Bitcoin is a digital currency. In the simplest of terms, Bitcoin is a form of money, although it is not issued by any country or government. Bitcoin can be used in much the same way as fiat currencies, like the dollar, pound, ruble, and peso. However, Bitcoin is created by an algorithm—a computer program—instead of a central bank.
If Bitcoin is so similar to fiat currencies, what makes it so special?
Compared to traditional fiat currencies, Bitcoin has a few important differences.
To put these differences into context, let’s examine why Bitcoin is unique and look at real-world examples to illustrate why these differences are so important.
1. Limited supply
Unlike traditional fiat currency issued by governments, Bitcoin is nearly inflation-proof. A maximum of 21 million Bitcoins will ever exist. In January 2018, there were close to 16.7 million Bitcoins available and 4.3 million Bitcoin remaining. Roughly every 10 minutes, new Bitcoins are created through the process of mining.
Why this matters: The phrase “fiat money” describes a currency that has no intrinsic value but has been established as money by government regulation. In the past, currencies were commodity-backed (backed by assets, such as gold or silver), but in today's world, every country has adopted fiat money as a natural evolution of currency. Because the value of fiat currency is derived from the economy of the issuing country, anyone holding currency depends on the issuing country's economic health for their money to keep its value. Currency holders are also subject to relevant regulations and laws.
2. Non-government backed
Bitcoin is not backed by any government or central bank. This makes Bitcoin truly independent from politicians, bankers, and government regulation (for now).
Why this matters: The phrase “fiat money” describes a currency that has no intrinsic value but has been established as money by government regulation. In the past, currencies were commodity-backed (backed by assets, such as gold or silver), but in today's world, every country has adopted fiat money as a natural evolution of currency. Because the value of fiat currency is derived from the economy of the issuing country, anyone holding currency depends on the issuing country's economic health for their money to keep its value. Currency holders are also subject to relevant regulations and laws.
In 2013, the Republic of Cyprus faced an economic crisis. As part of their international bailout, the government imposed an asset seizure on bank deposit holders with more than 100,000 euros in their accounts in order to avoid a financial crisis. Depositors ended up losing an estimated $4 billion and around 47.5% of their savings.
3. Purely digital
Although digital currency is often depicted with gold coins, Bitcoins don’t exist in physical form. Because Bitcoin is purely digital, it is heavily utilized for Internet transactions, online payments, and cross-border remittances.
Why this matters: In Sweden, “no cash accepted” signs are becoming more and more common. Just five years ago, nearly 50% of transactions were paid with cash. Today, that number has dropped below 20%. While Sweden leads the world as a cashless society, nearly every other country is experiencing similar shifts away from paper money as our lives move further into the digital world.
4. Decentralization
Decentralization is one of the most important and unique aspects of Bitcoin compared to fiat currencies. There is no single institution that controls the Bitcoin network, and there is no single point of failure. The entire network is based on open source software that a group of volunteer coders maintain and it is powered by an open network of computers spread around the world.
Why this matters: In November 2017, Amazon Web Services, which powers many websites on the Internet, went down. For five hours, visitors encountered error messages when visiting sites like Expedia, Zendesk, Medium, and Trello. The downtime was later estimated to cost over $150 million for S&P 500 companies alone.
The cause of all this? Human error. An employee at a data center in Northern Virginia made the simple, human error of entering the wrong command. This is one of many risks associated with centralized networks.
5. Immutability
Once a Bitcoin transaction is complete, it can’t be reversed. That’s because there is no central authority with the ability to claim that a transaction should be reversed in the first place. Every transaction that ever happens on the blockchain is recorded permanently and cannot be changed or altered in any way.
Why this matters: When you use a credit card to make a purchase, you typically have a window of 90 days to dispute the transaction. This is known as a chargeback and, while it can protect consumers, it also puts merchants at risk of fraud. In the United States alone, chargeback fraud is a $7 billion problem every year.
6. Divisibility
Bitcoin also has the potential to support micro-transactions, due to its flexible divisibility. One single Bitcoin can be divided by up to 8 decimal places (0.00000001).
Why this matters: If you’ve ever tried to purchase something for less than $1 with a credit card at a gas station, you’ve likely been directed to a sign that states there is a minimum purchase. The reason minimums exist is because of the fees merchant processors charge. Oftentimes, they charge between 10 and 30 cents per transaction, plus 2-3% of the total purchase amount. This makes transactions of less than $1 unprofitable for a merchant if paid with a credit or debit card.
Why this matters: Central banks can issue as much fiat currency as they want, and this often leaves citizens holding a currency whose value declines over time.
An example of this is the Zimbabwean dollar. Since the late 1990s, the Zimbabwe government has struggled with a declining economy. This has lead to more money being printed, thus increasing the fiat money supply while simultaneously devaluing the value of the Zimbabwean dollar. By November 2008, the estimated inflation rate was 79,600,000,000%. In other words, with more printed dollars chasing a relatively fixed supply of goods and services, the cost per item rose by an astonishing 79 billion percent.