What is Bitcoin?

last updated 9 October 2024

If I only had a Bitcoin for every time I’d heard someone say: “I don’t understand it”. Even after I explain Bitcoin – and I’m pretty good at explaining stuff – many still shake their head and say “I still don’t get it”.

Often I think this is wilful ignorance. Bitcoin does take some effort to get to grips with. The concept of a money system that is not state-issued is hard for many to wrap their heads around, and the tech can be a little baffling to non-techies, so the easy route for many is to say, “I don’t understand it” and walk away.

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I will also say this: do you know how money – and I am talking about national currencies such as the pound, dollar or euro – really works? Do you know how it is created? Do you understand the difference between M1, M2 and M3 money supply? Do you understand interest rates? Most of us don’t (and even those who do, still don’t appear to understand how all of these things interact with each other). And yet we all use it.

The internet is, essentially, a borderless medium. I’m in the UK. I can communicate with someone in the US, Australia, South America, Asia or Africa as instantly as though they were in my own country. I can send them messages, photos, videos, or any kind of content, and they receive it instantly. Yet, until Bitcoin, I couldn’t send them money with the same ease. I would have to go through Paypal, or a bank or a credit card company. There would be foreign exchange costs, money transfer costs, and regulatory processes.

(For example, only recently, I saw that somebody had transferred 14,892 Bitcoins. That’s over half a billion dollars in value. I know that that value was transacted – the transaction was broadcast on the blockchain. But I have no idea who sent the money, or to which location it was sent. I rather suspect it was Elon Musk – but who knows? I also know that the cost of the transfer was a few dollars and that the transfer was almost instantaneous).

Bitcoin’s creator, the (still) anonymous Satoshi Nakamoto, wanted to create a system of money that was apolitical and resistant to state actors. In other words, a politician or central banker couldn’t start printing this currency, even if they deemed the circumstances demanded it. Bitcoin’s inflation rate is set out in its code with full transparency.

Moreover, Nakamoto wanted to design a deflationary system of money. Central bankers and governments can create pounds or dollars when it suits them. Thus fiat money is an inherently inflationary system of money – the supply of money never stops growing. Nakamoto wanted to code a system of money that is finite. There will only ever be 21 million Bitcoins. By making it finite, by limiting supply, you make it desirable. Like gold, its rarity makes it precious.

There are umpteen Bitcoin exchanges around the world where Bitcoin is traded for fiat money and other cryptocurrencies. Billions of dollars in value are traded every minute, rather like the foreign exchange markets, and the amalgamation of all these trades is the Bitcoin price. The market sets the price. If there are no buyers, the price will fall until buyers appear. If there are no sellers, the price will rise until sellers appear.

At this point, it is worth defining what money is, because this is another area where confusion arises. Money has several functions. First and probably foremost, money is a medium of exchange.

I give you money in exchange for your good or service. All sorts of things have been used as a medium of exchange over the years – shells, whales’ teeth, metal, paper, cigarettes, brandy. Today fiat money (money printed and controlled by governments, such as the pound, euro or dollar) is the most prevalently-used medium of exchange, but air miles, supermarket rewards points and gift cards are all other accepted media of exchange.

It’s unlikely I am ever going to go into my local corner shop and buy a pint of milk in Bitcoin. Fiat money is much more convenient. But Bitcoin still finds widespread use as a medium of exchange on the internet, as long as the buyer and the seller are both content to use it. It’s a preferable medium of exchange to fiat for cross-border payments, but for small, local payments in the physical world, fiat still prevails.

Money’s use as a standard of deferred payment, to use economists’ jargon, is closely tied to money’s role as a medium of exchange. You and I can agree on a price now –for a good or service – and the debt will be settled later.

Money is also a store of value. I pay you for a job you do today. You keep the money to be spent at some later date. Fiat has proved a rotten store of value. It has lost something like 99% of its purchasing power over the last hundred years. Look, for example, at how much less house fiat money buys you than it did 30 years ago. There may not be huge inflation in the price of phone calls, Primark clothes or bread, because these items are not in short supply. But there is huge inflation in the cost of housing, art, stocks and bonds, and school fees, for example.

Gold, because it is permanent and immutable, has proved a much better store of wealth over the very long run than fiat money. An ounce of gold buys you as much food, clothing or energy as it did a hundred or a thousand years ago. (Gold, however, is not a great medium of exchange).

Bitcoin, albeit volatile, has proved a wonderful store of value. Over the past three months, one year, five or ten years it has beaten every other asset class hands down. Its purchasing power has increased every year. Indeed, Nakamoto designed Bitcoin to be a form of digital gold – a digital store of value.

Finally, money is a measure of value – or, to use the parlance, a unit of account. You use money to measure the value of a good or a service. We still tend to think in terms of fiat money when measuring value. But it is a flawed measure because the value of £100 today is a lot less than it was 20 years ago. That’s why the use of “inflation-adjusted” pounds or dollars has become so commonplace.

Gold and, to an extent silver, are better historical measures. Their value is more consistent over time. We can look at the cost of wages or goods in Ancient Rome, for example, in gold and silver and compare them today. Until the 20th century, gold and silver were the standard. But ordinary people, brought up on fiat money, no longer think in terms of gold and silver, but their national currencies.

Dominic Frisby (“mercurially witty” – the Spectator) is as far as we know the world’s only financial writer and comedian. He is the author of the popular newsletter the Flying Frisby and is MoneyWeek’s main commentator on gold, commodities, currencies and cryptocurrencies. He has also taken several of his shows to the Edinburgh Festival Fringe.

His books are Daylight Robbery - How Tax Changed our Past and Will Shape our Future; Bitcoin: the Future of Money? and Life After the State - Why We Don't Need Government.

Dominic was educated at St Paul's School, Manchester University and the Webber-Douglas Academy Of Dramatic Art. You can follow him on X @dominicfrisby