Bitcoins overview

Bitcoin is a digital code. (Some) people use it as currency.

Started in 2009 by Satoshi Nakomoto. He could be a man or a woman or a group of
people- real identity unknown.

There are two ways to get Bitcoins:

#1: Mining
#2: Exchange
Aluminum is hidden inside bauxite
ore in earth.
Similarly, Bitcoins are hidden in
If you dont want to mine bitcoins, then simply find
data blocks designed by Satoshi
someone who has already mined bitcoins. then
and spread across the internet.
You can mine Bitcoins by solving
A. Offer him real money (rupee, dollar, euro)
those datablocks using special
and get bitcoins in return. Websites that
computer softwares.
facilitate such transactions are called
Reward for solving one data
Bitcoin exchanges. OR
block=25 bitcoins at the moment.
B. Sell him some goods/services, and earn
Total number of Bitcoins in the
Bitcoins in return.
system =~21 million. Additional
bitcoins cannot be created beyond
that.

Once youve have bitcoins (BTC), you can use them to buy goods/service (But very few
sellers accept bitcoins.)
OR you can just wait for the BTC vs.$ exchange rate to rise then sell your bitcoins to a
third party.

But what about anonymity and terrorist angle? what about money laundering? what about
inflation? isnt this a ponzi/MLM scheme? Well all those things in detail later on. I gave the
overview right now, because for next 5-6 articles, atleast ^this much knowledge of bitcoin topic
is required before we start comparing Bitcoin system with barter system and money system. Now
lets start first article.

Barter system

People have been trading with each other even before the advent of money, coin, cash,
currency, rupee, dollar, euro or Yuan.
They simply exchanged goods and services with each other through barter system- 1 kg
rice for a 200 gms tomatoes, 1 kg tomatoes for 50 gm almonds and so on

Barter system: advantages

1. Simplest form of exchange. Had all nations did foreign trade on barter system, there will
be no headache of foreign exchange rates and associated problems. Today if Dollar
strengthens by some action of US federal reserves (=American RBI), then it
automatically becomes expensive for India to import oil from Saudi=>everything else
transported through petrol/diesel becomes expensive= inflation.
2. Less chances of overproduction, hoarding, profiteering etc. =less chances of inflation.
Although itll be wrong to say there will be no inflation in barter system- because war,
famine and natural disasters can create mismatch in supply and demand even in a barter
system => lead to inflation.
3. Difficult to concentrate wealth= Less inequality of income, and all the social problems
associated with it.
4. Barter system ensures need based production. In money system, firms create products
to create demand e.g. so many softdrinks and plastic bottles+ the subsequent harm to
health and environment.
5. Barter system promotes personal contact among individuals, social harmony, and healthy
community life, joint families etc.
But Bartering system had many limitations, thats why people shifted to the money system. So,
What are the limitations of Barter System?

#1: Double coincidence of wants

farmer I want you to cut my hairs just Amir Khan in Dhoom3. Ill give you 5 kilos of rice
But I already have 200 kilos of rice from previous customers. I dont want rice anymore!
barber
Ill cut hairs only if you bring 1 kilo tomatoes as payment.
Another case
My son wants to get admission in your coaching class. I can give you 500 beer bottles as
fees.
Sir
I dont drink at all! Although I do want new table and benches for my classroom.
But I dont know any carpenter in this area, and even if I find one, there is no guarantee
Mallya
hell accept beer bottles as payment for making furniture!
Mallya

Thus, under barter system, the wants of two parties must coincide with each other,
otherwise they cannot trade with each other. This increases the transaction cost as
everyone will have to waste time and energy to find another party with double
coincidence of wants.
Money system solves this problem. Farmer can sell his rice for money, use that money to
get a haircut, and barber can use the same payment to buy tomatoes from another farmer.
Money thus facilitates the exchange of goods and services, lessens the time and effort
required to carry on trade.

What about Bitcoins?

Bitcoin also serves the same purpose but with some caveats
Fiat money

Bitcoins
Bitcoins are not issued by any
Fiat money= money issued by the government
government. Bitcoins are unique
(or its central bank) example Rupee, dollar,
pieces of digital codes that (some)
Yen, Yuan.
people accept as digital currency.

It is legally recognized money for settling all

payments and debts within the territory.
If you walk with a 5 rupee coin to a teavendor, he must serve tea, irrespective of your
race, religion, color, caste, age or gender.
If he refuses to serve tea, hell be in legal
trouble.

Even better, you can get your rupees

exchanged in a foreign currency and import
any commodity from any part of the world to
India. So a fiat money (rupee) removes the
double coincidence of wants for the trade
within country and abroad.

An IT professional in Banglore
may accept bitcoin payment for
creating software for some
American businessman.
But if the same techie offers to pay
house rent in bitcoins, the landlord
is legally free to refuse this
payment and can even order him to
vacate the property.
Bitcoin removes the double
coincidence of wants ONLY for
the people who believe in bitcoin
system, and not for everybody
everywhere.

Lets make comparison table:

FEATURES

BARTER

trade can happen without double coincidence of

No
wants?

FIAT
MONEY

BITCOIN

Yes

Yes, if two parties

agree.

#2: Division of Labour

In the barter system, buying/selling/trade can only happen, when two parties want each
others stuff- the double coincidence of wants e.g. farmer wants haircut and barber wants
rice from that farmer.
But that doesnt always happen, so each household tries to produce all of its daily
requirements- from growing green tea, tomatoes, chilies in their backyard; raising cows
and poultry for milk and eggs; even making pickles, paper and papad for entire year.

So is this good or bad?

Good from Gandhian principle of self-reliance.

Food inflation is kept in check- because everyone is growing vegetables in their
backyard.

But overall bad because:

Everyone is wasting their time and energy to become jack of all trades, instead of
becoming master of a single trade -medicine, engineering, construction, accounting,
teaching, singing, painting etc.
Thus, a bartering economy is less likely to produce specialists like Alexander Graham
Bell (telephone)=> Vin Serf (Internet)=> Sergey Brin (Google) because everybody busy
growing vegetables in their backyard and trying to become self-reliant-jack-of-all-trades.
And even if there are talented specialists, they wont have the necessary capital or
resources to continue their research. Imagine how many parties with Double coincidence
of wants youll need, for assembling the parts of a Large Hadron Collider or a Param
Supercomputer.
Money system also facilitates savings to become investment for the entrepreneurs =>
more companies, more job, division of labor, optimal usage of manpower, good for
economic growth, R&D and international trade.
And with the money thus earned, anyone can buy his daily necessities, doesnt need to
grow vegetables or rear cows in the backyard.

What about Bitcoins?

Just like traditional money, Bitcoin also promotes division of labour, but it is limited by the
factor that not everyone accepts Bitcoins- especially the local milk-veggie sellers. So if a
software professional decides to live only on bitcoin, hell have to start growing vegetables and
wheat in the backyard of his house, arrange a goat/cow for milk, and so on, we are back to
square one- everyone trying to become jack of all trades like in Barter system.
However, in future, Bitcoin may promote Division of labour to a whole new level (when and if
Bitcoin is accepted by a large population):

Imagine a laptop manufacturing company- owned and operated by an AI (or robot) that
accepts bitcoin payment, robots make and pack the laptops into parcel, and drones deliver
them at your door step.
AI uses these bitcoins for paying the cost of raw material, warehouse rent, electricity bill
etc. to humans (or other AIs).
And whatever bitcoins left (=profit), are reinvested in buying more drones, bigger
servers and so on.

This is not possible in the present money system because legally- an AI or Robot doesnt meet
the KYC norms for opening a bank account = impossible for them to pay electricity bills
through netbanking or creditcard!

Anyways, lets update the table:

fiat money
(Rs./$)

Bitcoin

trade can happen without double coincidence

No
of wants

yes

Only if both parties agree.

Promotes division of Labour?

Yes

Yes, lot possibilities in

future.

Features

barter

No

#3: Divisibility of Value

Under the barter system

JK Rowling Give me a cup of tea, Ill give you two pages from the latest Harry Potter book.
chai-walla I dont want just two pages, I want the whole book for my son!

Even if chai-walla continues serving tea to Ms. Rowling for 300-400 days, gets all the
pages of Harry Potter book and staples them together => still that stapled book will not
sell at the original value of a brand new Harry potter book (which is say worth 30 kilos of
rice).

Meaning:

You cannot always divide the value

You cannot always re-unite the divided values.

Other scenarios:
1. Jeweler wants a matchstick box. But its not possible to divide gold to such a micromicro-micro quantity where gold becomes proportional to the value of a matchbox.
2. Mallya wants to buy a pencil box for his son, offers 1 table-spoon of liquor for 1 pencil
box but stationary-walla will not accept because such low quantity of alcohol cannot give
the kick.
3. To pay for a cup of tea, Picasso cannot cutout 1 mm2 of canvass from his original
painting.
Fiat Money system (and Bitcoins) dont suffer from this problem of divisibility, and hence
facilitate the trade.
currency
smallest unit
Rupee (Rs.) 1 paisa=0.01 Rupee (that is 10-2)
Bitcoin (BTC) 1 Satoshi= 0.00000001 Bitcoin. (that is 10-8)

You can see it is possible to divide 1 BTC into so many small parts, so even if new
bitcoins are not created, it can continue as mode of payment by lowering the
corresponding values of commodities.
e.g. if today MRP of 1 laptop =1 bitcoin then in 2050, MRP of 1 laptop may adjust itself
to 0.00165 Bitcoins, if there is shortage of bitcoins.
And still you can pay 0.00165 BTC to someone by simply typing that specific amount in
your keyboard. Same thing is not possible with rupee or dollars because of the chillar
shortage in real life.

#4: Fungibility
Even if items are divisible, their fungibility is a problem under barter system.
Fungible items = those items whose individual units have same uniform value and mutually
exchangeable, inter-changeable. For example:
1. The value of first five pages of harry potter book= Not same as the value of last five
pages of the same book. Because in the last pages you get the climax so theyre more
precious= not fungible.
2. Value of one diamond of 100 carat = not equal to ten smaller diamonds of 10 carat each.
In this case, bigger the size, more precious. Even those 10 carat diamonds are not
mutually interchangeable because their individual value may vary depending on cut,color
and clarity.= not fungible.

3. If Picassos painting was cut into nine equal square parts, then Central Square will be
more precious than others. So you cannot interchange them. And if you glue these torn
parts together= its total value will be far less than the original painting=not fungible.
4. Exception: Precious metal. Value of 1 kilo gold bar= Value of 100 gold coins of 10
grams each. You can melt to reunite them, you can melt again to divide them. And those
100 gold coins will be interchangeable because their individual value will be same.=
fungible.
But by and large, goods are not fungible and this creates obstacle in barter trade, when two
commodities are not available in their standard weight/size. For example, Suppose the ongoing
barter rate is 5 kilo salt = one live hen weighing 500gms.

A poultry farm owner wants to buy 2.5 kilo salt. He gives the whole live hen to
shopkeeper.
Common sense suggest that shopkeeper should give 2.5 kilo salt and cut half of the hen
and return it.
But which half? In non-veg cooking, the legs of chicken are considered more valuable
than its head and neck upper part. = dispute between customer and shopkeeper.
Overall, the customers in a barter-trade will end up buying more than what they really
need. (e.g. 5 kilo salt even if he needs only 2.5 kilo.)= considerable wastage and suboptimal use of resources.

Money system solves this via fungibility.

Rs.1000 note= can be exchanged for 20 notes of Rs.50 each. And each of those 50 rupee
notes have equal purchasing power. A 50 rupee note in your pocket will buy as many
ballpens, as the 50 rupee note in my pocket. (as long as ballpens are of same brandmodel.)
Similarly ten notes of Rs.100 can be exchange for a single note of Rs.1000 and so on.
But there is an exception: Someone might offer 1000 rupees for a single 10 rupee note
that has unique serial number like ABCD-123456789. but ignoring such exception,
currency notes are fungible.
So, if you give Rs.100 note to shopkeeper to purchase a ten rupee worth ballpen=> hell
give you 10 rupee pen + one note of 50 Rs. + four notes of 10Rs.

Still Money system too has limitations:

You cannot pay Rs.149.75 through notes and coins because 25 paisa is out of circulation.
(Although possible if you pay via credit card, debit card or internet banking)
Persistent shortage of chillar coins. And if you cut a ten rupee note into ten parts using a
scissors, itll not become ten 1Rs. notes.
Persistent looting by Shopping malls. Items priced @Rs.99, 499 or 999 often, cashier
wont give you one rupee coin back but instead gives a chocolate. (He is making
additional profit because for him cost price of 1 chocolate is less than 1 rupee.)

Bitcoin and Fungibility

Bitcoins (BTC) are fungible because

1. Individual units are identical. 1 BTC in Rajas Digital wallet will buy same amount of
goods & services as 1 BTC from Kalmadis digital wallet. (Even if their unique digital
codes are different.)
2. Mutual substitution possible. it doesnt increase or decrease the value. e.g. 100
centibitcoins (cBTC)= 1 bitcoin (BTC).
As such chillar/change problem doesnt arise in Bitcoin because you can pay exact amount to the
seller. E.g. if a pen valued at 0.4 BTC. you can type 0.4 in keyboard and eletronically transfer
that amount to seller. Its not like you have to give him 1 Bitcoin(BTC) and he gives 1 pen + 0.6
BTC in return. This is a digital transaction after all.
But there is trouble brewing:

You may have read in newspapers that Bitcoin transactions are anonymous and hence can
be used by terrorists, druglords and tax evaders.
Therefore, some experts have came up with the idea of coin validation. Well see about
that in a separate article later, but for the moment the gist is:- Through coin validation
software, you can separate GOOD BITCOINS (those earned through honest work) vs
BAD BITCOINS (those earned through hacking & other illegal activities) via analyzing
their transaction history and origin.

This coin validation will destroy the fungibility of bitcoins. How?

Because then most users will refuse to accept bad bitcoins.

Some American users might even refuse to accept bitcoins originating from people of
Cuba, Pakistan, Afghanistan, North Korea or Iran-for the fear that later US authorities
may persecute/harass them while hunting for Bad Bitcoins/Al-Qaeda/Terrorists.

Anyways lets update the table:

features
trade can happen without double
coincidence of wants

barter

Fiat money (Rs./$)

Bitcoin

No

Yes

Yes, if both parties agree.

Promotes division of Labour

Hardly

yes

Divisible?
Fungible?

Not
always
Not
always

Yes, but limited @the

moment.
Yes but limitation e.g. Yes and less limitations
Rs.14.199
than fiat money
Yes

Yes, for now.

In the next article, well see more on Barter vs Money vs Bitcoin, with reference to storing
wealth, account keeping, deferred payment, circular flow of income etc. parameters. click me