2022-04-21
When we want to trade goods or services for other goods or services, we find it is difficult to match up with someone who wants what you have and has what you want. You could try to trade for things you don't need but they could wear out or become useless and worthless. And it would be difficult to keep track of what is worth how much, store everything, and just get the things you want in general. Money is designed to solve all these problems. It creates a medium of exchange for goods and services that can easily be traded for any other goods or services elsewhere. It creates a store of value; a store's value is the sum of it's parts, like the currency of a nation's value is the sum of its productivity, exports, deficits & debts, etc. It also creates a unit of account to allow us to universally measure the value of assets and flow of capital, that is necessary to interpreting and understanding the economy, business, and of course taxes.
In the early history of money there would be many different coins used in the market and a standard coin would be used to measure the value of transactions with in official ledgers for the government. Eventually we reached a point as society where the need for a centralized currency was realized. Many forms of currency have been experimented with historically. Paper notes were note always common until relatively recent history. Coins were common, and valued upon their weight and metal makeup. We also experimented with the Gold standard, backing the value of paper notes with the value of stored gold, which was when banking also became much more centralized.
These metal backed currencies stopped seeing use because the growth of the population was continuing to rise, and they needed more dollars to go around, so they made more notes, and the value of the dollar deflated, and there was little gold left to add to the stores to increase the value and combat the deflation.
This gave birth to new more complicated fiat currencies that are backed instead by exports, productivity, growth, national debts and deficits, etc. This new form of paper currencies, fiat money promised a more stable economy; offering the ability to pace inflation with growth, by centralizing control over debt, interest rates, and the printing of new bills.
Fiat money brought it's own problems as well, unlike the deflation problem of backing the currency with a limited resource, the inflationary properties, and centralization of fiat money combined pose 2 problems. inflation is constant, however manageable, but more importantly centralization of monetary policy control and supply is a significant risk.
Throughout history there have been many times where the relationship between debt and fiat money printing would create a bubble, or outright hyperinflation.
The digital revolution in the mid 90s quickly brought in digital money to the world. Credit card systems or bank routing systems would become the mainstream form of moving money digitally. Other attempts to digitize money existed, which mostly failed.
For many years it was clear there was a demand to make money digital. People wanted to enter a world of fast, and secure global digital commerce, and the demand was constantly increasing. Money on the Internet evolved rapidly in less than 30 years, first with credit card payments online starting in the mid 90s at simple internet web merchants, and even digital banking. In the 2000's, the smartphone revolution began and personal digital devices started to become more and more common, and web based applications were developed for these devices. This new technology led to us having access to the stock exchange in our pockets with no trading fees, fully automated digital banks and financial services, and nearly any other good or service available through a mobile device application by 2020.
As technology evolved, crime evolved just as rapidly. Criminals and terrorists could operate and communicate secretly and securely, getting access to money or moving money with greater agility. Security and accountability is a critical and essential part of digital business and money because of this. All this communication on the Internet is taking place in a platform that is largely open to everyone to look at. Data, messages, information about us and our lives, bits and bytes that authenticate our payments and authorize access to our bank accounts need cryptographic security to protect them. But it is not all bulletproof and there have been many virus driven or social engineer driven 'hacks' of secured networks to reveal confidential data before, and is common in the world of cryptocurrency also. If security is compromised, money can easily be stolen from a centralized ledger, or can be intercepted in transit, and if network communications are poor enough and accounting isn't robust, transactions could simply get lost. How to deal with these problems to digitize money without depending on a central authority to mediate transactions and maintain control of the ledger has held back previous attempts to create peer to peer digital payment systems.
Then around the time leading up to the 2007 financial crisis in the United States that Bitcoin development was suspected to have begun based on the mysterious creator's activity online. Bitcoin emerged with a digital ledger system called a blockchain, and a digital currency, to form the two main components of a fully digital money system. The ledger is timestamped, and auditable, to allow public tracking of transactions. Bitcoin ledger entries track movements and accounts of the cryptocurrency bitcoin.
A consensus mechanism is used to determine who is authorized post updates to the blockchain ledger. In the case of Bitcoin, the mechanism of consensus is proof of work, where a Bitcoin node must prove it has done the work of solving a complex computer logic problem before anyone else, and it earns the right to post a block of transaction records to the ledger, and collect a bitcoin reward, and transaction fees from the network users. The cryptocurrency bitcoin is on a fixed supply, and the rewards it gives for transactions cuts in half periodically. The limited supply can never be adjusted, there is just over 19 million bitcoin at the time of this writing, and a maximum of 21 million bitcoin can ever exist.
In cryptography and encryption there is a concept of public and private keys for securely encrypting and decrypting information algorithmically. Blockchain technology uses private keys the same way to negotiate and authenticate transactions. A user has no other information than a public key (wallet address) on the blockchain. Someone wishing to send a transaction would then use the recipient's public key to encrypt their transaction to them, so that only the intended recipient may decrypt the message and accept the transaction. When the transaction is accepted, it is then queued up to be posted to the blockchain by miners competing for rewards.
The Bitcoin network was designed to create a finite supply of 21 million bitcoin. It is slowly released to miners as a reward for reaching consensus, and posting transactions. The miners also collect fees for the network transactions. Every 4 years, the bitcoin rewards are cut in half for miners, driving the scarcity of the coin and prolonging its growth lifecycle before all coins are finally in circulation. Because of this, bitcoin does not share the inflationary properties of fiat currency.
Because the blockchain is a distributed ledger which has duplicated itself onto Bitcoin nodes around the world, the Bitcoin blockchain also has many redundant backups of the ledger, and the network will verify the legality of transactions against the ledger. Multiple verifications on independent nodes are required to finalize a block of transactions on the Bitcoin blockchain. This leverages the redundant supply of duplicate ledgers to create a highly secure mechanism for network data integrity, protecting from any attempts to forge entries in the ledger to authenticate illegal transactions with for example. It does however result in a long process to verify on a great number of nodes before being permanently written to the blockchain, most transactions are considered legitimate after passing about 4-6 verifications. This decentralized structure with robust record keeping and authentication policies solves the problem of a secure and functional digital money without central authority.
At some point Bitcoin will run out of rewards for miners as it reaches the 21 millionth bitcoin. When that time comes, mining will have to become more efficient than it is now, and transaction fees will likely be adjusted to maintain incentive for mining operations to continue to maintain the network and keep new transactions posting. As the ledger increases in size, the burden of maintaining the blockchain on node providers increases also. New technologies to interface with the Bitcoin blockchain like Lightning offer to improve the network efficiency and scale it better, but there is still more technological growth required.
Bitcoin has also seen its fair share of criminal and terrorist activity, but as the world of cryptocurrencies has grown, its economic dependence on criminal activity has been unleveraged, public education about the blockchain ledger, and government regulations around on and off ramps into cryptocurrency exchanges has significantly reduced the criminal capacity to use Bitcoin and other cryptocurrencies, and further education and regulation are still being pursued for these reasons. Still governments believe that it will be more difficult to control international rivals with sanctions if they can skirt the traditional financial system with their own blockchain technology.
It does seem to me that the scalability issues present with Bitcoin pose a threat to its viability as a currency, and the degree of that threat can change what form it will take in society on the global stage. We have already seen small countries adopt it as an official currency, and there is steadily increasing regulatory clarity around it, and acceptance of it by traditional financial institutions is increasing. The US and Canadian governments have both taken great interest in cryptocurrencies and blockchain technology recently, and regulatory discussion is ongoing while the governments actively pursue studying cryptocurrencies and blockchain technology. In the future I imagine Bitcoin competing with digital versions of fiat currencies known as Central Bank Digital Currencies (CBDCs), such as a digital USD or Yen, on a global stage economically, as smaller countries with very weak and failing fiat currencies turn to Bitcoin more and more.