This article will give Web3 product designers an understanding of where blockchains came from, what the current blockchain landscape looks like, and where blockchains are headed in the future. We start with Bitcoin – the world’s first ever blockchain. Stay tuned for future Web3 Design Courses where we discuss emerging dApps that will disrupt the internet as we know it today.
Bitcoin was created by an anonymous figure, named Satoshi Nakamoto, and released as open source software in 2009. Looking at the Bitcoin Whitepaper, Satoshi intended Bitcoin to be a digital currency that could be exchanged without any intermediaries like banks. But this is all sort of abstract. What is Bitcoin exactly?
There are several layers to Bitcoin – let’s talk about each. First, Bitcoin is a piece of open-source software that is referred to as the Bitcoin Protocol. Open-source means that anyone can download it, and any developer can suggest improvements to the protocol or build applications on top of it. Satoshi released the first implementation of the Bitcoin Protocol, called Bitcoin Core on Github in 2009.
When someone installs, and runs, Bitcoin Core their computer becomes a node on the Bitcoin network, which brings us to the second layer. Bitcoin is a decentralized, peer-to-peer network of Bitcoin nodes, or computers running the Bitcoin Protocol. The protocol defines the rule set for how these nodes interact with one another in order to keep Bitcoin up and running.
For example, when I first run Bitcoin Core, my computer connects to other Bitcoin nodes and downloads the Bitcoin blockchain from them, which is a file of around 400GB. This brings us to the third, and final, layer of Bitcoin. Bitcoin is a blockchain that tracks the movement of a decentralized digital cryptocurrency called bitcoin (BTC).
Remember the blockchain is simply a ledger that is distributed across all the Bitcoin nodes. In other words, each Bitcoin node stores its own copy of the Bitcoin blockchain – this is what makes blockchains decentralized. But how does the blockchain get updated in a decentralized way? If one Bitcoin node had unilateral rights to update the blockchain with new transactions then this would defeat the purpose of decentralization. Nodes take turns updating the blockchain, and coordinate with each other based on a predefined rule set specified in the Bitcoin Protocol.
When a node creates a new block, and adds it to the blockchain, and the other nodes accept the new block, and add it to their blockchains – this is called “consensus”. Bitcoin uses something called “Proof of Work” as its consensus mechanism. This is a highly technical topic, so just understand that, with Proof of Work, nodes must spend large amounts of electricity and computing resources to win the right to create a block and update the blockchain. This high energy expenditure is by design, and is what prevents the blockchain from attackers; however, it’s also a criticism of Bitcoin. The Bitcoin Network consumes a comparable amount of power to Thailand, which critics argue is bad for the environment.
Consensus mechanisms are important when it comes to the technical design of blockchains. They have a great impact on the security and performance of blockchains. We’ll see in later sections the innovations that are taking place around consensus mechanisms within emerging blockchains.
Bitcoin Protocol is open-source software that establishes the Bitcoin node network, which maintains the Bitcoin blockchain, which tracks the movement of bitcoin cryptocurrency. I know this is confusing – bitcoin (lower-case “b”) is the native cryptocurrency of the Bitcoin protocol (upper-case “B”). Nodes are rewarded with bitcoin when they create a block – this is what incentivizes them to spend electricity to win the right to do so. This reward is also called “bitcoin issuance”.
You may wonder how a digital currency can be valuable. Most of the digital content we’re used to, like images, can be replicated millions of times for free. This brings us to the concept of “tokenomics”, or token economics, which has to do with the monetary policy of cryptocurrencies. A limit on the total bitcoin that will ever be issued is encoded directly in the Bitcoin protocol. Once 21M bitcoin have been issued, estimated to happen sometime in the year 2140, then no more bitcoin will be issued. This limit of 21M is called a “hard cap”, and is the most important thing to understand about bitcoin’s monetary policy. It’s fundamental to why people believe bitcoin has real value.
Juxtapose this 21M bitcoin hard cap to the US dollar. $3.38 trillion were issued just in the year 2020, largely in response to the COVID outbreak. This increased the supply of US dollars by about 20%. There is no hard cap to the US dollar. The Federal Reserve (FED) has total control over the national currency, and can issue as much currency as they see fit. When you create more of something it becomes less scarce and, assuming constant demand, less valuable. This is why you may have heard people say that the currencies are being devalued.
So how can bitcoin, a digital currency currently trading at ~$40k, demand this real world value? There is a fixed supply of bitcoin, so if demand increases then the price of bitcoin will increase. And there is always demand to own assets that hold value or, better yet, increase in value over time. Bitcoin hasn’t seen a great amount of adoption in terms of a currency – something that people use to pay for goods and services (although this could change with the mainstream rollout of Bitcoin’s lightning network). Instead, bitcoin has seen adoption from retail investors, and increasingly institutions, under the premise of “bitcoin as a store of value”.
Scarce resources have been the backbone of currencies for thousands of years. Gold is a good example. One of the reasons it’s valuable is because it’s naturally scarce and difficult to extract from the Earth. Gold is the original store of value asset; however, there’s still a problem with gold. The global supply of gold is estimated to increase by around 2% per year.
Michael Saylor, a prominent Bitcoin evangelist, talks about how bitcoin is the only solution for transferring your money over 100 years – everything else loses its value entirely due to asset inflation. Let’s follow his line of reasoning. He estimates fiat currency (like the USD) is currently inflating at 15% per year, which means you lose all the purchasing power of your money within years. Going back to the 2% gold inflation – you lose all your purchasing power in 36 years. He reasons through other assets like real-estate, but I’ll leave you the pleasure to hear it from him. Gotta love his delivery.
So now you can start to see why bitcoin is thought of as a store of value by an increasing number of investors. The Bitcoin community seems to be content with this limited use-case as evidenced by slow and conservative upgrades to the Bitcoin protocol. Interestingly, bitcoin has not seen much adoption as a currency to pay for everyday goods and services, but this could change soon with the rollout of Bitcoin’s lightning network in mainstream products like Cash App.
That’s Bitcoin in a nutshell. We talked about how Bitcoin is open-source software, a network of nodes, and a blockchain ledger that tracks the bitcoin cryptocurrency. Also, the 21M hard cap grants bitcoin the never-before-seen property of digital scarcity. An increasing number of investors consider bitcoin a store of value asset, similar to gold. The next section covers the second evolutionary phase of blockchains, which enables the growth of a Web3 ecosystem of dApps.
If you enjoy videos over reading when it comes to online learning then checkout the course on YouTube. This is part 2 of 5 in the Blockchain Design Course 2022. Also, make sure to stay tuned for future Web3 Design Courses where we will get into more interesting topics about emerging dApps.