Understanding Bitcoin — Five Key Concepts

Published in

The LocalBitcoins blog

6 min readDec 8, 2021

Money is a simple concept. Or is it? You pay for something, and you get the product or service. Simple, right? Well not quite.

Money is also a belief system. It’s valuable because people believe in its value. The value of USD, for example, used to be based on gold, but the gold standard ended in 1971. Since then, the global economy has been mostly based on fiat currencies, government issued so-called free-floating currencies.

Just like Bitcoin, government currencies are complicated beyond basics. It’s no wonder that Bitcoin seems complex to many, who dismiss it as a pyramid scheme or just digital nonsense. In reality, it’s nothing of that sort.

Bitcoin is the digital open-source evolution of money, and it will transform every aspect of digital value transfer. The global economy is increasingly digital, and most value is already transferred digitally. It is vital for everyone’s future prosperity to understand Bitcoin. This article helps you understand it through five key concepts. Hopefully, after reading this article, you will understand why Bitcoin continues to increase in value.

Decentralization

The most revolutionary aspect of Bitcoin is the fact that it’s the most decentralized human creation ever discovered. Decentralization is the opposite of centralization, such as centralization of power to the hands of a dictator.

The Bitcoin network has millions of users, it’s secured and validated by tens of thousands of nodes, powered by over a million miners, and upgraded by thousands of developers from all around the world. Bitcoin does not rely on any individual. Taking down the entire network is practically impossible.

Bitcoin is the polar opposite of central banks, which have arguably centralized monetary power to the hands of the very few. Decentralization turns the so-called money pyramid upside down. Each network participant can contribute as much as they want to. They can own as much of the network as their financial situation allows.

Limited Supply

There will only ever be a total of 21 million bitcoins. This is called a limited maximum supply. Bitcoin is the only major asset in the world with a pre-defined maximum supply. For example, the supply of gold increases by 2% every year.

Approximately 3-4 million bitcoins have been lost and some of it hasn’t been mined yet, so the actual available supply is even less. Currently the Bitcoin network is worth over $1 trillion dollars, which is only about 1/11 of the total value of gold. As gold is not actively used for value transfer, it is possible that Bitcoin’s value will overtake gold sometime in the future.

The number of new bitcoins created also drastically decreases every four years. This happens every 210,000 blocks, to be precise. Blocks are the digital building blocks of the blockchain, which stores all bitcoin transactions.

In the so-called halving event, the bitcoin mining reward per block is halved. Currently that reward is 6.25 bitcoins but in three years it will be halved to 3.125 BTC. On approximately 15 December, an important milestone is reached when 90% of all available bitcoin will be mined. Thus, for the next 119 years, the miners will only compete for the remaining 2.1 million freshly minted bitcoins.

Mining

One of the most common arguments against Bitcoin is that it uses a lot of electricity. This is true, but there is a valid reason for it. At first, it might seem counter-intuitive that a digital currency consumes a lot of power. Since it’s digital, why can’t people just create new bitcoins out of thin air? This is what governments do with their fiat currencies.

This power consumption protects and secures the network. The SHA-256 cryptographic algorithm that protects Bitcoin is one of the more complex mathematical encryption mechanics. It’s the best compromise between security and incorruptibility. It is digital calculation work, Proof of Work, that the calculations needed to create new bitcoins have been done.

Other digital currencies have implemented different ways of protecting their network such as Proof of Stake. In this system, owners of said currency stake it to prove their commitment to creating new coins. PoS is more eco-friendly on the surface, but this change removes one layer of security. This security needs to be provided elsewhere and this implies more centralization. The blockchain needs to be stored and validated on very few nodes or even in centralized cloud services such as AWS.

Immutability

Recent years have proven that those in power can change the monetary policy of any nation. In the last few years, the US has increased their money supply like never before to support their economy. Recently Europe and China have also been forced into very unusual economical decisions to, respectively, save member states and large construction companies out of expiring debt.

Bitcoin, on the other hand, is largely immutable. The monetary policy of Bitcoin has never changed. The predefined release schedule of new bitcoins and the maximum supply of 21 million bitcoins are vitally important to the value proposition of Bitcoin. Even changes to the technical side of the network, such as the recent Taproot update, need the support of the majority of node runners and miners in order to be implemented.

If anyone disagrees with some of the updates, or just wants to change any of the features of Bitcoin, they can create a soft fork where the network remains backwards compatible, or a hard fork where the fundamentals change so much that it becomes a network of its own. There have been a total of 105 Bitcoin forks, which all have only ended up proving that BTC is what the strong majority of network participants want and support.

Wallets

If you own paper money, you own the money. The value of the money is still defined and backed up by the government that prints it. If you have money on your bank account or use digital money, banks effectively own the money. They’re allowed to loan it forwards according to the fractional reserve money system.

These fractional reserves used to be backed up by 1/10 money reserves in the bank vaults. In practice, this means that if a bank has money worth $1 million, they can lend out a total of $10 million. However, the digital economy and the ever-bloating fiat money system has removed this requirement. In other words, the money that you have on your bank account might not actually be there. If all the bank’s customers want to get their money out at once, the bank will be in big trouble.

There are two main types of bitcoin wallets. Custodial wallets, which most exchanges use, are similar to bank accounts. It’s ok to temporarily store your bitcoin on an established regulated exchange, such as LocalBitcoins, if you trade it actively or want to sell it fast when the price increases rapidly. However, this is not the recommended storage method for long term savings since you still need to trust the service provider.

With self-custody wallets, you can personally prove that you own the money. It’s crucial that you use a self-custody mobile wallet application or a hardware wallet to store your bitcoin whenever your savings become more than you would store in a physical wallet in your pocket.

If you are tech-savvy enough, you might even build such a wallet yourself, but nowadays there are several companies that offer reliable options where you should store your bitcoin. This is to avoid exit scams or exchange hacks, where your bitcoin is stolen, not because of your own carelessness but because of the carelessness of others.

Take control of your financial future and buy bitcoin today!