Disclaimer: Nothing in this article shall be construed as financial advice. This article is purely for expressing the author’s opinions and observation regarding Bitcoin and cryptocurrency in general.
Now this chapter might be important if you want to invest (buy and hold for the long term). Cryptocurrency is a very controversial subject. There are champions of Bitcoin who tells people to mortgage their house and buy Bitcoin. Seriously, give this video a spin.
There are others who believe Bitcoin will be useless and will not have a price. So I think it is worthwhile for us to take a look at Bitcoin as is.
If you want to do short term crypto trades then this article will not be important. Be sure to keep a close eye on those big whales so that you can conduct your flow analysis properly. Or maybe use a technical indicator like RSI? I don’t know.
But hopefully, if the chart is like below, you know what to do or what not to do.
What is a cryptocurrency? Or Bitcoin?
In its purest form, it is software that is run by people. In fact you can take a look at Bitcoin’s codebase if you fancy. This is the most popular bitcoin implementation that is contributed by 900+ developers as of 2024. There are alternative Bitcoin implementations such as btcd (one that is written in Go programming language) but its not popular.
And what software is this? Is it a software that runs a ride hailing app? Or is it a software that runs a B2B market place? Let’s take a look.
What is Bitcoin Core?
Bitcoin Core connects to the Bitcoin peer-to-peer network to download and fully validate blocks and transactions. It also includes a wallet and graphical user interface, which can be optionally built.
Now that’s a mouthful. From peer-to-peer network to blocks. If you are the nerd-type, you can take a look at the Bitcoin white paper for more details. If you are just a normal human being, let me try to explain those g1bb3r1sh in the most intuitive way possible.
Essentially Bitcoin is an accounting software. It is a really special accounting software because it has the following features:
(i) it accounts for all transactions in public
(ii) it is publicly available and
(iii) it requires little trust. Toby please write in english.
Put it very simply and intuitively, implication of the above is that if Toby wants to send 1 BTC to Budi, Budi would know if Toby has that 1 BTC or not. If Toby does not have 1 BTC, he cannot send Budi 1 BTC. But how is this significant?
Traditionally the flow is as follows:
Alex owns $100 in the bank
Alex wants to send $50 to Bob via bank transfer
The bank approves the transfer to Bob because Alex has $100
Bob receives $50 and his bank account increases by $50
Now let’s say we have Charlie who wants to send Alex some money:
Charlie owns $10 in the bank
Charlie wants to send $50 to Alex via bank transfers
The bank declines the transfer to Alex because Charlie has $10
Alex never receives $50 from Charlie and his bank account remains unchanged
Notice point where the bank is a middleman verifying transactions between Alex, Bob and Charlie. Banks would reject invalid transactions because it has a ledger (or bookkeeping) of all transactions of their customers. Of course you cannot make up money out of thin air, otherwise that money is meaningless.
Why cryptocurrency, Bitcoin, is special
It is special because it does verification of transactions without banks. Banks do not have to have a role in verifying transaction of bitcoins between two parties (they are irrelevant). In fact, the motive of creation of Bitcoin in the wake of Global Financial Crisis is to make banks irrelevant.
but but banks are buying bitcoin and the price should go up! Shouldn’t it?
So who verifies my Bitcoin transaction? And how is it done?
Anyone who can run the accounting software I shared above. Remember that it is a public bookkeeping of all transactions that happen in the network. That’s why people call it a decentralised network. People from all walks of life, age, background, ethnicity, you name it can run a bitcoin software and start verifying transaction. For example, if Alex runs the bitcoin software using his computer, he is deemed as a node. A collection of these nodes (let’s say run by Alex, Bob and Charlie) is called the bitcoin network.
Now, if Alex wants to transfer 1 BTC to Bob, how does Alex’s transaction gets verified? Remember, this is the public and you cannot expect public to act honestly without a well-defined protocol. Dishonest activities include:
How does one prevent others from forging transactions on behalf of others?
How does one prevent from spending more than one owns?
How does one know that all transactions in the network are not fraudulent?
In a very simple and intuitive way, we have a well-defined protocol. What do you mean by well-defined protocol? It is a set of rules that are obeyed by participants. If the rules are obeyed, the system (game) works.
For example, the rules of playing football or soccer. There are simple rules like only the keeper can use their hands to guard the goal, others must only use their feet.
But there are more edge cases rule like during a goalkick, a striker from the opponent team cannot “steal” the ball from the keeper. Everybody who plays football, needs to adhere to that rule, otherwise you don’t participate.
Now Bitcoin, or the accounting software, has those rules as well. Put simply here are the rules:
Each person is assigned with 2 keys. Private and public. Private keys are the keys you keep secret and they are unique. Public keys are keys that others know.
If you want to make a transaction, you have to digitally sign that transaction using your private key and then publicly broadcast that transaction to the network.
Others can verify that it is a transaction you made using your public key to know that transaction is valid
All transactions that occur in one epoch (period of time) are then collated together and grouped together forming a “block” of transactions
For a network participant to verify the block of transactions, they need to solve a complex mathematical problem (cryptographic hash function to be precise) that can only be solved by brute force or trial and error.
But once it is solved, it is very easy to verify that the person (also known as miners) has done the correct work. And obtaining an answer to that math puzzle is a hard proof that you have done the work (proof of work).
For the reward, you will get an unspent currency that can be spent (because it is unspent) and people refer that to Bitcoin.
Eittss, we are not done.
After getting the reward, to mine the next block, you need to take into account the hash (or result) of the previous block.
So the current block of transactions will always be connected to previous one. Forming a chain. Hence, blockhain.
And how do we trust the blockchain? We trust the longest one. Why the longest one? Because it has the most work that is put into it to verify the transactions. Makes sense? That way, you don’t need a single entity to decide whether this transaction is valid or not.
Now if you don’t understand still, that’s alright. There is a great video by Grant Anderson in explaining how this is done in technical terms. He explains it super clearly that involves very minimal math.
Okay, so we have managed to breakdown what Bitcoin is in its purest form, which is the longest public ledger (transaction records) that has the most work done on it.
But why does it become more and more valuable?
Irrespective of the sentiments of the day (per this article was written and edited), Bitcoin has become more substantially valuable in USD terms. But why?
It seems that people suggest:
the central bank is corrupt, therefore we need an alternative currency
Bitcoin only has 21,000,000 coins and it will therefore be rarer than gold
and many more
But in essence, Bitcoin is more valuable today than lets say 10 years ago because:
More people today believes that Bitcoin is going to be more valuable in the future.
Regardless of the features, lightning network, stacks (NFTs that are built on top of Bitcoin), Hemi networks etc. So Bitcoin is valuable because of the network effect that it has achieved.
But does Bitcoin has a chance to be less valuable tomorrow? Of course. Something that has network effect does not always have to be relevant or valuable forever. Telephone line for example, eventually gets replaced by WhatsApp.
Will Bitcoin be able to withstand technological changes that breaks its current protocol?
Closing Remarks
So now you know the fundamentals behind Bitcoin. But let’s be honest, what’s the point? Prevailing sentiments in social media suggests that fundamentals is dead. Isn’t it? There’s no point understanding fundamentals if we can’t make money from the financial market or the crypto market.
But the fact is: you’ve spent 10 - 15 minutes of your time reading this article, exploring about the fundamentals of Bitcoin. It might mean that fundamentals is important to you.
But what is it for? To make you look smart in front of others? Or to benefit you becoming more knowledgeable? Or to make you profitable?
Well in the spirit of making you profitable, I honestly think that:
fundamentals is dead
and
fundamentals is not dead…
You might be confused now, so let the article below explain it clearly.