500 Words — Day Forty: Bitcoin
Today, Bitcoin jumped over 10% to move above $40,000 a coin. Although, Bitcoin has been wandering around this value, this jump was perhaps a signal that the days of cheap Bitcoin may be coming to an end. However, I understand that people are not convinced and see Bitcoin has a speculative instrument that has no value other than enriching its promoters. So, I’ll explain what I see in Bitcoin and why I think it’s valuable. I don’t think anyone should buy Bitcoin unless they understand it and want it for their own personal reasons. I do not claim to understand it.
Bitcoin is valuable for many reasons, but perhaps it makes the most sense to compare against some other forms of money. Bitcoin is scarce with a limited supply of coins (21 million). This makes is comparable to other scarce items like precious metals or houses, although those things have intrinsic utility built into them. Bitcoin is also extremely portable and can be used anywhere with an internet connection (or more generally a connection to a network node). Credit card and banking networks also provide similar functionality but come with trust compromises that allow for fast transactions but longer settlement times. Bitcoin is also censorship resistant. All of the other items in this list do not fall in that category. Third parties can prevent the use of all those other items from being spent or transferred. With Bitcoin, given a large enough incentive (via fee), miners have no reason not to accept and distribute that transaction.
Perhaps, you can see Bitcoin’s value from the previous paragraph, but maybe you think it wastes too much energy. That’s a valid thing to pick up on. Bitcoin utilizes Proof-of-Work to determine which miner gets to determine the next block. The idea of incurring a cost at a chance to win the next block is that you punish miners that don’t take the incentives given to them and punish them more for breaking the rules. Censoring transactions means that you are collecting less fees in addition to the block reward. This serves to protect the network by making network attackers eat the cost of their censorship. Also, if an attacker wants to publish invalid transactions, they have to outcompete the legitimate network indefinitely in order to maintain that transaction ordering. This makes Bitcoin hard to attack and hard to manipulate its properties because of the cost associated with it.
To make the distinction of Proof-of-Stake chains, these often suffer with cartels of large holders being able to control the monetary policy of the chain. This appears fine because the holders have the incentive of their stake to guide them away from maliciously attacking the network, but it does leaving them vulnerable to make near-term optimization decisions that incur long term costs. The massive holders of Bitcoin do not have this level of control as they either would need to buy hardware to mine Bitcoin and/or would need to run hardware to mine Bitcoin. Running that hardware and spending that electricity has a cost. This is the sacrifice that miners pay to continue to get rewarded. They get some Bitcoin to secure the network but they also have to continue to spend money or Bitcoin to maintain those mining operations. There is no maintenance cost in Proof-of-Stake coins.
So, we have a mechanism that promotes censorship resistant transactions through the use of incentives — Proof-of-Work mining encourages miners to be honest as well as securing the network and distributing coins over time to maintain mining capability. Why is censorship resistance important? Well as we have seen in the past couple of weeks with Canada freezing bank accounts of people donating to protestors and western countries essentially removing Russia and it’s people from the international banking system, a means of moving value around without the need for a third party to approve those transactions is a massive growing need. Bitcoin has been overvalued at these prices before, but perhaps now that governments are exposing the weaknesses with trusted third party monetary systems, the value of Bitcoin is more apparent than it has ever been.
