Bitcoin: Still A Decentralized Alternative to the Traditional Financial System?
Reflecting on the fundamental problem which Bitcoin was created to solve.
Magical internet money
Even in 2023, and although adoption has consistently been up and to the right for most positive metrics, the countless negative headlines mean the majority of people still associate Bitcoin and cryptocurrency to either money laundering, dodgy dark web dealings or its impressive record of obituaries. Contrary to this image, the idea of Bitcoin was actually spawned as a transparent digital peer to peer payments system. Many early adopters, and those with enough curiosity to dive deep enough down the rabbit hole, hail Bitcoin as being a suitable candidate to become the native currency of the internet. The first question one might ask is, why do we need a new currency at all when it’s already possible to buy things online easily and conveniently? Although online payments and eCommerce has developed to become super quick and mostly very reliable, it is inefficient, costly and the core infrastructure which is used to manage and govern digital payments is incredibly centralized.
The risks of too much centralization
Centralization has its benefits. Speed and power are two examples, and through these come further opportunity for technological development and innovation. Instant messaging and video applications came along with smartphones and quicker internet speeds and allow for real-time conversations across space and borders, these applications however, are generally powered from a few centralized locations across the globe. We’ve likely all been affected by Facebook Messenger or WhatsApp services temporarily going offline - because of their centralized nature, a technical issue or outage has a widespread and immediate impact on the entire ecosystem of users who rely on it. Similarly, and even more important, if there is a data breach or hack, the number of users whose data is compromised can exceed hundreds of millions per event.
In any transaction between parties there needs to be a certain level of trust, and in the modern age of non-commodity government backed fiat currencies (fiat; Latin for ‘let it be done’), this trust usually comes in the form of a financially regulated intermediary, or third-party institution (banks, payments and remittance processors, etc). These intermediaries are required to act in kind for their customers who engage in a trade or transaction with another party – ensuring the expectations agreed upon for said transaction, are met. For the most part, this works well in the age of capitalism and an open and competitive market because any financial services provider whose service is poor or is deemed to be untrustworthy will lose customers and market share to competitors, so they are forced to ‘adapt or die.’ This means there is strong incentive to provide a good service and to act and make decisions with users and customers in mind. However, there is always the risk that individuals or bad actors make decisions out of self-interest or the interests of affiliated groups. The repercussions of such decisions aren’t always immediately felt, or even noticed, until it’s too late.
Consider the financial crises in 2008, it was a complete fucking shitstorm on many levels and mostly out of the scope of this post, but when discussing Bitcoin it seems almost rude not to mention it. The crisis was essentially caused by a combination of heavy deregulation of the banking industry in the previous two decades, and rock bottom interest rates in the early noughties. This was all in an attempt to boost the economy in a response to the dot-com crash – we love you, capitalism! Of course, this was all with good intention, and it initially it seemed to work. With cheap debt, came cheap short-term mortgages, cheap mortgages increased house demand, and with-it house prices. Interest rates unfortunately couldn’t stay low forever, so years later when homeowners monthly mortgage payments increased back to normal rates years into their agreement, it rapidly became unaffordable. Unfortunately, this wasn’t the only problem, with a more lenient deregulated industry came self-interested, opportunistic investment bankers armed with some of the most complex financial instruments the industry has ever seen, which of course spread like wildfire once they caught on. One of these instruments, known as collateralized debt obligations (CDO’s), allowed banks to wrap up and bundle housing debt, not forgetting a little bow, and positioned it as a ‘low-risk’ mortgage-backed security which could then be sold to other investment banks.
We have the benefit of being able to reflect on this in hindsight, but it sounds absolutely batshit that anything close to this was allowed to happen. The reality at the time was that mortgages were considered a safe haven due to the misconception that nobody ‘doesn’t pay’ their mortgage payments. But of course, millions missed payments, defaulted on their debt obligations, the CDO’s eventually became worthless causing a snowball effect that lead to the demise of numerous banks. Because of how intertwined (and centralized) the banking industry was, barely anyone escaped the contagion from the fallout when shit hit the fan. For a solid overview for what happened, I’d recommend watching The Big Short. Spoiler… banks still win.
Bitcoin fixes this…
The motivations behind Bitcoin’s creation, and the many other attempts at a digital currency which preceded it, was a move away from having to depend on these centralized third parties and pivoting towards a more decentralized and democratic monetary asset. When you consider the above, it’s pretty rational to want an alternative.
Before we get into it, two things to keep in mind when reading; there is Bitcoin the network, which is the software protocol managed by network participants and validators; and then Bitcoin the currency (or coin), which can be traded or used as payment and is often referred to by its trading ticker, $BTC.
You may have heard the bitcoin network described as a distributed public ledger. For those unfamiliar with accounting terms, a regular ledger is a financial tool utilized by businesses to accurately document incoming and outgoing transactions. The bitcoin public ledger is essentially no different to this, except that it is open, transparent and every transaction is evidenced on the blockchain, available for analysis and inspection on the bitcoin blockchain explorer where it remains immutable and impregnable to change or corruption. This strength is thanks to Bitcoin’s founder, the pseudonymous Satoshi Nakamoto, and their groundbreaking proof of work consensus mechanism, the fundamental concept of which is that there is a ‘real-world cost’ to generating new coins and securing the network. This allows the network to self-regulate through supply, demand, and the cost of creation – this cost is ultimately what makes the network so difficult to manipulate because not only would it require massive capital, but also enough proof of work, to fool network validators into accepting a compromised version of the blockchain - basically its very unlikely to happen.
Unlike fiat currencies, it is not possible to generate (or print) new coins on a whim to fund fiscal stimulus, Bitcoin either needs to be purchased on the open market where the price is determined organically; or acquired by becoming a miner on the network and competing to solve the mathematical problem to achieve the proof of work required to validate transactions and to receive $BTC incentives. The difficulty of the problem (hashrate) increases as more miners join the network; this is to ensure the time to add a new block to the network remains at roughly 10 minutes. Currently, the reward for successfully adding a new block of transactions is just 6.25 $BTC. This amount is reduced by 50% every 4 years (with the next halving event in 2024) and it is programmed so there will only ever be 21 million Bitcoins in existence. The final coins will be mined in over a hundred years’ time. This limitation ensures $BTC cannot be debased, and it can hold its value over time successfully as a sparse and hard monetary asset.
Bitcoin is regularly compared to a digital version of gold. The two have many similar qualities which give them fundamental value as a desired commodity; sparsity, limited in supply, not easily counterfeited and there is a cost of work required to acquire them. Arguably, of the two, it is Bitcoin which excels as it holds value through time and borders, but also through space – this is a drawback for gold as the cost to physically move it is significant, both financially and the time required to do so. As long as there is an internet connection, Bitcoin can be sent from one place to any digital wallet in the world almost immediately for a very small fee for the network.
The power and resilience of decentralization
Bitcoin transactions are confirmed and secured by a vast global network of ‘nodes’ every 10 minutes. In comparison to Visa or PayPal payments it might sound slow, but the length of time this takes is by design to ensure the decentralization of the bitcoin network. Through running the bitcoin software, all active participant nodes on the network can sync and register a new ‘block’ of transactions, which has a maximum size of 1mb. This relatively small amount of computing power required to document the bitcoin blockchain remains one of its greatest strengths as it means anyone can support to broadcast and further decentralize the network. The more decentralized it is, the more difficult it becomes for one or more centralized actors (good or bad) to retain a significant proportion of control of the network and initiate a 51% attack or facilitate a double-spend. In the instance an authority claims that they want to outlaw bitcoin and choose to shut down bitcoin mining facilities, would the network be affected? Yes and no. From the perspective of miners, the difficulty in securing the network changes and adjusts down automatically to account for fewer participants on the network competing to secure the next block. However, the bitcoin network, which is the settlement layer for any transactions that occur on its blockchain, is mostly uninterrupted and is continually documented by the bitcoin nodes as usual - anyone who sends or receives $BTC during this time wouldn’t notice any change. The only caveat to this, is that there can be delays if there are too many transactions being processed and there is network congestion – after all, there is only so much information which can be crammed into 1mb. In this instance, unless higher fees have been paid to get priority service, you might be waiting for the next block before your transaction is processed.
If Bitcoin truly offers an ‘opt-out’ of the current economic system and empowers the average person to take full ownership over their personal wealth, traditional finance (TradFi) simply won’t exist and thrive in the same way in the future. This might lead one to think that because of this, individuals and institutions with a stake to lose may be driven to jeopardize the integrity and security of Bitcoin due to the threat of being displaced or becoming obsolete. Yes, I know, it’s a Netflix series begging to be created. As much as it would be great to see a fully financially independent and ‘bankless’ world, in reality, TradFi probably won’t become obsolete due to the power it holds over policies and bodies of governance. Most likely TradFi will survive in a decentralized world, grasping to hold on for relevance and power through lobbying for domineering crypto regulation to put a stranglehold on decentralized finance innovation.
Realistically, now that Bitcoin has gained the traction and adoption that it has, it would be almost impossible, at least unviable, for any one or multiple entities to attempt to sabotage it. To gain a controlling stake in Bitcoin would require hundreds of billions of dollars to achieve, but even if a mega bank, a group of corporations, or sovereign state attempted this, it would have the adverse effect of causing the price to go parabolic and further pricing out any possibility of majority ownership. It could always be possible to coordinate a more widespread initiative to locate and shut down network participants in more than one location, but when we consider the reality of this, the difficulty comes from the coordination and manpower required to do so. This would mean total alignment from each jurisdiction interested in doing this and with a common understanding that they should spend the necessary time and resources even trying to. Not to mention the negative and destructive fallout this would have by upsetting a fundamentally libertarian, intelligent viral sub-culture, armed with vast communities, and specifically opposed to any oppressive governance practices. This also comes at a point where countries, large corporations and mega banks have begun to not just accept the inevitability of Bitcoin, but also understand its fundamental value as a long-term store of value as an asset.
At one point it may have been possible to shut the network down, but Bitcoin adoption, has passed the point of no return and will naturally manifest itself into becoming an international standard for digital payment settlement and a hard monetary asset which transcends space, time and borders.
If you got this far, I really hope you enjoyed the first ever CC article! I really appreciate you reading to the end. If you want to, let me know your thoughts or if you have any feedback and hope you look forward to the next one! f.
Brief disclaimer: It should go without saying that any opinions are my own and nothing included above should be considered as financial or investment advice. I have written directly from personal opinion whilst also trying to remain factual and have made no conscious effort to plagiarize or copy other essays or articles. For full disclosure I’ve included a hand full of websites which I used for reference while writing, mostly to ensure there was no misinformation.
Sources used to reference:
https://bitcoinwhitepaper.co/
https://99bitcoins.com/bitcoin-obituaries/
https://www.moneyinternational.com/fiat-currency/
https://bitcoin.co.uk/satoshi-nakamoto/
https://www.investopedia.com/terms/f/fiatmoney.asp
https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp
https://blog.coinpayments.net/resources/bitcoin-network
https://medium.com/@rick-malzyner/the-economics-of-21-million-2b32bb73415f
https://bitcoinmagazine.com/technical/proof-of-work-is-important-for-bitcoin
https://www.bitcoinmining.com/what-is-the-bitcoin-block-reward/
https://cryptobriefing.com/ray-dalio-likens-bitcoin-digital-gold/
https://www.investopedia.com/terms/1/51-attack.asp
https://www.linkedin.com/pulse/bitcoin-nodes-vs-miners-whats-difference-bill-gough
https://www.bbc.co.uk/news/world-latin-america-57398274