Lesson 10


Bitcoin as Currency

VIDEO: Christian Fernandes - Bitcoin - The Better Money

Overview

Bitcoin is a private decentralized digital cryptocurrency. It is not issued or controlled by a government or central bank as it is the case with fiat currency. That is why Bitcoin is classified as a kind of 'private money'.

Bitcoin is based on a peer-to-peer network. There is no central party that issues bitcoins. Instead bitcoins are created when a peer in the bitcoin network solves a difficult mathematical problem through a process called 'mining'. This decentralized currency issuance started with 50 new bitcoins every ten minutes in 2009 and halves every four years until 21 million bitcoins are created. Inflation in Bitcoin is therefore underlying unchangeable rules and completely expectable. That's probably the biggest difference to fiat.

Bitcoin is a digital currency that is electronically created and stored. Unlike fiat currency, there are no physical coins (it is possible however to have your bitcoins in physical coins of gold/silver). The terms 'digital' and 'virtual' are used interchangeably to classify Bitcoin. However digital and virtual currencies are two different things with the term virtual currencies mostly used to describe a 'virtual economy’ like the World of Warcraft. 

Bitcoin is a cryptocurrency. The Bitcoin technology is based on cryptography which battles the counterfeiting problem which is a problem that all currencies face. For digital money like bitcoin it is not possible to use sophisticated papers or printing technology to tackle the problem of the authenticity of the money. Instead, in the Bitcoin network the use of cryptographic digital signatures enables a user to sign a transaction proving the ownership of that asset. 

We will now see whether Bitcoin serves the three main functions of money. As we saw in the previous section, money can be anything that serves three main functions: it must be a 'medium of exchange', which can be exchanged for goods and services. It should be a stable store of value enabling users when retrieving their saved wealth to finding its purchasing power more or less intact. It should also function as a unit of account, a standard measurement against which value in an economy is measured.  

To date, Bitcoin functions better as a medium of exchange than as a store of value or unit of account. 

Bitcoin is a very good medium of exchange: 

  • highly durable: Bitcoin is just a computer code. 
  • highly portable: Bitcoin is portable to anywhere where there is internet.
  • highly fungible: one bitcoin is considered the same as any other bitcoin when it comes to price and acceptance.
  • highly divisible: one bitcoin can be divided in 100 million units. The smallest portion of a bitcoin is called satoshi: 1 BTC = 10^8 satoshis = 100,000,000 satoshis. 
  • highly resistant to counterfeiting: thanks to the cryptography underlying Bitcoin, it is highly unlikely if not impossible that a bitcoin can be counterfeited.


Due to the high fluctuation of its price so far it would be too early to say whether Bitcoin could serve in the longterm as a stable store of value or viable unit of account. Many argue that price stability is unattainable for a currency that, unlike most others, is not supported by any government with the power to tax its citizens. Whether they are right or wrong is difficult to say at this point of time. What however is difficult to question is that Bitcoin is a new innovative technology that offers an elegant answer to the many problems associated with fiat currency. 

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