(Pete’s second post on Bitcoin is a sequel to his original post and my followup — JB)
So how does Bitcoin actually work?
It works by the voluntary association of peer-to-peer computer nodes all around the world, much like BitTorrent. Except whereas BitTorrent each carry slightly different files on them, each Bitcoin node carries the exact same data on its SSD, namely, a full history of all the Bitcoin transactions that have ever occurred on the network dating back to 2009. Having each node store all the transactions provides redundancy and decentralisation, while the fact that the overwhelming majority of nodes have their software tailored to the specific needs of their users provides ecosystem diversity in the face of Heartbleed and other 0 day exploits.
Within each full transaction history on each node, transactions are chunked into “blocks” that are no more than 1 MB in size with a median transaction being 227 bytes in size. There are now over 500,000 such blocks that are indelibly linked together to form a “blockchain,” which can be thought of as an append-only registry that keeps track of all the bitcoins in existence. Since this registry is public, Bitcoin “ownership” is therefore simply the ability to use one’s private key to demonstrate control of a piece of the blockchain by cryptographically signing a transaction. He who owns the keys, owns the kingdom, as it were. Once the transaction is signed, it’s broadcast to the other nodes on the network who ultimately relay the transaction to a miner. If the miner likes the look of the fee attached to the transaction (there is a competitive fee market, currently around $10 for a median-sized transaction), the miner incorporates that transaction into the next block he “discovers,” which is then appended to the longest chain.
The security for the blockchain is provided by the “miners” who cryptographically “mine” bitcoin (by brute-force hashing SHA256 problems generated automatically by the software) in exchange for block rewards and the aforementioned transaction fees. Miners are currently rewarded with 12.5 BTC for every block they “discover” before anyone else on the network and their newly minted coins constitute the programmatic money supply into this nascent financial ecosystem. New blocks are “discovered” every 10 minutes on average and the software automatically adjusts itself every two weeks to respond to increases or decreases in the number of computers trying to “mine” in any given period so that the 10-minute average is maintained. Transaction fees currently make up about 30% of a miner’s revenue and this proportion will continue to increase as block rewards logarithmically decay from their initial 50 BTC level until the last 0.00000001 BTC (aka 1 “satoshi”) is mined around the year 2140 (that’s in 112 years, not the 12 years you’ll mistakenly see written some places). Mining rewards halve every four years and we’re currently in the third such four-year period.
As you might have gathered from the reward structure, Bitcoin (and to a lesser degree its imitators) is therefore the only predictably scarce asset on the planet. There will only ever be 21 million bitcoins and almost 17 million are already in circulation. It will take over 100 years to mine the remaining 4 million meaning that the gold rush is very much afoot. Bitcoin has been the largest computing project in the world for the last five years and the network is currently doing more math than the entirety of humanity combined over the course of the millennia up until 2009. Every. Single. Second. That’s all the Roman bureaucrats and all the NASA launch calculations and everything else in between. Again and again and again. Even compared to the world’s most powerful supercomputer – the Sunway TaihuLight with 93 PFlops/s – the Bitcoin network is >150x more powerful and growing fast.
Why is Bitcoin a big deal ?
Bitcoin is a big deal because it allows for broadly practicable, almost mass individual sovereignty. Previously, the power to be sovereign was tied inextricably to the power to fight neighbouring bodies with physical force. Valuable assets such as gold, silver, real estate, and fine art have always been large and cumbersome, meaning that their protection (in quantity) always required standing armies and some sort of castle. Bitcoin takes the idea of these same highly sought-after assets – namely that of knowable scarcity – and resolves the “bug” of their physicality with cryptography while leveraging the peer-to-peer nature of online networks to provide ultimate portability. The result is lightweight, flexible, and highly, highly disruptive.
What are the limitations of Bitcoin ?
Bitcoin is far from perfect even if it seems to be better than just about every alternative. It’s technically complicated to operate safely and even more complex to understand with any degree of confidence. Most of the basic software used to run nodes (all the way down to the kernel) is poorly written, which makes digital security a continual sore spot for even the most advanced users. The Bitcoin codebase is constantly being improved upon but there are limitations to these efforts given the patchwork legacy that Satoshi left us. A full rewrite is inevitable but few if any are capable of such a Leviathan task.
Furthermore, the incentive structure within Bitcoin is incomplete (viz. relay nodes are not paid to transmit transactions between senders and miners, and therefore relay nodes must serve the network altruistically). Miners also appear to be selected for rampant short-term idiocy but this problem also appears intractable. Other limitations include “price” volatility. Even though a bitcoin is a bitcoin is a bitcoin, the unknowable numbers of dollars in existence make the exchange interface between the two continually troublesome. Stocks, options, and other wagers priced entirely in BTC terms have worked well for years and years but anything parlaying between fiat and crypto worlds inevitably burns one of the parties involved. See the story of Mt Gox. Still other limitations include human psychology itself and its poor familiarity with deflationary assets bearing such extreme opportunity costs.
What does Bitcoin mean for me ?
Probably not much. Bitcoin isn’t competing with dollars, pesos, or euros so much as rare art, collectibles, precious metals, and luxury real estate. Unless you own a penthouse overlooking Central Park, a Ferrari 250 GTO, or Salvator Mundi, chances are that your investments will be unaffected and your life will go on as it always has. You might experience a little more inflation in the years ahead but that’s QE-Infinity’s fault, not Bitcoin’s. If you’re an individual looking to diversify from a steamy stock market or a bland bond market, the best time to plant a tree was 20 years ago, the second best time is today. Hup to it. Even still, you shouldn’t expect to understand Bitcoin in less than 200 hours of dedicated research. Anything short of that and don’t beat yourself up if it doesn’t click.
Recommended primer reading includes David Graeber’s “Debt: The First 5000 Years,” Nassim Taleb’s “Black Swan,” and of course Satoshi Nakamoto’s Bitcoin White Paper.
What are Bitcoin’s imitators and can they threaten its dominance ?
Bitcoin’s main imitators at the moment are Ethereum, Ripple, Litecoin, and Bitcoin Cash.
Ethereum was marketed as a “smart contract platform” but that has proven to be grossly exaggerated after the DAO hack in early 2016 (you can google it but suffice to say that a smart contract was used to create millions of dollars of new tokens quite legitimately but that the Ethereum “community” objected and so “undid” the “bad” transactions by hardforking the project). It’s now clear that Ethereum is a centrally managed cryptocoin that offers none of the advantages of Bitcoin (decentralised development, limited coin supply) and all of the disadvantages of fiat (centralised development, unlimited supply). It currently trades at about 0.06 BTC.
Ripple is also a centralised banking product with serious limitations in that it requires blind trust, is premised on 0% interest rates, and creates fatal fungibility between unequal parties. It currently trades at about 0.0002 BTC.
Litecoin is a less secure version of Bitcoin with a few magic numbers diddled to no apparent benefit. It was marketed as “silver to Bitcoin’s gold” and “ASIC-resistant” but neither promise has born fruit in the last few years. It’s founder also recently claims to have divested his entire ownership stake in the coin. It currently trades at about 0.02 BTC.
Bitcoin Cash was an attempt to hard fork from the main Bitcoin blockchain in an effort to “listen to the community” by providing larger blocks with which to accommodate more transactions per minute so that user fees could be lower. Miners have not adopted this fork very broadly and neither have many users. It currently trades at about 0.2 BTC.
Bitcoin has significant first mover advantage in the space, the best security in the business, the most robust infrastructure around, the most liquidity, and the brightest minds behind it. For all intents and purposes, its crown is unassailable. Other coins might have more media pizzazz at any given moment but none has the durability, reliability, and proven track-record of Bitcoin. Over the next 10 years, one or two of the thousands of “altcoin” competitors might edge out Bitcoin’s performance but your guess is as good as mine which of those it may be. Bitcoin is the surest bet in the space.
Why are all Bitcoiners such insufferable pricks ?
Most aren’t. Most are congenial, hard-working introverts who yearn for independence from overbearing governments. Almost all are idealistic to a fault. This idealism can, however, lead Bitcoiners to the bleeding edge and beyond, which is why we’re likely to either offend you or bankrupt ourselves (if rarely both). Those who enter the space being “nice” and stay that way tend to be too weak of stomach for the insane volatility or they get scammed left, right, and centre, but either way they’re selected against in the long-run. Those who stick around can handle a hundred daily dips of 30% in their net worth, likely experience periodic bouts of paranoia, but aren’t afraid of much you can say to them, so sometimes they’ll push other boundaries just for the experience. This can come off as prickish, and it’s hard to argue that it isn’t from a certain lens, but it’s very rarely personal.
If I buy Bitcoin today, will I be able to buy an M3 or Huracan in 10 years ?
Depends how much you buy, but if it’s a decent chunk and you secure it properly, I wouldn’t bet against it.
Where can I buy my first Bitcoin (or fraction thereof) ?
Try localbitcoins.com. Most Bitcoin deals happen person-to-person in cash. Meet in well-lit cafes. Avoid Coinbase.
Where do I store my first Bitcoin (or fraction thereof) ?
In order of most secure to least : paper wallets, TRB node, “Core” node, blockchain.info webwallet.
Any final words of wisdom ?
These are still early days. Remember what I said about planting trees.