Back to the Future: Bitcoin as a Vehicle for Innovation

Back to the Future: Bitcoin as a Vehicle for Innovation

Money is an interesting thing; it infiltrates our lives at every turn. It has become a necessity for life, and through its use, people can gain access to just about anything they need or want. From something as simple as bread and other foods needed for basic subsistence, to extravagant luxury items like mansions and diamond-encrusted Rolex watches.

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It’s easy to take for granted the convenience money affords to people, even though it hasn’t always existed. Without it, we would have a difficult time even attaining very simple things because everyone would be forced to find a person who had the exact thing they needed. Even if they do find a person who possessed the exact thing they wanted, then, in return, they would have to possess or locate the exact thing that person wanted in exchange. Money benefits everyone by expanding their options — everyone universally values money, and therefore will accept it as a form of payment.

Bitcoin: Innovating Money

dollar-726884_1920Bitcoin is an innovation to the financial system, sometimes called a new kind of currency. While it is true that Bitcoin is a digital form of currency, meaning it can be spent on goods and services like any other form of currency, this definition only scratches the surface. What truly makes Bitcoin unique is how it confirms or secures payments. Our current financial system is built upon trust; trust that the issuers of a currency will back its worth with the “full faith and credit” of government; trust that banks will securely store their money, transfer payments, and protect personal information. The more we can remove trust from third-parties or middle men — eliminating errors of human judgment — from decisions that affect money, the better.

Bitcoin does exactly this because it doesn’t rely on centralized institutions to be conveniently stored, to transfer payments, or to check for counterfeiting. All of this is done on the blockchain, which decentralizes these processes. The blockchain allows people to be their own banks, storing bitcoin in digital wallets on their computers or smartphones. It also records all payments to a public ledger, which has the effect of simultaneously confirming the authenticity of the bitcoins in circulation. Thus, Bitcoin provides further economic benefits to consumers by eliminating the need for middlemen, which gives people direct control of their money.

Why is Decentralization so Important?

The most significant aspect of the currency, through which every other benefit of Bitcoin originates, is the decentralized nature of the blockchain. What is decentralization? According to Merriam-Webster.com, it is the dispersion or distribution of functions and powers.

One very well known example of this concept is political decentralization of a government. A political system that disperses power among a national government and smaller component states is also known as federalism — which is how the United States government operates. In other words, if a law is implemented by the federal government, it applies to the entire country, but a law that bans dancing in Oklahoma only applies to Oklahoma. Centralization is more of a one size fits all deal, and decentralization is more of a personalized system.

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Typically, people don’t handle large sums of money in a physical form (cash) or store their savings themselves. Instead, people entrust financial institutions to store their savings and electronically transfer their payments, eliminating the burden of bulkiness that comes with physical currency. People also entrust the government to issue currency, thus it is tasked with creating money and enforcing its value as a legitimate payment method.

Contrasted with this financial system, the Bitcoin network works through the code it was programmed with. Bitcoin runs on a decentralized network that disperses the control of money among thousands — if not millions — of private computers. This means the digital currency isn’t controlled by any one single person or institution.

Furthermore, Bitcoin transactions are encoded through complex algorithms that are solved by people known as miners. Miners use computing power to decode the algorithms to reveal a private key linked to a public key (like a pin number linked to a bank account), and a specified bitcoin amount. Once they decode the encryption they, put the information in a block, which is then entered chronologically into the blockchain, which acts as a public record of all transactions. Miners compete to confirm these transactions, because they are rewarded with a certain amount of bitcoin with each successful confirmation — and can charge a transaction fee — thus giving them a monetary incentive to continue this mining process.

Bitcoin is essentially digital cash because there are no financial intermediaries involved in transactions, it’s just you and the person you’re trading with. However, this sometimes confuses people into believing that Bitcoin’s purely digital platform is its main advantage. Even world renowned scholars, such as Nobel Laureate, Paul Krugman, make this mistake. In a short video posted on FEEhe asks what advantages Bitcoin gives people that the digitizing of money hasn’t already given people. Of course, there are many advantages to Bitcoin, and they all originate from its decentralization, not because the currency is merely is digital.

One of these advantages is a controlled supply growth, which is programmed into the Bitcoin protocol. Bitcoin is created through the mining process; when a miner discovers a new block, they are rewarded bitcoin automatically by the protocol. This is how new bitcoin enters circulation, and the amount awarded is halved every four years until 21 million bitcoins have entered into circulation, which is the protocol’s hard-coded supply cap. This means Bitcoin will become a completely deflationary currency; at some point new bitcoin will stop entering circulation and its total supply will begin to slowly decrease. To compensate for its fixed supply, bitcoin can be divided to the 8th decimal point, or 1 hundred millionth of a bitcoin. So, as the supply of bitcoin decreases relative to the goods it can buy, and prices begin to decrease, the more valuable smaller units of bitcoin become.

With Bitcoin, there is no Boom and Bust

maxresdefaultThe supply cap is important, because it doesn’t allow for arbitrary expansions in the supply of bitcoin by a central bank or government. This is something governments often do to stimulate demand, but a consequence is that it causes inflation making prices higher. It also allows governments to determine interest rates, and many times governments set interest rates low as another way of boosting demand. However, according to the Austrian School of economics this is the main cause of the boom-bust cycle. The boom being the period of growth and the bust being the recession. Bitcoin avoids both, which is to the benefit of consumers, because their money can retain its value without being inflated.

In essence, Bitcoin benefits people by allowing them to control their money more directly, and takes away the ability of third-parties from manipulating its supply and negatively affecting its value. Bitcoin’s decentralized nature disperses control of the money, which also eliminates any single point of failure. Every aspect of the network is just one part that makes up the entire whole. This means that no single part is necessary for the rest of the network to continue operating. It is the dispersed nature of Bitcoin that really makes it unique and innovative; giving people more control of their money, and consequently all aspects of their lives that go through their money.

What do you think the future holds for Bitcoin? Let us know in the comments below!


Sources: Investopedia, Bitcoin Foundation, FEE, Merriam Webster

Images courtesy of Wallpapers Craft, TechCrunch, Econ Stories