Written by Grant Ralph
Bitcoin is working and making progress and there are more people wanting to understand why this thing called Bitcoin, which doesn’t have a CEO, a board of directors or employees, can thrive like it does.
However, often when someone offers an explanation as to why Bitcoin works, the explanation only includes something to the effect that “Bitcoin works because we can trust the math and software”. Sometimes the explanation also includes reference to “the Blockchain”. In my opinion, this sort of explanation is not doing Bitcoin’s growing audience any favours. Here’s why:
The breakthrough with Bitcoin was the design of a system that uses ‘economic incentives’ to constantly encourage people to perform certain acts instead of others. Building on this explanation, Bitcoin works because notwithstanding the array of different preferences and opinions in society we are all united by our desire to create rather than destroy wealth. This universal human preference allows Bitcoin to work.
An explanation that only refers to ‘math and software’ or ‘blockchain’ ignores these elements which: (1) are more fundamental to Bitcoin’s success; and (2) will enable a broader audience to understand why Bitcoin works and why it can be trusted.
These fundamental elements are also more likely to resonate with anyone no matter their age, ethnicity, gender, religion, sexuality or level of education. This is important because Bitcoin’s existence and success impacts every single person’s financial well-being and it will continue to impose itself for decades to come.
I’d still like to write further articles that explain why bitcoin impacts, and will continue to impact, every single person’s financial well-being but for the time being, all we need to acknowledge is that as Bitcoin succeeds and becomes fully monetized, those who understand and adopt it earlier will be better off than those who adopt it later. For these reasons, I am very passionate about ensuring that everyone has an equal chance of understanding why Bitcoin works and why it can be trusted.
This article describes how and why the economic incentives influence people to do the things that the Bitcoin system wants them to do and how this makes Bitcoin work. My hope is that it can be used to introduce anyone to the main reasons why Bitcoin works and why it can be trusted.
Bitcoin is for everyone and it will have an impact on everyone.
A recap of some of the important principles
Before going any further, it’s important to recap some of the important principles that provide the mindset needed to understand the various things about the Bitcoin system.
Firstly, we need to think about bitcoin as money and have an appreciation of the fact that a money only gets you something if others accept it from you in exchange for their goods, services or other money that they are holding. We are therefore reliant on the decisions and actions of others. For these reasons, we want to converge with what others think is the best money rather than have our own contrarian points of view on this subject.
Secondly, people use something as money because that money demonstrates that it has the ability to perform the functions of money. For early-stage money, like bitcoin, the good must first be able to function as a store of value. This means that the holder must be able to sell it on the market and recover the same, or inconsequentially similar, value that the money had when the holder acquired or received it. You can read more about the functions of a money and how a good comes to perform all of these functions in my article “What’s Next For Bitcoin: 2019 And Beyond”
A money’s ability to function as a store of value stems from it having the attributes of a good money. These attributes are durability, portability, fungibility, verifiability, divisibility, scarcity, established history and the ability to resist censorship. You can read more about these attributes and how they pertain to bitcoin in my article “Bitcoin Is Like Gold, But It’s Superior”. In addition, Vijay Boyapati’s article “The Bullish Case For Bitcoin” provides a brilliant explanation of these monetary attributes.
Right, let’s go on a journey of tracking a bitcoin transaction through the network. At each step we’ll engage with how ‘economic incentives’ enable the Bitcoin system to work. I’ll also include some other interesting information and stories about Bitcoin where the inclusion helps to explain a concept.
Disclaimer: The comments, views, opinions and any forecasts of future events reflect the opinion of the quoted author, do not necessarily reflect the views of his employers or other professionals working for the same employers, are not guarantees of future events or results and are not intended to provide financial planning, investment or legal advice.