When attempting to explain bitcoin, people often start with a technical definition of how the actual protocol works. Somewhere between describing how blocks are formed and what miners do, you usually start to lose your audience. Understanding whats going on under the hood is both important and interesting, but to the laymen, I think it’s the wrong place to start.
Bitcoin is a technology that is leveraged by end-users every day across the globe. So let’s focus on how bitcoin is actually being used and why. A user-centric versus a technical-centric definition provides a more relatable explanation and one that points to its emergent use cases.
Bitcoin can be defined as a deflationary store of value that is uncorrelated and censorship-resistant. Currently, the killer-app for bitcoin is financial speculation and a vehicle to hedge against systemic risk.
So let’s break that down:
Deflationary
The Bitcoin protocol has a fixed supply of 21 million bitcoin. The rate at which new bitcoin is minted gets reduced every 4 years. To date, over 16 million bitcoin are in circulation. The last bitcoin will be minted some time approximately between 2110 and 2140.
A Store of value
Bitcoin is the granddaddy of the crypto-world. Bitcoin has been up and running since 2009 with zero downtime and its liquidity has grown significantly over recent years. It can be accessed, transferred, and most likely exchanged into fiat 24/7. Although exchanging bitcoin to fiat and vis versa remains to be a major bottleneck, the number and quality of crypto-exchanges have dramatically improved helping to solve this accessibility challenge. It is reasonable to presume that over time the user experience of moving between fiat and bitcoin will improve and one day could become ubiquities.
Censorship resistant
Bitcoin is a peer-to-peer protocol that enables users to send value from point A to point B without relying on a trusted third party, like a financial intermediary. By design, there are no major central points of failure. The protocol itself doesn’t care about KYC/AML or any financial regulations for that matter. As long as you have a device connected to the Internet with one of the many open-source wallet applications downloaded, you can send, receive, and store bitcoin without having to ask anyone’s permission. You could memorize a private-key and walk across a border moving millions of dollars.
Uncorrelated.
Bitcoin was born outside of and continues to thrive outside of the traditional financial industry. The protocols design, uptime, and functionality are not subject to the whims of central banks, government entities, or any financial institutions. If there were to be an economic or political crisis, similar to what was experienced in Greece or Cyprus, the protocol and the ability for anyone to use it would not be compromised. Bitcoin isn’t built on top of any banking or other legacy systems but is an extraneous system. As a result, bitcoin has anti-fragile properties.
So what problem does bitcoin solve?
Bitcoin’s properties have enabled some interesting use cases; financial speculation and a vehicle to hedge risk.
The former applies to those who invest in bitcoin in order to speculate on its price movements. I expect this to be the main driver behind its price. Crypto-exchanges provide very low (sometimes zero) trading fees when compared to mainstream brokerage accounts and offer leveraged margin trading.
Bitcoin is also very volatile. This, along with low fees on exchanges, has made bitcoin attractive to day traders. Large online communities have formed around chatting and speculating on bitcoin’s price forming its own subculture with some very entertaining memes.
The later application applies largely to those living in a world of political and financial uncertainty (Argentina, Venezuela, India, China et al.) Bitcoin’s censorship resistant characteristics are primarily why it provides opportunities for those living in turmoil. It can be used to transcend any financial system that has become unreliable or has put an individual’s traditional assets at risk.
When individuals flee or migrate from troubled jurisdictions they most likely experience strict capital control restraints and are often forced to leave behind large portions of their wealth. They do not yield true and independent ownership over their assets, namely fiat. Many are forced to cut their losses in exchange for an opportunity to start a new life elsewhere.
To what extent bitcoin has been leveraged in such circumstances is difficult to quantify. When the Indian government subjected its citizens to its demonetization policies, for example, bitcoin was trading at a premium in Indian markets.
How much of the premium was driven by speculation versus raw demand for a vehicle to hedge is, again, hard to reliably determine but suggests that a genuine utility for bitcoin as a safe haven exists.
In a world where more people have a mobile phone than they have access to access to a flushing toilet, it is conceivable that much of the world’s population in developing countries are in a position to leverage bitcoin’s properties in times of crisis.
Wasn’t Bitcoin suppose to be a digital currency?
I don’t consider bitcoin as an alternative currency, as many do at first glance, because that is not currently a common use-case. And for good reasons.
For one, it’s very volatile. Secondly, those who bought bitcoin did so because they are bullish on bitcoin. For example, people don’t go to Starbucks to buy a coffee with their Apple shares, because they probably went through the hassle of buying Apple to sell at a profit, not to be used as a medium of exchange. The same logic applies to bitcoin.
With that said, bitcoin could be adopted as a medium of exchange one day, it just hasn’t yet by any meaningful manner other than for the exchange of illicit goods (online drug markets). Again, a result of its censorship resistant nature.
In short, bitcoin shares many similarities to that of gold as a financial asset, but with some important upgrades. For now, bitcoin still largely exists as a new asset for traders to speculate on. Given it’s unique properties, it could one day serve as the worlds financial save haven.
-Written by Filip Cybula
