Bitcoin Basics
15 minute guide to go from a beginner to a self sovereign bitcoin holder.
This document will cover the basics of bitcoin, to help you understand why it is valuable. There is much more to learn however. From the philosophy of money, to the technical security of bitcoin, or the new features that have been made possible from the taproot upgrade. There will no doubt be important things I have forgotten. It takes 1000s of hours to truly understand bitcoin, and hundreds more each year to keep up with changes, financial markets and government policies. And as is often the case when studying many subjects, the more you learn, the more you realise you don't know.
But by reading and understanding everything below you will know more about bitcoin than 99% of people. And have the knowledge to be able to research further and learn more. However you do not need to understand everything to see why bitcoin is important or to use it and benefit from it. Just like today's system which most people don't understand, but they swipe their credit cards everyday and get goods and services for it. They might not know what happens technically, but they can still gain from it and use the system. Though of course the more you know the greater you can use the system.
In bitcoin, learning some of the philosophy of money can be crucial to getting the most out of it. Moving from a high time preference to a lower one can improve the quality of your life and benefit humanity as a whole.
What is Money:
-Money is a common good used to trade goods and services.
-You convert your time and energy through work into money, which you can save and spend at a later date.
-There have been many different forms of money throughout history, including shells and stones, silver and gold, paper fiat money and now digital money such as bitcoin.
-There are 6 main properties for making a good money. Durability, portability, fungibility, scarcity, divisibility, and recognizability.
-Before bitcoin gold was the best form of money. It is very durable and cannot be destroyed. It is highly fungible, meaning every gram of gold is as valuable as each other. It is relatively scarce as it requires large amounts of energy to mine more and increase the supply. However it struggles with portability, how easily it can be moved and transferred. It also struggles with divisibility as you must melt it down into smaller pieces and there is a physical limit on how small these pieces can reasonably be. And finally it isn't very recognizable, due to things like fools gold, or diluting with other metals and needing specialized equipment to determine whether it is 100% gold.
-This is why paper money was created, to increase these 3 properties that gold wasn't good at. Paper is easier to transport, it is more divisible and it is slightly more recognizable, although can still be counterfeited relatively easily.
-Fiat means 'by decree', or 'because I said so'. Meaning a government says something is money and will defend it with military and economic policy.
-Unfortunately this means that fiat money is highly centralized and is created by a single entity. Essentially giving absolute power to the central banks and governments that issue the currency. Absolute power corrupts absolutely.
-The central bank now has the power to determine the supply of money and ultimately control inflation. This is a huge over simplification however.
-This allows them to have no limit on their spending, other than losing control of the currency and a loss of faith amongst the holders of the fiat money. Leading to a collapse and people exiting the system for a different monetary system.
-This collapse of currency happens regularly around the world. Eg, Venezuela, Argentina, Lebanon, Nigeria, Weimar Germany, and many more. These countries over printed their currency to pay for debt and government over spending.
Fiat Debt:
-Governments issue bonds to other countries and private individuals to pay for their spending plans. A bond is a promise to pay interest on a loan. So if I buy $100 of US bonds, I am lending the US government $100 over a period of time, and I will receive interest payments while I hold the bond. Then when the bond hold period ends I will receive my $100 back. So for me to profit on this trade the interest rate must be higher than the inflation rate of the currency. Because the $100 i receive at the end is worth less in goods and services due to inflation.
-This means governments that sell bonds have to pay interest payments to the bond holders, and the higher the interest rate the higher the repayments are.
-For example the US has over $30 trillion in bond debt. And with current interest rates around 5% they must pay $1.5 trillion every year to bond holders.
-They mostly pay for this through printing money, which leads to inflation.
-And the higher the inflation the higher the interest rate, meaning the higher the inflation the higher the yearly bond payments are.
-This is a viscous cycle, needing to print more money to pay for the debt, leading to higher amounts they must repay.
-And the higher the inflation the worse off everybody who uses the currency is. Due to increasing costs of living.
Bitcoin Fixed Supply:
-Bitcoin has a predetermined fixed supply. There will never be more than 21 million bitcoins.
-Bitcoin can increase in value over time, meaning it is deflationary for goods and services. The cost of living can go down instead of up.
-If a government that uses bitcoin wants to spend more money they must get it from its citizens or by doing work which is rewarded with bitcoin. They wouldn't be able to just create more like they can with fiat money.
-This has many profound effects, such as living more sustainably and incentivizing saving instead of spending.
-If you know your money will be worth the same amount or higher in food/shelter/etc, then you can plan for the future more efficiently and responsibly. You no longer need to spend the money due to fear of it losing value.
-Bitcoins value is able to increase forever, so long as humans that use it are productive and creating economic growth. In the long run this is estimated to be around 3-5% growth every year on average.
-So if you held onto your money for a few years you could afford to buy 10% more with it in the future.
-Some fear hording, but if the supply is truly limited then people will have to spend, simply to survive, but also for all the other aspects of normal life that require spending money. Also we can still have lending and interest rates, if people were hording a bit too much and the market needed capital then the interest rate will go up, incentivising people to lend their bitcoin for productive purposes.
Open Ledger & Auditable:
-Bitcoin uses a blockchain, where every block is saved in order. A block is a collection of transactions, which happen every 10 minutes on average. This is similar to a written ledger of which address owns which bitcoins.
-Anybody can audit and read this ledger, and know whether a transaction is real and if a wallet really owns the bitcoin it claims to.
-However it is pseudonymous, you only know which wallet addresses are making transactions, not the names of the owners of the wallets or any other personal information. So if I share my wallet address publicly, people can track my transactions and know how much I have and how much I send and receive.
-So a government using bitcoin could be made to release its wallet addresses and have its spending tracked.
-You could know exactly how much bitcoin a country truly has and how much they are spending.
-Unlike the current system where the money supply is estimated and asset holdings like gold are unknown. Bitcoin removes the trust needed, you simply can audit them.
Bitcoin Self Custody & Implications on War:
-Similar to gold and cash you can self custody your bitcoin. Meaning you are responsible for storing it and have control over your own money.
-However it is digital and not physical, meaning it cannot be physically stolen. Unless they take your private key, which is like the password for spending your bitcoin, that you have backed up in some way, maybe on paper or steel.
-To have bitcoin you need a bitcoin wallet. This is a piece of software that tracks your public key on the bitcoin network. So it knows what the balance of a private key is. It also allows you to send transactions by signing with your private key which is stored in the wallet.
-When you create a bitcoin wallet you are given either a cryptographic string of letters and numbers or a list of words. This is called a private key, and whoever owns this key owns the bitcoin.
-There are many different versions of these wallets, but they are all interchangeable, meaning you can recover your bitcoin from any companies wallet. They are just different in design.
-Some wallets however are custodial, meaning they aren't actually yours. You do not receive the private key for the wallet. They are kept by the company of the software. This is not where you want to keep your bitcoin, as the company could take it at anytime. Examples of these wallets are exchanges, like Binance or Coinbase. You only use these to exchange fiat currency like USD for bitcoin. Then you should send it to a self custody wallet using public keys to do so.
-You could write this key down, or store it with cryptographic security, or you could simply remember it inside your head and have no physical version of the key.
-You do not need permission from anybody to create a bitcoin wallet.
-These 2 points are very important, as it means anybody in the world can have a safe place to store their time & energy (money).
-And it can be taken anywhere in the world without telling anybody. For example you could remember your private key in your head and escape from a country at war with all of your savings. Previously this was nearly impossible, either due to needing permission from the bank to transfer money or because of the limits for taking gold/cash across a nations border. It is very hard to take $1 million of cash or metal from one country to another without permission from the government.
-This can lead to a world with far less war. As you can no longer burn down a building and take the money that is stored inside. The money is now digital and stored all over the planet across the bitcoin network.
-Only by giving somebody your private keys can they take your money. And you still have a chance to transfer your bitcoin to a new wallet before the thief does it.
Bitcoin Mining & Energy Use:
-Bitcoin is created by 'mining'. This is where you use a computer to try and solve complex maths equations.
-Every 10 minutes a new block of transactions is added to the blockchain, the history.
-Only 1 computer can do this every 10 minutes. The computer that solves the complex math equation. This computer is then rewarded with the block reward. A predetermined amount of bitcoin, currently 6.25 bitcoins.
-This is how bitcoin is created, through the block reward. It will stop being created once there have been 21 million bitcoin rewarded to miners.
-In 2009 when bitcoin was created the block reward was 50 bitcoins. This amount is halved every 210,000 blocks. Roughly every 4 years.
-in 2024 the reward will reduce to 3.125 bitcoins. With the final bitcoins being created around year 2140. This is the predetermined fixed supply.
-The computers used to mine now require large amounts of electricity. Currently the total energy use of the network is similar to a small countries energy use.
-This is what secures the system. The more energy used the more secure the system. This is because for somebody to create a false transaction or to change the history of transactions you would need over half of the computers that are doing the bitcoin mining. This is a very large money and energy cost.
-Bitcoin also has a difficulty adjustment, which means as more computers start mining, the maths equation will become more difficult, requiring more hash power (attempts to solve the maths equation).
-Or if less computers are mining it will make the maths equation easier.
-This incentivises people to join the network to try and win the block reward. Which increases in value when bitcoin increases in value.
-One way to be more profitable is to have lower electricity costs. If my cost of electricity goes down by 50% I can afford to run more computers to try and win the block reward.
-This incentivises renewable energy and reducing waste of energy. Because if I create a mining system that uses solar energy for example the cost of electricity can become nearly free, you only have the cost of the panels, and the sun does the rest of the work.
-Or i could use flare gas that will be wasted and instead burn it and produce bitcoin.
-This system allows energy anywhere in the world to be monetised, all you need is an internet connection. You no longer have to create pipes and cables to send the energy to a place with people, you can instead mine bitcoin and take the money to the people.
-Also when building a new renewable power station you can start making money as soon as you have electricity and you can make money 24/7. Previously you would have to wait for all of the infrastructure to be built so you can send the electricity to buildings where people can pay you for it. And maybe there aren't enough people nearby to buy all of your energy and you end up wasting the energy.
-This means it is more economical now to build renewable energy stations.
-One example is with wind power, maybe you receive most of the energy through the night when people don't need to use it. You either then have to waste the energy or find a way to store it. Batteries are one option, but are very costly and require lots of space. Instead you could mine bitcoin with the energy that would be wasted and use the bitcoin money to purchase more energy during the day or to offset costs in other areas.
Decentralization & Governance:
-Bitcoin is a global network, and isn't concentrated in any one region.
-Nodes are computers that run the bitcoin software and check the ledger to make sure transactions are valid.
-A bitcoin miner runs a node, but you can also have none mining nodes which are just used to govern the system software and to audit the ledger.
-The current version of the software is determined by the majority of nodes and the economic activity that they verify.
-This is why the rules of bitcoin are very hard to change. Such as the 21 million supply rule.
-In order to keep bitcoin valuable it's supply must never change.
-So the decentralised nature of bitcoin and the high cost to overpower it is what makes it so secure and robust.
-The location of the nodes is also mostly unknown, any computer in the world could potentially be running the bitcoin software.
-The system however does allow for changes to be made if absolutely necessary, such as if a major bug was discovered. It would just take a majority of users to agree to the changes and to switch software versions.
-Bitcoin mining is also decentralised because energy itself is decentralised. Coal, gas, solar power, hydro, wind, etc are not all found together in one source. They are spread all around the world fairly equally.
Lightning Network:
-The lightning network is the second layer of bitcoin.
-It allows for much faster and cheaper transactions.
-Channels are opened on the bitcoin network which then allow for almost free and instant transactions to be made until the channel is closed.
-When the channel is closed this is then put on the bitcoin blockchain as a single transaction.
-This means one bitcoin transaction could include many lightning transactions inside of it.
-So as the fees on the bitcoin network increase and it becomes less reasonable to use it to buy coffee for example, you can send bitcoin to the lightning network and transact there inside a channel instead.
-A channel is opened between 2 people with a determined balance, for example 1 bitcoin worth. These 2 people can now send bitcoin to each other so long as their combined balance remains 1 bitcoin.
-It is like a bar tab, the bar tender knows you can spend up to 1 bitcoin in the bar, but doesn't make you pay every time you want a drink. You instead pay the total at the end of the night. This is what happens when the channel is closed.
-The reason a channel would be closed is so one of the 2 people or both can take their bitcoin and put it back in their bitcoin network wallet or to spend it on something else with a different person.
-There are some trade offs that come with the benefit of lower cost and faster transactions. Such as slightly reduced security.
-However there are other benefits such as more privacy. You cannot see transactions on the lightning network unless you are one of the nodes passing transactions around. When the transaction goes to the bitcoin blockchain it is a group of many transactions that cannot be known who the owners were.
-You can think of bitcoin and lighting as savings and checking accounts. You would keep your savings on bitcoin as there is more security and better knowledge that you own the bitcoin you think you do. And you would hold a smaller amount on the lightning network for every day transactions. Or for transactions you wanted to be more private.
-There are many more features on lightning that aren't possible on the main bitcoin network, this would take a very long time to explain though. It is these extra features that lead to a slightly lower level of security.
Congrats for getting through this, hopefully you found it interesting and now have a desire to continue learning more. As I said at the start, this document isn’t 100% literally accurate, i have purposefully attempted to simplify some concepts and technical details, something you will potentially notice as you study further. The basic concepts are all here though. Good luck on your journey, and always remember; “Not your keys, not your coins”, practice self custody as much as possible.