Bitcoin is the first and largest cryptocurrency to ever exist. It was created in 2009 after its creator, Satoshi Nakamoto, mined the first block of Bitcoin transactions and put Bitcoin’s blockchain network online. 13 years later, Bitcoin is a global asset with a $381 billion market cap used all across the world for payments, storing value, and speculative purposes.
Everyone knows what Bitcoin is and what it's used for. But rarely anyone knows how Bitcoin and its tokenomics work. In this article, I’m showing you everything you need to know about this wonderful cryptocurrency, its utility, incentives, use cases, and tokenomics.
What Is Bitcoin?
Bitcoin is a digital currency that facilitates online payments and money transfers. Bitcoin works on the premise of blockchain technology - decentralized, immutable, public, and anonymous networks that process transactions. Blockchain technology is attractive because it allows you to send money over the internet without the need of intermediaries.
Let’s say you have a friend in a country with no access to modern banking systems. You want to send money to him but no option works. You can’t Venmo him, make a wire transfer, or send money over PayPal. But guess what, you can tell your friend to create a cryptocurrency wallet and send him some of your Bitcoin.
Your friend receives your Bitcoin and sells it to a local vendor or private individual. Voila! You have now sent your friend money even though it was impossible to do so via traditional banking methods. That person could be a friend, a freelancer you’re paying for a job, a boss who’s paying you, or a family member in need of emergency funds - the possibilities are endless.
Bitcoin has other use cases as well. Imagine you hoard a large amount of wealth but don’t want to secure it keeping it in cash or in a bank account. You might want to convert your cash into Bitcoin and store it in a digital wallet that’s located on your computer, mobile phone, or a hardware wallet the size of a USB thumbstick drive.
And since you’ve converted your money into Bitcoin, you’re no longer tied to the volatility of fiat markets. Some own Bitcoin because they believe it’s a store of value asset – much like gold. Reality has shown us that Bitcoin is not immune to the events on Wall Street, but hey, if the economy crashes you at least hold full ownership over your coins. What if a bank doesn’t let you withdraw funds because it went illiquid?
Bitcoin Tokenomics: How Bitcoin Transactions Work
Bitcoin inventor Satoshi Nakamoto outlined the tokenomics and inner workings of this grandiose cryptocurrency in the Bitcoin Whitepaper. In it, Satoshi states that Bitcoin is a peer-to-peer electronic cash system that allows online payments to be sent from one party to another without going through a financial institution.
The Bitcoin network tracks and facilitates transactions with the help of digital signatures, Proof of Work, timestamps, and miners. Let’s take the time to inspect each mechanism individually.
A blockchain transaction is a digital and cryptographically-proof transaction that involves the transfer of coins from one wallet address to another. When you want to send coins to another person, you have to input his address and issue the transaction by signing it with your private key.
A private key is a string of numbers and letters that is exclusively known to a wallet’s owner. On the other hand, a public key is a public string that identifies your address among millions of other wallet owners on Bitcoin’s blockchain.
But remember, I mentioned that blockchain networks are decentralized. Who then decides which transaction passes the network and which doesn’t? Or who decides that your transaction history is the correct one and that you didn’t lie about spending your coins twice?
Proof of Work: Mining and Confirming Transactions
Because of decentralization, there is no single authority on the Bitcoin blockchain. Instead, the network is ruled together with the help of a community of miners who validate transactions by contributing computer power.
A miner running a Bitcoin node expends his computer’s hardware power and electrical energy required to mine transaction blocks. Mining transaction blocks entails solving what are basically complex mathematical problems that, upon completion, grant a reward in the form of Bitcoin.
The end goal behind mining is confirming blocks of transactions. So if you, the user, sends Bitcoin to someone, the miner will be the one who confirms the transaction and applies it to the blockchain. Thousands of miners do this together and vote transaction blocks that will permanently be etched into the blockchain – therefore achieving consensus on the right order of transactions.
As you might have noticed, this is where Bitcoin’s first utility in its tokenomics comes into play. A miner mines blocks and if he is the first one to solve the mathematical puzzle, he receives a so-called block reward. Block rewards diminish through time – they halve after the creation of 210,000 blocks - and currently hand out 6.25 BTC per block.
But hey, not everyone gets to receive the block reward, so what incentivizes everyone else to mine? Transaction fees. Whenever you send BTC to someone you also have to pay a transaction fee. This fee goes directly to the miner. This means that miners passively receive BTC rewards during the entire mining process.
Learn more about transaction fees here
BTC Tokenomics Explained
We’ve arrived at the final stage: Bitcoin’s tokenomics. The following statements are clear at this point:
- Payers pay fees to miners for confirming their transactions
- Mining transaction blocks emits new BTC into the supply
- The blockchain incentivizes miners to confirm transaction for fees and block rewards
You now understand that Bitcoin has a major utility and more than enough incentives within its own ecosystem. New coins enter the network through mining, users have to pay a small amount of Bitcoin to send a transaction, and those who make the transactions possible in the first place do so because of block rewards.
Bitcoin has a maximum supply of 21 million tokens. When Satoshi Nakamoto put Bitcoin online, the network had no existing supply apart from the first coins that were mined. This means that Bitcoin’s supply increases through time as more people use the network.
Bitcoin’s supply in October 2022 stands at 19,168,887 coins. 6.25 BTC enter the network with each mined block until 2024, when a new halving will decrease block rewards to 3.125 BTC.
Estimates show that the final coins will be mined roughly 100 years from now. It takes such a long time to mine the last coins because of Bitcoin’s progressive mining difficulty and the Bitcoin halvening events that occur every 4 years. So even though Bitcoin does experience inflation like many modern currencies, it does so at a predictably lowered rate.
Bitcoin is a digital currency powered by blockchain technology that enables decentralized, anonymous, public, and immutable peer-to-peer cash transfers. These cash transfers are processed through digital transactions placed into a collective block which other users mine.
Bitcoin generates new coins with each newly mined transaction block. Rewarding miners with block rewards incentivizes them to power the network and keep it online. Apart from that, miners also earn a small amount of Bitcoin through transaction fees.
Bitcoin has an inflationary supply that will reach a maximum amount of 21 million coins. However, mining difficulty and halving events lower the effects of inflation by decreasing the number of blocks emitted through block rewards each 4 years.
Bitcoin has use cases in payments and speculative investing. Some also treat Bitcoin as a store-of-value asset and form of ‘digital gold.’ Bitcoin represents the largest cryptocurrency with a market cap of $381 billion and is priced at $20,077 as of October 2022.
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