The Bitcoin Standard: The Decentralized Alternative to Central Banking

by Saifedean Ammous

Nakamoto programmed Bitcoin to produce a new block roughly every ten minutes, and for each block to contain a reward of 50 coins in the first four years of Bitcoin's operation, to be halved afterwards to 25 coins, and further halved every four years.

Gold became the prime money of every civilized society precisely because it was the hardest to produce, but Bitcoin's difficulty adjustment makes it even harder to produce. A massive increase in the price of gold will, in the long run, lead to larger quantities being produced, but no matter how high the price of bitcoins rises, the supply stays the same and the safety of the network only increases.

The security of Bitcoin lies in the asymmetry between the cost of solving the proof‐of‐work necessary to commit a transaction to the ledger and the cost of verifying its validity. It costs ever‐increasing quantities of electricity and processing power to record transactions, but the cost of verifying the validity of the transactions is close to zero and will remain at that level no matter how much Bitcoin grows. To try to commit fraudulent transactions to the Bitcoin ledger is to deliberately waste resources on solving the proof‐of‐work only to watch nodes reject it at almost no cost, thereby withholding the block reward from the miner.

Bitcoin's supply is made up of a maximum of 21,000,000 coins, each of which is divisible into 100,000,000 satoshis, making it highly salable across scales.

No single entity is relied upon for maintaining the ledger and no single individual can alter the record on it without the consent of a majority of network members.

Beyond digital scarcity, Bitcoin is also the first example of absolute scarcity, the only liquid commodity (digital or physical) with a set fixed quantity that cannot conceivably be increased. Until the invention of Bitcoin, scarcity was always relative, never absolute.

Bitcoin blocks are added to the shared ledger roughly every ten minutes. At the birth of the network, the block reward was programmed to be 50 bitcoins per block. Every four years, roughly, or after 210,000 blocks have been issued, the block reward drops by half. The first halving happened on November 28, 2012, after which the issuance of new bitcoins dropped to 25 per block. On July 9, 2016, it dropped again to 12.5 coins per block, and will drop to 6.25 in 2020. According to this schedule, the supply will continue to increase at a decreasing rate, asymptotically approaching 21 million coins sometime around the year 2140, at which point there will be no more bitcoins issued. (See Figure 14.)

Because new coins are only produced with the issuance of a new block, and each new block requires the solving of the proof‐of‐work problems, there is a real cost to the production of new bitcoins. As the price of bitcoins rises in the market, more nodes enter to compete for the solution of the PoW to obtain the block reward, which raises the difficulty of the PoW problems, making it more costly to obtain the reward. The cost of producing a bitcoin will thus generally rise along with the market price.

With its supply growth rate dropping below that of gold by the year 2025, Bitcoin has the supply restrictions that could make it have considerable demand as a store of value; in other words, it can have salability across time. Its digital nature that makes it easy to safely send worldwide makes it salable in space in a way never seen with other forms of money, while its divisibility into 100,000,000 satoshis makes it salable in scale.

By November 2017, the total market value of all the bitcoins in circulation was in the range of $110 billion, giving it a value larger than the broad money supply of the national currencies of most countries. If Bitcoin were a country, the value of its currency would be the 56th largest national currency worldwide,

with the current size of Bitcoin blocks being limited to 1 megabyte, 500,000 transactions per day is close to the upper limit that can be carried out by the Bitcoin network and recorded by all peers on the network.

As demand for Bitcoin transactions grew, miners could afford to be more selective and prioritize transactions with higher fees. Fees were under $0.1 per transaction up until late 2015, and started rising above $1 per transaction around early 2016. With the quick rise in Bitcoin's price in 2017, the average daily transaction fee had reached $7 by the end of November.

the only limited resource, and in fact the only thing for which the term resource actually applies, is human time. Each human has a limited time on earth, and that is the only scarcity we deal with as individuals.

Until Bitcoin's invention, all forms of money were unlimited in their quantity and thus imperfect in their ability to store value across time. Bitcoin's immutable monetary supply makes it the best medium to store the value produced from the limited human time, thus making it arguably the best store of value humanity has ever invented. To put it differently, Bitcoin is the cheapest way to buy the future, because Bitcoin is the only medium guaranteed to not be debased, no matter how much its value rises.

As the block subsidy declines, the resources dedicated to mining bitcoins will be mainly rewarded for processing the transactions and thus securing the network, rather than for the creation of new coins.

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With Bitcoin, on the other hand, verifying transactions is trivial and virtually costless, as anyone can access the transactions ledger from any Internet‐connected device for free

Bitcoin does not have to be stored on a computer; the private key to a person's bitcoin hoard is a string of characters or a string of words the person remembers. It is far easier to move around with a Bitcoin private key than with a hoard of gold, and far easier to send it across the world without having to risk it getting stolen or confiscated.

Bitcoin's advantage lies not in competing with these payments for small amounts and over short distances; Bitcoin's advantage, rather, is that by bringing the finality of cash settlement to the digital world, it has created the fastest method for final settlement of large payments across long distances and national borders.

Gold is the only traditional monetary medium that is not someone's liability, and is free of counterparty risk, but moving gold around is an extremely expensive operational task, fraught with risks. Bitcoin, having no counterparty risk and no reliance on any third‐party, is uniquely suited to play the same role that gold played in the gold standard. It is a neutral money for an international system that does not give any one country the “exorbitant privilege” of issuing the global reserve currency, and is not dependent on its economic performance.

Without a lender of last resort, fractional reserve banking becomes an extremely dangerous arrangement

The gold standard offered a solution to this problem, wherein a single form of money, independent of the control of any single government or authority, was the monetary standard worldwide. Prices could be calibrated against gold and expressed in it, facilitating calculation across borders. The physical heft of gold, however, meant that it had to be centralized and settlement had to be carried out between central banks. Once the gold was centralized, its lure proved irresistible for governments, who took control of it and eventually replaced it with fiat money whose supply they control. Sound money became unsound as a result.

Anyone who joins the Bitcoin network generates a public address and a private key. These are analogous to an email address and its password:

When a transaction is made, the sender broadcasts it to all other network members (nodes), who can verify the sender has enough bitcoins to fulfill it, and that he has not spent these coins on another transaction. Once the transaction is validated by a majority of the CPU behind the network, it is inscribed onto the common ledger shared by all network members, allowing all members to update the balance of the two transacting members.

Only by making accuracy based on CPU cycles expended by members, in other words, employing a proof‐of‐work system, can Bitcoin solve the double‐spending problem without a trusted third party.

Nodes compete to solve the PoW math problems for a block of transactions, and the first node to produce the correct solution broadcasts it to network members, who can very quickly verify its correctness. Once the validity of the transactions and PoW are verified by a majority of the network nodes, a set quantity of bitcoin is issued to reward the node that correctly solved the PoW. This is known as the block subsidy, and the process of generating the new coins has been referred to as mining,

On top of the block subsidy, the node that correctly solved the PoW also gets the transaction fees included by senders. The sum of the transaction fees and the block subsidy is the block reward.

Although solving these problems might initially seem a wasteful use of computing and electric power, proof‐of‐work is essential to the operation of Bitcoin.

For an attacker to try to insert fraudulent transactions into the Bitcoin ledger, he would need to have a majority of the processing power behind the network to accept his fraud. Honest nodes that are part of the network would have no incentive to do so, because it would undermine the integrity of Bitcoin and devalue the rewards they are receiving, wasting the electricity and resources they have expended on it. So an attacker's only hope would be to mobilize a quantity of processing power that constitutes more than 50% of the network to verify his fraud and build on it as if it were valid.

The reward to nodes for verifying transactions has proven to be a profitable use of processing power. In January 2017, the processing power behind the Bitcoin network is equivalent to that of 2 trillion consumer laptops. It is more than two million times larger than the processing power of the world's largest supercomputer, and more than 200,000 times larger than the world's top 500 supercomputers combined.

All of these miners have no conceivable purpose but verifying Bitcoin transactions and solving proof‐of‐work. Should Bitcoin fail for whatever reason, these ASICs would be rendered useless and their owners' investment would be lost, so they have a strong incentive to maintain the honesty of the network.

Should an attacker succeed in altering the record, he would be highly unlikely to gain any economic benefit from it, as compromising the network would probably reduce the value of bitcoins to close to nothing.

Node operators can now generate unlimited wallets, allowing businesses to offer convenient wallets for users who can send and receive bitcoins without operating a node or spending processing power on verifying transactions. This has moved Bitcoin away from being a pure peer‐to‐peer network between identical nodes, but the main functional importance of the decentralized and distributed nature of the network has arguably remained intact,

This immutability is not a feature of the Bitcoin software, which is trivial to change for anyone with coding skills, but rather is grounded in the economics of the currency and network, and stems from the difficulty of getting every member of the network to adopt the same changes to the software.

To the best of this author's knowledge, there have been no significant coordinated attempts to alter the monetary policy of Bitcoin,3 but even far simpler attempts at altering some of the technical specifications of the code have so far failed. The reason that even seemingly innocuous changes to the protocol are extremely hard to carry out is the distributed nature of the network, and the need for many disparate and adversarial parties to agree to changes whose impact they cannot fully understand, while the safety and tried‐and‐tested familiarity of the status quo remains fully familiar and dependable.

Bitcoin's value comes from it having an immutable monetary policy precisely because nobody can easily change it.

Bitcoin is straightforward to use, but virtually impossible to alter. Bitcoin is voluntary, so nobody has to use it, but those who want to use it have no choice but to play by its rules. Changing Bitcoin in any meaningful way is not really possible, and should it be attempted, will produce another pointless knock‐off to be added to the thousands already out there. Bitcoin is to be taken as it is, accepted on its own terms and used for what it offers.

Bitcoin's 1‐megabyte blocks mean that the capacity for transactions as it stands is around less than 500,000 transactions per day.

Each Bitcoin transaction is recorded with all network nodes, who are all required to keep a copy of the entire ledger of all transactions.

Centralized payment solutions, such as Visa or MasterCard, employ one centralized ledger to which all transactions are committed, as well as a backup that is entirely separate. Visa can process around 3,200 transactions per second,

Bitcoin's current 1‐megabyte blocks are able to process a maximum of four transactions per second,

Bitcoin mass use for merchant payments is not even very feasible given that it takes anywhere from 1 to 12 minutes for a transaction to receive its first confirmation.

Instead of the rising fees slowing Bitcoin's adoption, all that is happening is that the less important transactions are being moved off‐chain and the on‐chain transactions are growing in importance. The most important use cases of Bitcoin, as a store of value and uncensorable payments, are well worth the transaction fees.

for any crime that actually has a victim, it would be inadvisable for the criminal to use Bitcoin. Its pseudonymous nature means that addresses could be linked to real‐world identities, even many years after the crime is committed. The police, or the victims and any investigators they hire, might well be able to find a link to the identity of the criminal, even after many years. The Bitcoin trail of payments itself has been the reason that many online drug dealers have been identified and caught as they fell for the hype of Bitcoin as completely anonymous.

Any form of money can be used by criminals or to facilitate crime, but Bitcoin's permanent ledger makes it particularly unsuited to crimes with victims likely to try to investigate.

Bitcoin, on the other hand, takes an entirely different approach to computer security: it does not bother to secure any of its computers individually, and operates under the working assumption that all computer nodes are hostile attackers. Instead of establishing trust in any network member, Bitcoin verifies everything they do.