Bitcoin Part 1: Base Layer for Sound Money

Part 1 of a Bitcoin series explaining how the Bitcoin serves an important purposes as a globally distributed, secure, free and open monetary network.

By now, you've probably heard of bitcoin. While there's a ton of information out there, I feel like it's important to provide an explanation that is very simple and broken up in to logical sections. In order to understand where bitcoin will go, we need to know what has happened so far.

"If you don’t believe it or don’t get it, I don’t have the time to try to convince you, sorry." - Satoshi Nakamoto

Fortunately, I do have time to convince you. This post is meant to be an introduction and explain how Bitcoin is in its nascent phase, but will provide massive amounts of utility in the future. I specifically want to focus on Bitcoin as the starting point for an open monetary system, and how this this "base layer" opens up a variety of real-world applications that are sorely needed.

What does it mean to be "the base layer"?

When designing something as game-changing as Bitcoin, the creator had to make trade-offs to optimize for what he/she/they thought was most important. Satoshi Nakamoto certainly acknowledged that Bitcoin will have its limitations, and in analyzing those limitations we can see exactly what Bitcoin was designed for: security, trust, and openness.

Security

When it comes to money, nearly anyone would agree that security is absolutely top of mind. People hear of some new story about a hack or loss of funds all the time, and the fear of potential loss makes security and trust paramount. In my mind, perhaps the most interesting and novel aspect of Bitcoin is its built-in capability to secure the network.

A group called Bitcoin miners performs various critical functions in the Bitcoin ecosystem: verifying new transactions, putting new coins into circulation, and maintaining trust among market participants. While the details of what miners do can be expanded on greatly, for our purposes it's important to understand how they combine computing power to make up Bitcoin's hash rate.

This means a single malicious actor couldn't gain control of the Bitcoin network without providing 51% or more of the mining hash rate (computing power). This type of attack is nearly impossible in today's world, as China previously dominated global hash rate but has since banned Bitcoin mining. This move distributed a large chunk of Bitcoin mining power all across the globe, making Bitcoin even more decentralized than it was before!

A common attack on Bitcoin is that it uses too much energy. I'd argue that the use of aggregated computing power, which in turns uses energy, is that it provides the essential utility of securing the network. This is a difficult task to tackle and of course, trade offs have to be made. In my mind, the use of energy to make the Bitcoin network ultra secure incentivizes clean energy that is cheap to generate (ie. renewable).

The bottom line is that Bitcoin has to make a choice in regards to what it prioritizes. If you envision a sliding scale where one side is speed, and the other side is security, Bitcoin as a base layer tends to slide towards the security end. And that is perfectly okay, as the speed required for massive scale can be built on top of the Bitcoin base layer, as evidenced by protocols such as Lightning (more on that later).

Trust in the Protocol

A great characteristic of Bitcoin is that we know exactly what the rules are. The code is open source, and thousands of validators called "Bitcoin nodes" are constantly validating transactions. Imagine every bank in the world doing quality checks on every banking transaction that occurs. It certainly points towards a world where we have less fraud and zero reliance on any single centralized institution. Ideally the "Too Big to Fail" designation can cease to exist and we can stop bailing out institutions that gamble with the assets deposited with them.

In the existing banking system, settlement of funds sent is a long and convoluted process with several layers of middle men. These institutions check that the user has adequate funds available for the transaction and that the sender and recipient are who they say they are. Bitcoin miners and node operators are the actors in the Bitcoin network that perform this function, and they do it across the world with no barrier to entry other than having adequate computing power. Again, we democratize the ability to validate transactions and can eliminate the need for centralized third parties.

Normal node operators "validate" transactions, and special node operators (miners) "confirm" it and add it to the universal ledger known as the Bitcoin blockchain. The specifics of Bitcoin mining are outside the scope of this introductory post, but it is an essential actor in keeping the Bitcoin network running with maximum trust and security. Bitcoin node operators ensure that everyone is "playing by the rules" as specified in the open source code, and allow operators to be truly be their own bank.

Open and Transparent Network

So what benefits does society get from having an open, secure monetary network? For starters, we maintain a similar system of trust and fraud prevention that we have currently. This is abstracted from the end user in both traditional finance and in the Bitcoin world. However, the big difference here is that no one node controls the network or can dictate its own set of rules. We no longer need to trust third parties in this extremely essential and sensitive settlement layer.

For actors looking to send and receive payments, this means we don't have to ask anyone for permission to be able to securely transact value across the globe. In today's world, someone trying to send money to a relative in a country across the world would have to go to a Western Union or similar institution and pay its exorbitant fees. Bitcoin doesn't care about the destination or the amount of value being sent, as evidenced by a recent example of over $1 billion being send for a network fee of just $3.54.

With a low-fee, transparent and permission-less monetary network available, we achieve two major goals: 1) prevent dependence on third parties and 2) allow anyone on Earth to take custody of their funds become their own bank.

Scaling Things Up ⚡

As mentioned earlier, on the sliding scale between speed and security, Bitcoin leans towards optimizing security. It takes time to validate transactions, which means buying a cup of coffee with Bitcoin only would mean you'd have to wait for this process to complete. In short, Bitcoin needs something else to help it scale to millions of people buying coffee or anything else at the same time.

This is where the Lightning Network comes in. Lightning is a protocol that sites on top of the Bitcoin base layer and helps solve the scaling problem described above. The TLDR of its utility is that it allows the major parts of a transaction to be verified instantly, and officially settles the transaction on-chain at a later time. The official docs describe its scalability in a pretty compelling way:

Capable of millions to billions of transactions per second across the network. Capacity blows away legacy payment rails by many orders of magnitude. Attaching payment per action/click is now possible without custodians.

As we can see, it makes the actions that are currently performed by various middle men much faster and simpler. Websites and vendors can allow payments with a single click or scan of a QR code. There is much more to discuss about Lightning in a separate post, but this introduction should hopefully explain why Bitcoin should be viewed as the base layer.

We can think of Bitcoin as the frame of a large house or building. It's required in order to take actions such as adding a roof, doors, and other additions that make having the building worth while. By combining the security, trust, and openness of Bitcoin with he speed and scalability of Lightning, we have a network that is much more efficient and trustworthy than the existing convoluted and closed system.