Unless you have been living under a rock then you have probably heard of bitcoin. You have probably even heard of someone, a friend maybe who invested some of their money into bitcoin in its early days and is now living their dream life.
The big question, however, is whether it is an actual investment or a gamble hyped by people. In this article, we are going to discuss what it is, the technology behind it, and most importantly how it works. But first, we are going to dive into some history to discover what led to this revolutionary technology.
A brief history of money
Barter trade
For the longest time, paper currency has been used as a medium of exchange and also as a store of value. But this was not the case some centuries ago. Systems like barter trade were implemented 6000BC. Barter trade was a system where goods were exchanged for other goods. For example, let’s say I want to buy a cow and I have 10 goats.
The price was not constant as you had to come into an agreement with the seller. Let’s say in this scenario that 7 goats would buy me a cow. It is easily evident how this system was full of flaws. One of the biggest and most inconvenient ones was you had to find someone who would actually be interested in your product for the exchange to occur. This system was later abolished due to its inconvenience.
Use of gold
Gold was later used especially during 700BC. Gold was mainly used since it satisfied as a medium of exchange and it also held its value quite well. It was highly valued due to its scarcity and was used for quite some time. Despite its ability to hold value it still had flaws that led to it being abandoned later.
Disadvantages of gold as a medium of exchange
- It can be debased.
- This basically means that someone could take his gold coins, melt them then add some impurities in order to increase its value but by doing so it was only lowering the value of gold.
- Hard to transport.
- If some gold was to be transported from point A to point B, there were huge security concerns as it was very valuable. In addition to that, the infrastructure was not well developed by then.
Can fluctuate based on supply
As with any commodity be it silver or even oil, prices are subject to fluctuate based on supply and demand. If there is a great supply, the prices drop and if the commodity is scarce meaning there is more demand than supply, then the prices rise. There was one particular incident that saw the value of gold drop by a margin. In the year 1849, there was a gold rush in California meaning that a huge deposit of gold was found. This led to a drastic fall in Gold value.
Paper money was introduced
This is where things start getting juicy. Between 619 and 907 paper money was introduced. It was first adopted by the Chinese people. It wasn’t until the 17th century that the Europeans started adopting this system. Paper money simply meant an I.O.U. This simply meant that you could go to your local bank and exchange your gold coins for an I.O.U paper.
This I.O.U was issued by the bank and symbolized the worth of gold that you exchanged for. Like the previous systems, this one had a flaw too. For instance, consider, going for a business meeting from point A to point B. Since each bank issued its own I.O.U it was almost impossible to exchange the one you had with other banks. In some instances, some banks dropped the value of I.O.Us from other banks up to 75% which was not ideal for many people since it was a loss.
The only solution to get the gold that you gave the bank was to go back to that specific bank. Furthermore, banks figured out that not all people could, come and demand all their coins at once, so they decided to lend out a fraction of other people’s gold coins in order to make a profit on the interest that would be earned.
This system is known as the Fractional Reserve System of banking which simply operates on the basis that not all customers are going to demand all their cash at the same time hence giving the bank flexibility to lend it to other customers and benefiting from the interest gained over time. This system is still in use today. This led to the development of central banks.
One of the earliest central banks to be established was the Bank Of England in 1694. The sole purpose of the central banks was to regulate the amount of paper currency being circulated hence controlling its value. The central bank also issued notes which were subject to be used only in that country.
For example, the Canadian dollar can only be used in Canada and if you want another currency of the same value you have to go to a foreign exchange for the swap to occur. This is pretty much the system we use today but there is a twist to this story. The government was basically now in control of the money flowing in the economy.
The Gold Standard Era
A problem emerged where central banks were misbehaving. They were printing more and more I.O.Us which led to lower value of money. A system was therefore put in place. And this was the gold standard system.
The gold standard ensured that each money was accounted for. This simply means that the amount of money printed was of the same value of the one in the bank reserves and anyone who wished to exchange their paper money for gold could do so if they so desired.
This meant that the currency was backed by gold. At that time one ounce of gold was exchanged for $20.67. This system was amazing such that it limited the government from printing more money which reduced inflation.
How the Gold Standard changed until it was finally abolished
The Gold Standard did pretty well in the 19th century but in the 20th century a lot of events occurred which led to the abolishment of the system. This started with the first world war in 1914. During this war countries needed resources such as ammunitions and since there was not enough money, banks started printing a lot of money. This essentially meant that there was a lot of money being printed and circulated than the actual amount of gold in bank reserves.
As if that was not enough, the Great Depression of 1929 happened. The government had to figure out a way of boosting the economy back and one of the methods used was printing even more money. The US government also introduced FIAT currency. This was under the execution of the president’s order. This meant that everyone was to return any amount of gold that they had in exchange for paper currency.
This paper currency basically had no value by itself and people considered it to have value since they government said so. Printing of money posed a great risk as this meant countries could devalue their currency so that countries with a stronger economy could buy more goods hence boosting their economy. This had to be stopped in one way or another.
In 1944, 44 countries attended to witness the signing of the Bretton Wood agreement in Bretton Woods, New Hampshire. Since there was not enough gold for each country, all the other countries decided to back their currency against the US dollar which was in turn backed by gold. So essentially, the other countries were backed by gold indirectly. The IMF was in turn created. The sole purpose of the International Monetary Fund was to lend money to underdeveloped countries in order for them to grow.
Printing of money went on and this was building up a much bigger problem. Since the other countries had backed up their currencies against the US dollar, they could at any time come and demand for their gold provided they gave back the US dollar. The US dollar was in abundance due to printing and the US government realized that if more countries continue to demand their gold back then they would be in trouble since the amount dollars available outweighed the amount of gold in the bank reserves.
On August 15th 1971, President Nixon announced that they were no longer going to abide by the Bretton Woods agreement and at that moment the Gold standard was dropped hence the value of the dollar was floating meaning that it’s value was not backed by anything.
Start and rise of Bitcoin
The main reason why Bitcoin and most cryptocurrencies was started was due to trust issues and privacy concerns. You see block chain technology is mainly used in cryptocurrencies but it was originally intended for use in bank transactions. It was meant to make transactions faster and easier and this involved middlemen who were not trust worthy hence some transactions were not entirely legit.
Later in the article we are going to dive deeper in to Block chain technology. Furthermore, due to online transactions, government could track any transaction made online and some people were not happy about this. One of these people was Satoshi Nakamoto, whom to date no one still knows who he or she really is. Anyway, thanks to him or her Bitcoin was invented. Bitcoin came at the perfect moment, just after the 2008 market crash. However, it never took off immediately.
What is bitcoin and how does it work
Bitcoin is essentially a peer to peer electronic cash system. This means that bitcoin is not tangible and all of its transactions occurs digitally. It is also worth noting that bitcoin is independent from the government hence the transactions made are theoretically safe from scrutiny by the government.
Also the price of Bitcoin is based on supply and demand and is not controlled by the central banks. Bitcoin is based on a technology called block chain which was earlier discussed in this article. Block chain simply refers to a chain of transactions all stacked up in one block.
When many transactions are done and approved they are stored in block and the process occurs over and over again leading to a chain hence the name block chain. You may be wondering how these transactions are being approved. Well, Bitcoin operates on a large network of computers which are in constant communication with one another. This makes Bitcoin very safe and it is theoretically believed to be unhackable.
This is because when a transaction is conducted, it must be approved by other computers in the network. So essentially if you fake a transaction it would be impossible for it to be approved. When bitcoin was being built only 21 million bitcoins were created. At the time of writing this article, only 19m million have been mined so far. This begs for another question. What the heck is Bitcoin mining?
What is Bitcoin mining?
For bitcoin to work a secure network of computers have to be set up to essentially approve the transactions done online. In order to incentivize people to join the network, there is payment given to the person/ computer which firsts solves the complex algorithm needed for the transactions to occur.
The payment is in form of bitcoin. The process of a computer solving the complex algorithms needed for a transaction to be fully approved is known as mining. Anyone can join in this mining in order to gain some profits but it is not as easy as it was in the early bitcoin days. In the early bitcoin days you could essentially use the old computer in your attic to mine bitcoin.
Then it evolved to faster PCs with beefy graphics card and CPUs. Nowadays, even the best consumer computers don’t have the power to mine bitcoin. There are now special hardware for mining bitcoin which can cost up to $3000. In addition to that these machines use a lot of electric power hence your profit margins are rather low.
The Future of bitcoin
Some people speculate that it is the future of money while others say that it is just a hyped up scam. One of the best investors of all time, Warren Buffet is clearly against this technology since it brings gains on a short term basis. Some people even term it as a get rich quick scheme. Buffet has made his fortune buy buying and holding stocks for a long term basis. There is no doubt that bitcoin is a ‘stock roller coaster’. It rises and falls suddenly.
There are also two sides to this coin. Some people have made millions out of nothing while others have lost millions to nothing due to bitcoin. Whichever side of the coin you support, bitcoin is here to stay and as more companies embrace bitcoin it is bound to do well in the future. That has been pretty much for the history of money and a beginner’s guide into bitcoin.
That’s true
Yeah,the world money economy is evolving and thus giving technology a enlarged space for inventing Internet money such as bitcoin