impact of energy used for Bitcoin mining. While this is true, I’ve always found this argument difficult to swallow. The Bitcoin Maximalists' belief is that at some point in the future Bitcoin will force the US to reduce its spending on the military (because US Government spending reduces the value of the US dollar against Bitcoin, which is consequential when the world uses Bitcoin rather than the US dollar as its Global Reserve currency). I think that is a real possibilty, but the consequences of the US losing its military power would create dangerous instability around the world, which could be catastrophic before some new equilibrium is established.

Don't other blockchains provide security without using so much energy?

Yes, the best known example is Ethereum which moved from Proof of Work (PoW) to Proof of Stake (PoS) in 2022. In the PoS system, a validator of the ledger has to "stake" tokens (i.e. put money in an escrow account) to be eligible to earn a reward. If they attempt to post a fraudulent transaction to the ledger, they will lose that money, which provides a strong disincentive to try to cheat. This system requires very little energy use.

Bitcoiners argue that systems that rely on staking funds tend to move toward consolidation, where the richest validators will get bigger over time. Consolidation would threaten the decentralized nature of the blockchain, which is key to protecting all the smaller participants. The Ethereum move to PoS is a grand experiment. My hope is that it proves successful, which could potentially convince Bitcoin nodes operators around the world to agree to switch to this lower energy method of securing the blockchain.

Isn't quantum computing going to break Bitcoin encryption?

Yes, probably at some point in the future. This could allow attackers to steal funds. Of course, quantum computing threatens all sorts of data encryption beyond just Bitcoin. The cryptocurrency community is well aware of this threat and is actively developing new encryption methods specifically designed to resist quantum attacks. While the timeline for these risks is uncertain, it's likely that cryptocurrencies will adapt and implement these new security measures long before quantum computers pose a serious threat.

Why has the price of Bitcoin gone up?

Note: this is not investment advice and no one knows what the future will bring, but the primary reasons it has gone up are:

• Bitcoin is a fixed supply while governments debase currencies by printing money
• Increased adoption?- More people are using it over time (as it gets easier to access and becomes more mainstream) which creates Network Effects.
• Increased appreciation of its value by investors?
• Lessening risk - e.g. adoption by key financial institutions, US approval of Bitcoin ETFs, and the "Lindy Effect" (the longer a nonperishable thing has been around, the longer it is likely to be in existence).
• “The Halving” - every 4 yrs the rewards to Miners are cut in half, meaning selling from miners and the inflation rate drops over time.
• We are still in the early adoption phase. At some point it should slow down and likely grow only as much as currencies are debased, but today it’s still a relatively small percentage of global investments. (Gold is worth ~$14T while Bitcoin is ~$1.3T today). If Bitcoin is a “better digital gold” then one might expect Bitcoin at some point to be valued at least as much as the value of gold (a 10X increase). If it becomes the Global Reserve Currency, the price would likely be far higher.

Why do some people in power hate Bitcoin?

Because it threatens traditional power systems. If you own Bitcoin, the government literally cannot seize it without your permission (unlike traditional money, even in your bank account). In addition, it creates a system of exchange outside government control - which makes it harder for the government to extract taxes, reduces citizens' dependency on the local currency, and allows individuals to bypass government controls. Large financial institutions, which normally extract fees for holding and moving funds, are also cut out of the system, threatening their income streams. Finally, it threatens the position of the US Dollar as the Global Reserve Currency, which has been a tremendous benefit to the US, allowing the US to print huge amounts of debt to fund its economy, military and influence around the world. There's no question Bitcoin is a very disruptive technology.

What are the long term implications if Bitcoin becomes the Global Reserve Currency?

Currently many commodities (such as oil) and international transactions are priced in US dollars. That means the US is the “Global Reserve Currency.” This position has allowed the US to massively grow its debt (i.e. print more money) with great benefits to the US and detriments to everyone else. (Imagine a foreign government has a loan valued in US dollars. The more dollars the US prints, the more of that government's local currency is required to pay off that loan. The US gets all the benefits, and the foreign country is forced to produce more to pay off their loan).

As the US continues to run budget deficits (i.e. borrow more money) and prints more money to pay the interest on its ballooning debt levels, there’s a greater risk that other countries will no longer want to buy US debt nor will they want to use dollars to trade.? Bitcoin offers a unique alternative, as no government can inflate it and take advantage of that power as the US is doing.

In addition, when the US weaponizes the US dollar - such as seizing a foreign government’s bank accounts when we don’t like how they are acting (e.g. Russia) - it creates a strong incentive for other governments to keep their money in secure, non-seizable, assets such as Bitcoin.

If countries start to transact in Bitcoin instead of the US dollar, that means all countries' currencies (including the US dollar) will be measured against Bitcoin. (e.g. in the future people around the world may say “that car is worth 1 Bitcoin” vs “that car is worth $67,000”). Governments (including the US) will be forced to keep their currencies from inflating, or risk that everything becomes more expensive in terms of Bitcoin. (e.g. If the US prints more dollars, that car will still cost 1 Bitcoin, but now because there are more dollars, it will cost $70K or $80K etc in US dollars to buy that 1 Bitcoin… so it costs more dollars for people who get paid US dollars to buy that same car).

Forcing the government to not inflate its currency, and focus on productivity gains to fund its growth, will generally be good for people who are poorer and do not own assets. However, it makes it very difficult for the Government to respond to a crisis, such as Covid, where the US printed trillions of dollars to support citizens when businesses had to shut down. It would also force the US to dramatically cut back on spending that does not result in short term productivity benefits. That could mean cutting back on military spending (the long term impact of which is debatable, but, at the minimum, is likely to be extremely destabilizing in many parts of the world).

This is a much bigger topic than I have time for here, but let’s just say it would have profound, and currently unknowable, impacts around the world.

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Please: If you're thinking of buying BTC, do your own research. Get to understand Bitcoin and the risks involved. It will likely continue to be very volatile. In the past it has taken up to three years to reach a new high and has dropped as much as 80%. It’s possible it will lose all of its value. As with any volatile asset you should never put more money in it than you can afford to lose.

Note: I may update this from time to time if people have more questions and/or I update my thinking.? Feel free to ask questions in the comments section and I’ll do my best to answer them. #BTC