Traditional Money vs Bitcoin

The majority of countries in the world today are countries with centralized economies. In such countries, there is one authority, typically a central bank, that decides how much currency to issue and that controls the monetary base.

 

How centralized economies work

The idea behind a centralized economy is for the central bank of a country to be monitoring the rate of the exchange of goods between individuals and businesses and be issuing currency at a rate that matches the rate of the exchange so that individuals and businesses can trade products and services with stable prices. In the United States, the Federal Reserve operates the central banking system.

It would seem that the combination of powerful modern technology and finance would lead to markets where everything is transparent and based on numbers, stats and facts; after all, technology provides a lot of computing power and finance is about numbers. In reality, things work very differently: financial markets and the financial sector are largely driven by sentiment and by the decisions of a few key large players.

One of the reasons for the world financial crisis of 2008 was the subprime mortgage crisis in the United States. The mortgage crisis has occurred because several large banks started basing their decisions based on the erroneous assumption that property values can never go down. These assumptions lead to the collapse of several big corporations such as Lehman Brothers and Bear Stearns. The United States government had to bail out other large businesses involved in the subprime mortgage crisis such as the American International Group (AIG) and lenders Freddie Mac and Fannie Mae.

To provide the government and corporations with funds, the Federal Reserve, just like many other central banks around the world, started engaging in quantitative easing, which in practical terms meant printing more money that was not backed by anything. To prevent a recession, many central banks flooded the markets with cash and dropped interest rates to zero or close to zero. The effect of these actions was large fluctuations of currency rates in an attempt to make economies more competitive by currency devaluations. Usually, when a country starts devaluing its currency, it is hoping that the goods and services become more competitive compared to goods and services from other countries simply because they become cheaper.

When governments engage in actions like these, they fundamentally transfer the burden from several large players to the public by adding to future tax liabilities. The only other option would be to let big companies fail, which is what happened in Iceland.

 

How cryptocurrencies work

Cryptocurrencies offer a radically different approach to money. With bitcoin and altcoins, there is no central authority that issues the funds. The system is completely decentralized. There is no CEO of bitcoin or one server through which the transactions have to go through. This means that the users of the system do not depend on several key players and will not have to pay for their mistakes if something were to happen.

The currency on the bitcoin network is created by participants of the network. The participants create the currency by getting it as bounty for doing the work on the bitcoin network. The work consists of adding bitcoin transactions to a ledger, verifying transactions and creating blocks of a blockchain, which is a technology that bitcoin is based on. Currency creation is based on an algorithm that all users on the network know about. Nobody can suddenly decide to create more currency or to stop producing currency for some period of time. If a user tries to generate bitcoins without following the rules, the network will reject the currency, which means that such currency would be completely worthless.

One of the goals of the bitcoin network is to add blocks to its blockchain every ten minutes. Because of this goal, the work that miners have to do to create a new block may vary in difficulty. The more miners there are on the network trying to create new blocks, the more competition there is, the higher the difficulty is going to be. The number of generated bitcoins has been set to decrease geometrically. A 50% reduction happens when miners create 210,000 blocks, which occurs roughly every four years.

The result of the constant reduction is that the number of bitcoins will not exceed 21 million coins. The creators of the Bitcoin network have chosen such an approach because it mimics the way people have been mining precious metals such as gold and other commodities over the history of mankind. As of November 16, 2017, the bitcoin network had around 500,000 blocks. Since the blocks are added every 10 minutes, this number changes constantly. Every block from 0 to 210,000 was generating a bounty of 50 bitcoins. In its first year of existence (from January of 2009 to April of 2010), the bitcoin network added 52500 blocks, which resulted in the creation of 2,625,000 bitcoins. It took the network roughly another year to add another 52500 blocks and add another 2,625,000 bitcoins. The bounty for block addition went down from 50 bitcoins to 25 bitcoins in 2012. In 2016, the bounty went down from 25 bitcoins to 12.5 bitcoins. You can see when the next projected drop is going to occur by checking bitcoin clock here: http://bitcoinclock.com/

This website https://blockchain.info/ will show you how many blocks the bitcoin blockchain currently has and at what speed the miners are currently generating the blocks. The website also has complete information about all the previous blocks of the bitcoin blockchain, including information about all bitcoin transactions that have occurred in the past.

If the mining power remains somewhat constant, bitcoin miners would create the last coin somewhere around October of 2140.

Bitcoin network data shows that the mining power on the network has been historically increasing and will most likely to continue increasing in the future, which means that the last bitcoin will be mined earlier than in October 2140. However, it will probably be mined not too far ahead of this date, most likely somewhere around May of 2140.

 

What will happen when all the bitcoins are mined?

The rate at which the bitcoin network mines bitcoins is steadily going down. The bounty for the creation of the first blocks on the network was 50 bitcoins. The current bounty is 12.5 bitcoins and in the future, the bounty will keep decreasing. This means that if you are reading this, about 75% of all bitcoins that will ever be in circulation have already been added to the circulation. The annual inflation rate of bitcoin currency is about 4%.

Bitcoin miners are getting their reward for creating new blocks not just from the network bounty but also from other users in the form of transaction fees. This means that as the network matures and processes more and more transactions, the reward for miners will be coming from the fees and they will still have an incentive to mine bitcoin blockchain blocks. Initially, most transactions did not include any fees but today more and more transactions do include a fee. Any miner can include any transactions he chooses in the blocks that he mines. This means that transactions in which senders do not include a fee have to wait for confirmations from the network longer compared to transactions that do include a fee.

The way bitcoin network operates makes every block on the bitcoin blockchain a scarce commodity. Getting a transaction included in a block is similar to purchasing a part of the block by paying a transaction fee. The size of the fee is regulated by the laws of supply and demand.

Because block space is a scarce commodity, it can be compared to physical land and how land transactions work. The fact that there is no more land to discover doesn’t mean that people are not buying land or are not living on the land. The creators of bitcoin envisioned that by 2140 the bitcoin network becomes so popular, that most people will be using bitcoins in their daily lives and just like with the land, the fact that there are no more bitcoins doesn’t mean that they would stop using existing coins. Also, if the network does become very popular, it will have plenty of transactions on it and the fees from the transactions will provide an incentive for miners to keep mining.

Finally, bitcoin mining has a parameter called difficulty. Difficulty depends on the number of mining who are currently mining the blocks. Initially, when Satoshi Nakamoto just launched the network, it was possible to mine new coins by using a regular computer because there have been so few miners and the difficulty of mining was very low. Should the number of miners decrease in the future, the difficulty of mining would go down and it would mean that more users will be able to engage in mining. The idea is that if the network becomes very popular, the changing difficulty and the financial incentive will keep people interested in being miners on the network. So far the idea worked for bitcoin quite well.

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