WHAT IS BITCOIN?
Bitcoin is a digital currency and a payment network created in 2009 by the pseudonymous Satoshi Nakamoto [2]. It is a decentralized form of currency, meaning it does not rely on a central authority for its issuance, regulation, or control. Bitcoin is built on a distributed ledger system called the blockchain, which serves as a public ledger of all Bitcoin transactions that have ever occurred [1,3]. The blockchain is a network of computers that work together to verify and record each transaction on the network. The blockchain uses cryptography to ensure that once a block is added to the blockchain, it cannot be altered or deleted [5]. Bitcoin also uses a consensus mechanism called “Proof of Work” which ensures that the blockchain remains tamper-proof [8].
How Bitcoin Works?
Bitcoin is based on a peer-to-peer network, which means that users can send and receive payments directly to each other without the need for a central authority. Transactions are broadcast over the network and are verified by miners, who use specialized software to solve complex mathematical problems. When a transaction is verified, it is encoded into a block, which is then added to the blockchain. This process is known as mining. Miners are rewarded with a certain amount of bitcoins for their effort, this process is called “mining rewards”. The mining rewards are a combination of newly minted bitcoins and transaction fees of the transactions included in the block. This process is also responsible for releasing new bitcoins into the network and maintaining the integrity of the blockchain [4].
The Bitcoin Blockchain Technology
The Bitcoin blockchain is a distributed ledger system that creates an immutable record of all Bitcoin transactions. It is composed of a series of blocks, each containing a record of transactions. When a new transaction is added to the blockchain, it is verified and broadcast to the network. Once a block is added to the blockchain, it is impossible to change or alter it. This makes the blockchain highly secure and transparent, as every transaction is recorded and can be traced back to its origin. The blockchain is decentralized, meaning it is not controlled by any single entity and is maintained by a network of nodes, which are computers that run the Bitcoin software [4,5]. This decentralized nature of the blockchain allows for the creation of a trustless system, where users can transact directly with each other without the need for intermediaries [14].
What is Proof of Work and why is it different from Proof of Stake?
Proof of Work (PoW) is a consensus algorithm used by Bitcoin and other cryptocurrencies to ensure that transactions are valid and secure. It is based on the concept of miners competing to solve complex mathematical problems, also called “mining” in order to add new blocks to the blockchain. Miners use specialized hardware, such as ASICs, to solve these problems and are rewarded with newly created coins and transaction fees for their efforts. The process of mining also helps to secure the network by making it expensive to carry out a 51% attack[8].
Proof of Stake (PoS) is an alternative consensus algorithm that is based on the idea of users staking their coins in order to validate transactions. Instead of solving complex mathematical problems, validators are chosen based on the number of coins they hold and agree to lock up, or “stake”, as collateral. This process is called “staking”. This reduces the energy consumption associated with mining, making it more environmentally-friendly. PoS could reduce the risk of centralization as it does not require specialized hardware and the validators are chosen based on their stake rather than computational power [7,9].
Bitcoin maximalists argue that Proof of Work (PoW) is superior to Proof of Stake (PoS) because it provides a more secure and decentralized form of consensus. Their argument is based on the idea that PoS relies on users staking their coins, which can lead to centralization as the validators are chosen based on their stake rather than computational power and that it is too expensive to carry out a 51% attack on PoW [6,8,9].
Key Properties of Bitcoin
Bitcoin has several key properties [1,2,3] that make it unique among other digital currencies. These include:
- DECENTRALIZATION: BITCOIN IS NOT CONTROLLED BY ANY SINGLE ENTITY, MAKING IT RESISTANT TO CENSORSHIP AND MANIPULATION.
- IMMUTABILITY: ONCE A TRANSACTION IS RECORDED ON THE BLOCKCHAIN, IT CANNOT BE ALTERED OR DELETED.
- TRANSPARENCY: ALL TRANSACTIONS ON THE BITCOIN NETWORK ARE RECORDED ON THE BLOCKCHAIN, MAKING THEM VISIBLE TO ANYONE.
- PSEUDONYMITY: WHILE TRANSACTIONS ON THE BLOCKCHAIN ARE PUBLIC, THE IDENTITY OF THE INDIVIDUALS BEHIND THOSE TRANSACTIONS IS NOT REVEALED.
- LIMITED SUPPLY: THE TOTAL SUPPLY OF BITCOIN IS CAPPED AT 21 MILLION COINS, MAKING IT SCARCE AND GIVING IT THE POTENTIAL TO ACT AS A STORE OF VALUE.
- DIVISIBILITY: BITCOIN CAN BE DIVIDED INTO SMALL FRACTIONS, ALLOWING FOR A WIDE RANGE OF TRANSACTION SIZES AND FLEXIBILITY IN ITS USE AS A MEDIUM OF EXCHANGE.
Why is Bitcoin different from other cryptocurrencies and tokens?
Bitcoin is different from other cryptocurrencies and tokens in several ways. It is the first and most established cryptocurrency, and its network is the most secure. Additionally, Bitcoin is deflationary, meaning its supply is limited and its value is expected to increase over time. Finally, Bitcoin is the most widely accepted cryptocurrency, making it easier to use for payments and other financial transactions [1,2].
THE BITCOIN ECONOMY & SOCIETY
The philosophy and ideals of the Bitcoin community are deeply rooted in the principles of decentralization, censorship-resistance, and financial freedom. Bitcoin advocates believe that a decentralized and open financial system, free from the control of governments and financial institutions, is essential for ensuring economic freedom and equality. They also see Bitcoin as a tool for promoting economic and political freedom by enabling individuals to take control of their own financial affairs and bypassing traditional financial gatekeepers. Additionally, many in the Bitcoin community believe that the use of a decentralized and transparent monetary system, such as Bitcoin, can help to combat corruption, inflation, and other economic issues [1]. The community also values privacy, security and immutability, Bitcoin’s features that allow users to have more control over their own finances and data.
Austrian Economics
Bitcoin is based on the principles of Austrian economics, which is an economic theory that emphasizes the importance of individual choice and freedom in economic decisions [32]. Austrian economists believe that money is a store of value, and that its supply should remain stable in order to maintain its purchasing power. Bitcoin’s limited supply of 21 million coins aligns with this principle, as it ensures that the money supply will not be inflated, which in turn helps to maintain the purchasing power of the currency [33].
What is Stock to Flow and why is it applied to Bitcoin?
Stock to flow is a concept that is used to measure the scarcity of an asset. It is calculated by dividing the amount of an asset held in reserve (stock) by the amount of that asset that is produced each year (flow). Bitcoin has a high stock to flow ratio, meaning it is scarce relative to other assets. This makes it attractive to investors who are looking for an asset that is likely to maintain its value over time. The stock to flow ratio of Bitcoin is often compared to that of gold, which has historically been considered a store of value due to its scarcity [1].
Bitcoin Vs Gold
Bitcoin and gold are often compared to one another due to their similar properties. Both are scarce and have a finite supply, and both are used as a store of value. In fact, both Bitcoin and Gold have a high stock to flow ratio. However, Bitcoin has some advantages over gold, including its digital nature, which allows for faster and cheaper transactions, its portability, and its divisibility, allowing for a wide range of transaction sizes. Bitcoin can be easily stored and transferred electronically, while gold requires physical storage and transportation [34].
Bitcoin Legal Tender
El Salvador recently made history by becoming the first country to adopt Bitcoin as legal tender. This decision was made in order to promote financial inclusion and provide an alternative to the traditional banking system [11]. Other countries have also begun to explore the use of Bitcoin and other cryptocurrencies as legal tender, but the legal status of Bitcoin varies widely from country to country. The legal recognition of Bitcoin as a form of legal tender is still a developing and controversial topic.
Bitcoin in El Salvador
In June 2021, El Salvador became the first country to officially recognize Bitcoin as legal tender [11]. This decision was met with both support and criticism, but it is a sign of the growing acceptance of Bitcoin as a valid form of money. The government of El Salvador has committed to using Bitcoin to facilitate economic growth and development, as well as to provide financial inclusion for its citizens. Bitcoin supporters cite El Salavador’s growth of GDP, reduction in crime rate and strong increase in tourism as proofs of the success of Bitcoin as legal tender. However a large part of the international media including, Bloomberg and MSNBC have criticized heavily this decision, labeling at a “Failed Experiment”. In January 2022, the International Monetary Fund urged El Salavdor to end its “Bitcoin Experiment” [10,12,13].
Bitcoin ETFs
The history of Bitcoin Exchange-Traded Funds (ETFs) has been marked by continual efforts and repeated rejections from the US Securities and Exchange Commission (SEC). Over the past 10 years, all applications for Bitcoin ETFs designed to track the cryptocurrency’s current market price were declined due to concerns around market manipulation, volatility, and fraud risks [28,29]. However, a notable shift occurred in mid-June 2023 when BlackRock, the world’s largest asset manager, applied for a ‘spot’ Bitcoin ETF [30]. Their application not only sparked anticipation within the Bitcoin investment landscape, but also inspired other firms to resubmit their applications. The proposed BlackRock Bitcoin ETF deviates from the traditional structure of previous Bitcoin ETF applications, as it resembles a spot ETF in function, allowing for daily subscriptions and redemptions, which distinguishes it from existing Bitcoin investment vehicles. On the path to approval, BlackRock’s spot Bitcoin ETF application was officially accepted for review by the SEC in July 2023, reflecting a significant development in the evolution of Bitcoin ETFs [31].
Bitcoin criticism
Bitcoin, has been widely criticized for its high volatility which makes it difficult for it to be used as a stable store of value or currency, this is a concern for businesses and individuals who would like to use Bitcoin as a medium of exchange but fear its high price fluctuations [15]. Additionally, the energy consumption required for Bitcoin mining has been criticized for its environmental impact [17]. Bitcoin mining is an energy-intensive process that requires a significant amount of electricity to power the specialized hardware used to solve complex mathematical problems, this has raised concerns about the sustainability of the network and the impact it has on the environment [8,19]. The lack of regulation and oversight and the anonymity of transactions has raised concerns about its potential use for illegal activities such as money laundering and tax evasion. Criminal activity accounted for 0.24% of all blockchain transactions in 2022, worth 20 billion USD [35]. Bitcoin’s scalability has been a major point of criticism by both the traditional finance and payments industry, and by other members of the crypto community which advocate for more scalable blockchain solutions.
BITCOIN PAYMENTS
Bitcoin payments refer to the process of using the digital currency, Bitcoin, as a form of payment for goods and services. This typically involves the use of a Bitcoin wallet, which is a digital wallet that allows users to store, send, and receive Bitcoins.
How to perform a Bitcoin payment
To make a payment, the user would send a specific amount of Bitcoins from their wallet to the recipient’s wallet, using a unique address associated with that wallet. The transaction is then broadcast to the Bitcoin network, where it is verified and recorded on the blockchain, a public ledger of all Bitcoin transactions. Once verified, the transaction is considered complete and the recipient now has possession of the Bitcoins they received so it can proceed to deliver the product or service the user purchased.
Bitcoin Transaction Speed and Fees
Bitcoin transactions are processed by a decentralized network of computers called “miners.” Transactions are verified by these miners, who are rewarded with newly created Bitcoin and transaction fees [20]. However, the process of verifying transactions can take anywhere from 10 minutes to several hours and the fees associated with each transaction have also risen dramatically in recent years, which can make Bitcoin less attractive as a means of payment for everyday transactions [21].
Bitcoin Scalability and Limitations
Bitcoin is limited by its block size, which is the maximum amount of data that can be stored in a block. This limits the amount of transactions that can be processed in a given period of time. As the network grows and more users adopt Bitcoin, the block size will need to be increased in order to keep up with demand.
Different studies have estimated that the Bitcoin network can process between 7 transactions per second [36, 37] and 10 transactions per second [38]. One study has pushed the upper bound limit to 27 transactions per second. A more recent study has computed 27 transactions per second as the upper bound for the maximal transaction throughput of the bitcoin protocol claiming that previous studies yielded a smaller throughput due to the fact they were conducted prior to the introduction of Segwit technology [38]. However, these differences in maximum speed and throughput are negligible if compared with processing speeds of certain centralized networks such as credit card rails that can process thousands of transactions per second and verify each transaction within a few seconds. Visa, for example, Claims that it can process 65.000 transactions per second [27].
Transaction fees are also an important aspect to be considered when assessing a payment network’s scalability. Fess associated with credit card transactions are usually paid by the merchant and are either a percentage of the total transaction amount or a tiny, fixed fee plus a percentage of the amount transacted [39]. Bitcoin transaction fees are unrelated to the amount being transacted and are paid by the “sender” of the transaction, meaning that in a B2C transaction the customer pays the fees, not the merchant. This means Bitcoin transactions may be less suitable for small and everyday purchases.
A solution to the Bitcoin scalability problem is the Lightning Network through which Bitcoin transactions can be processed immediately and with fees close to zero.
Introducing the Lightning Network
The Lightning Network is a second layer payment protocol built on top of the Bitcoin blockchain. It allows for fast and low-cost off-chain transactions, by creating a network of payment channels between users. This enables users to make multiple transactions without the need for each one to be recorded on the blockchain, thus reducing the burden on the blockchain and enabling faster and cheaper transactions. The Lightning Network is seen as a solution to Bitcoin’s scalability issues as it can handle an immensely larger number of transactions per second compared to the Bitcoin’s on-chain transactions [23] which some estimate to be up to 1 million transactions per second. The Lightning Network is still in development and is not yet widely adopted but it has the potential to significantly improve the user experience of Bitcoin transactions.
BUYING, STORING, EXCHANGING AND CASHING OUT BITCOIN
In this section we will explore the different ways in which it is possible to obtain, store Bitcoin. We will also describe how to cashout Bitcoin both for money or use it directly to purchase goods and services.
How to obtain Bitcoin
Bitcoin can be obtained in several ways, including via exchanges, peer-to-peer transactions, and mining. Exchanges are the most popular option, as they provide users with an easy way to buy and sell Bitcoin.
- Mining Bitcoin: Mining is the process of verifying Bitcoin transactions and adding them to the blockchain. Miners use specialized hardware to solve complex mathematical problems in order to add new blocks to the blockchain and earn rewards in the form of newly created Bitcoin.
- Exchanging other cryptocurrencies into Bitcoin: Exchanging other cryptocurrencies such Eth or USDC into Bitcoin can be done through a process crypto-to-crypto trading. This typically involves using a cryptocurrency exchange, which is a platform that allows users to buy and sell different cryptocurrencies. To exchange other cryptocurrencies for Bitcoin, a user would first need to create an account on a cryptocurrency exchange, and then deposit the cryptocurrency they would like to exchange into their exchange account. Once the deposit is confirmed, the user can then place a trade order to exchange the deposited cryptocurrency for Bitcoin at the current market rate. Once the trade is executed, the Bitcoin will be credited to the user’s exchange wallet and can then be withdrawn to a personal Bitcoin wallet.
- Bitcoin Onramps and Fiat to Crypto Exchanges: Bitcoin onramps are services that allow users to purchase Bitcoin with traditional currencies, such as dollars or euros. These services provide an easy way for users to get started with Bitcoin for example using a credit card to buy Bitcoin. Exchanges that accept fiat accounts and that allow users to convert their fiat currencies into Bitcoin are also an onramp gateway. When using an exchange the user will deposit a certain amount of fiat such as dollars or euro into the accoungt held at the exchange and then place a trade order to exchange the fiat into Bitcoin at the current market price. Popular Exchanges include: Kraken, Coinbase and Binance.
- Peer-to-Peer transactions: To receive Bitcoin via a peer-to-peer transaction, the receiver will need to provide the sender with its Bitcoin wallet address. This is a unique string of numbers and letters, also called Public Key, that represents the Bitcoin wallet, and is used to identify the receiver as the recipient of the funds. Once the sender has the receiver’s address, they can initiate the transaction, and the funds will be sent to the receiver’s wallet, where they can be stored and used for future transactions or exchanges.
How and where to Store Bitcoin
There are several different ways to store Bitcoin, each with their own advantages and disadvantages:
- Hot wallets: These are software wallets that are accessible through the internet. They are easy to use and offer quick access to your funds, but they are also less secure and more susceptible to hacking. Examples include Mycelium, Exodus, and Electrum.
- Cold wallets: These are hardware wallets that are not connected to the internet. They are considered more secure as they are less vulnerable to hacking, but they can be more difficult to use and may require more setup. Examples include Ledger Nano S, Trezor, and KeepKey.
- Paper wallets: These are physical wallets that consist of a private key and a public address printed on paper. They are considered the most secure option as they are not vulnerable to hacking or malware, but they can be lost or damaged, and may require more setup. (You can create a paper wallet at Bitaddress).
- Online wallets: These are web-based wallets that are stored on a third-party server, rather than on your personal device. They are easy to access and use but less secure as the private keys are held by the third-party, making them vulnerable to hacking or theft. Examples include Coinbase, Blockchain.com and Binance.
- Multi-sig wallets: These are wallets that require multiple signatures in order to access the funds. They are considered more secure as they provide an additional layer of security, but they can be more complex and may require more setup. Examples include Copay, Electrum, and BitGo.
Ultimately, the best way to store your bitcoin will depend on the user’s personal preferences and the amount of security needed. It is generally recommended to use a combination of different solutions to be more secure and at the same time have a practical and efficient way of using the Bitcoin according to personal needs (e.g. making purchases, trades, etc.).
Bitcoin Offramps, Selling or Cashing out Bitcoin
Selling or cashing out Bitcoin, is the process of converting the Bitcoin back into fiat currency such as the dollar, British Pound or Euro. Bitcoin offramps are services that allow users to convert Bitcoin into other currencies, such as dollars or euros. This can be done through exchanges, specialized services, or ATM machines.
The same exchanges that allow users to convert fiat currencies held in their accounts into Bitcoin can usually be used to convert the Bitcoin back into fiat currencies. Once the Bitcoin has been converted into dollars, euros or other fiat, the currency can be wired to the user’s bank account via traditional bank transfer and wire services such as SEPA or SWIFT.
Buying goods or services with Bitcoin is considered a Bitcoin offramp because when a user buys goods or services using Bitcoin, they are effectively selling their Bitcoin in exchange for something else. This is also known as “cashing out” of Bitcoin. In this case, the user is “offramping” their Bitcoin as they are exiting their position in Bitcoin and swapping it for something else.
How to use Bitcoin to buy goods and services?
There are three main ways to purchase and goods and services with Bitcoin.
Some merchants have embraced Bitcoin technology and accept Bitcoin payments from their customers. These merchants use special crypto payment processors such as triple-A or Bitpay to process the transactions for them [41, 43]. In order to make purchases from merchants and retailers accepting the user will need to send the amount of Bitcoin specified by the merchant to a specific wallet address, usually within a certain time frame (to mitigate exchange rate risk). Usually the processor will convert the Bitcoin into fiat in real time at the current market exchange rate and credit the fiat amount to the merchant’s account.
As of January 2023, according to crypto payments processor Triple-A, there are approximately 420 million cryptocurrency users worldwide, approximately 4.2% of the global population [45]. According to research conducted by CryptoRefills labs, Bitcoin is the most popular cryptocurrency among those using cryptocurrency for shopping [46]. Furthermore, the number one ranking issue faced by 49,3% of crypto-shoppers (users that have paid for goods and services at least once with cryptocurrency) is the unavailability of stores that accept cryptocurrency [47]. So while merchant adoption is growing, it is important to understand that as of June 2022 only 15.000 merchants worldwide were accepting cryptocurrency. This means that currently there are limited options for users to pay merchants directly with bitcoin for everyday purchases.
However, due to increasing user demand for Bitcoin and crypto payment options, two alternative solutions have become quite popular.
- Crypto funded credit and debit cards: These new credit and debit products allow users to spend their cryptocurrency in the same way as they would spend traditional fiat currency. The card is linked to a user’s cryptocurrency wallet, and when the user makes a purchase, the card automatically converts the cryptocurrency into the local fiat currency at the point of sale. Some crypto credit and debit cards are also connected to a user’s crypto exchange account, which enables the user to buy cryptocurrency directly from the card, rather than going through the process of buying it on an exchange [48].
- Bitcoin to Gift-Card and Bitcoin to Top-up Providers: Another way to cashout or offramp Bitcoin into goods and services is to use special platform that allow the user to convert the Bitcoin directly into gift cards or into mobile credit or utility bill payments. For example on CryptoRefills you can purchase gift cards for a variety of global brands like Amazon, Airbnb, Apple, Google, Nike, Walmart and for local merchants such as super market chains, petrol stations with Bitcoin. You can then redeem the products or services by using the gift card on the merchant’s website or at their store [42, 44].
Crypto credit or debit cards are a convenient option for people who want to use their cryptocurrencies in their daily lives, as it allows them to make purchases at any merchants that accept Visa or Mastercard. However, some cryptocurrency advocates are critical of this type of solution, especially for Bitcoin transactions, as these are taking place offchain and via the traditional financial and banking payment rails. Therefore these transactions are not completely private or decentralized, thus defeating the main Bitcoin proposition.
Instead, Bitcoin transactions performed on Bitcoin to Gift Card platforms like CryptoRefills are real on chain blockchain transactions with all the advantages of decentralization and privacy that meet the values embraced by the Bitcoin community. Furthermore, due to the high specialization in blockchain technology by such platforms the users are offered advanced Bitcoin payment options such as Lightning Network and superior processing capability, payment experience and customer support. Services like CryptoRefills basically act as a middleman between the user and the merchant, allowing users to pay for goods and services using their cryptocurrency and merchants to receive payments in their local currency. This way, users can use their cryptocurrency to purchase goods and services from a very wide range of merchants, without the need for the merchant to accept cryptocurrency directly.
READ & LEARN MORE
We did our best to provide an unbiased, thoroughly documented introduction to Bitcoin. We hope we managed to provide a complete overview and spark further interest in the fascinating world of Bitcoin and Blockchain, not only as a technology but as a societal and economic innovation (if not revolution).
If you are interested in developing a good understanding of how the Bitcoin protocol works and operates, we definitely recommend watching this video.
[Embed https://www.youtube.com/watch?v=bBC-nXj3Ng4]
If you want to learn more about Bitcoin we definitely recommend reading the following books:
- “The Bitcoin standard: The decentralized alternative to central banking”, by Saifedean Ammous (Wiley 2018)
- “Mastering Bitcoin: Programming the Open Blockchain: Unlocking Digital Cryptocurrencies”, by Andreas M. Antonopoulos (O’Reilly 2017)
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