At some point in the last eight years, somebody might have tried to explain bitcoin to you and it didn't make one goddamned lick of sense. Maybe it was a well-meaning friend who made you sit through an ostensibly easy-to-understand YouTube explainer, or a techie blathering at the bar—either way, I'm willing to bet it wasn't very helpful.
But why do you need to understand bitcoin? It's a complicated beast that you may never have to engage with in your everyday life. Then again, a single bitcoin is now worth over $2,000 USD, so it might be time to finally come to grips with what the hype is all about.
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The very simple explanation that you've probably heard already is that bitcoin is virtual "money." You can buy things with it, you can buy more of it with regular money and hold onto it until it appreciates in value, and every bitcoin transaction is recorded to the blockchain, a public ledger. Great—but why is it worth so much right now?
The bitcoin currency runs on code that's based on the principles of "cryptoeconomics," which means that it uses math and money to influence people's behaviour. Bitcoin, albeit intangible, runs on a material infrastructure made up of human beings, their money, and their faith in the system. The idea is that if people put their money into the bitcoin system, the parameters set in the code ensure that the value of the currency goes up in proportion to their investment.
In real terms, it works like this: the base layer of real money in bitcoin is mining infrastructure. Miners are groups of people who run massive server farms (which cost a whole bunch of cash to start and maintain), and their computers perform calculations required by the bitcoin code to add transactions to the blockchain. As a reward for their work, the system automatically releases bitcoin back to them, which they can buy stuff with, or sell, or re-invest. And thus bitcoin's base economic layer is created.
The bitcoin code regulates this economy by reducing the amount of bitcoins that are released as a reward over time. One day, there will be no mining reward at all, and all the bitcoins that will ever exist will be in the wild. The price goes up because of this fixed supply, paired with steadily increasing demand—the only variable with wiggle room is the price.
But where does the demand come from? This part of the equation can be explained in the next economic layer of bitcoin: the people who actually use it, but aren't invested in mining. This includes the people who are just using bitcoin to buy goods, like domain names or shirts from an online store. People in this layer use real money to buy and sell their bitcoin on exchanges, which are kind of like stock markets for virtual currencies. When people buy bitcoin with real money, it pushes the price up, and when they dump their bitcoin in exchange for real money, the price goes down. This happens thousands of times every day.
Between the second and third layer are businesses that use bitcoin's underlying infrastructure—namely, the blockchain—to run services in the form of applications. One popular use of the blockchain is to timestamp information or documents by including them in a transaction with a small amount of bitcoin. There's also a number of financial institutions who are looking into adopting bitcoin's infrastructure as, for example, an instant settlement layer for stock trading. These applications provide value for layer three.
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And here we find the third economic layer of bitcoin that contributes to its price going up: speculators. This is the most fickle of layers, since it's buoyed by people's ever-changing belief in bitcoin's future instead of their own monetary investment. People and organizations in this layer also don't contribute anything to bitcoin beyond their money and attention, which is nonetheless enough to drive the price up in relation to the increased demand that speculators represent.
All of these layers—really, just people spending money inside a system with parameters decided by its code—have been working together to arrive at the whopping $2,000 price for a single bitcoin that we have today. As for what has motivated the individuals within these layers to invest more lately, well, that's even tougher to pin down.
It might be a new Japanese law that allows retailers to legally accept bitcoin. This is a boon for Japanese people and businesses who use bitcoin, and for speculators who see a global market opening. A debate about a code change that would affect miners and has ripped the bitcoin community apart for years also seems to be circling the hoop, conclusion-wise.
Alright, so that's about it. What should be clear to you now, whether you really get it or not, is that bitcoin is completely bonkers. It's a massive system worth billions of dollars that's based on nothing more than people, their money, and some code. Altogether, it spins value seemingly out of thin air. It's kind of bullshit, but so is everything else in this world. And that doesn't make it any less real.
But while bitcoiners are no doubt celebrating the high price, questions about bitcoin's future linger, namely because elements of all three economic layers are in competition with each other. If some miners get their way, some fear that average users running full versions of the bitcoin software may no longer be able to, centralizing the network. If the speculators get their way, bitcoin might end up being another dry financial tool, bereft of its world-changing potential.
So far, however, the cryptoeconomic idea behind bitcoin has worked out, and that's why bitcoin is worth more than $2,000 USD. But, as bitcoin has demonstrated time and time again, one crack in the pressure cooker can cause the whole pot to explode—what happens next is anybody's guess.
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