Dynamic Layers of the Bitcoin Ecosystem
This article aims to introduce you to the Bitcoin ecosystem, primarily focusing on the general architectural features and dissecting their functional capabilities.
Welcome back to NeuroInvest Research!
In recent years, the world has witnessed a surge in interest for blockchain technology, primarily due to its potential to redefine the way we store, exchange, and transact value. The uniqueness of decentralization offers optionality and change from the traditional fiat system. Bitcoin being at the core of this discussion, has the inherent capabilities to let this free banking system run fluidly.
While some remain captivated by the status quo, believing that central banks can effectively manage the money supply through monetary policy tools (utilizing the fractional reserve banking model (FRB), a growing number of people are recognizing the systemic flaws inherent in the current financial infrastructure.
"The establishment of free banking was never seriously considered precisely because it would have been too efficient in restricting credit expansion." – Ludwig von Mises
As the esteemed economist Ludwig von Mises observed, free banking was never seriously considered because it would have been too efficient in restricting credit expansion. Bitcoin presents a solution to this problem. Bitcoin’s design is devoid of capitalistic monotheism. It expands on this concept of globalism, by providing the world with a unified monetary language. It represents billions of dollars in subsidies which are geared toward the energy sector, offering vast improvements to the economics of renewables and mitigation of products (i.e gas flaring). The fundamental design of this economic machine holds the potential to improve so many sectors of the world’s problems, yet still in modern democracies, sovereigns fear the the application of a decentralization. The free banking model threatens the entire core of centralization and capital control.
In this publication, my objective is to raise awareness and dispel biases surrounding Bitcoin by offering an in-depth understanding of its fundamental design and exploring its dynamic use cases.
Let’s get started shall we!
Abstract
Getting to know the Ecosystem
On-chain vs Off-Chain
Summary
Core Developments to the Evolution of Bitcoin
Fundamental Limitations
The layers of the ecosystem
An analogy that has helped me build a mental schematic of the Bitcoin ecosystem is through its resemblance of a roadway network. The Blockchain is like the main highway, where all the traffic flows directly on the road. This aspect of the public ledger is where all records are transparently recorded and exchanged amongst network participants. It allows the network to exchange P2P, without a 3rd party intermediary.
On the other hand, the off-chain aspect of Bitcoin can be thought of as the peripheries of the our roadway system. The roads represent the various second-layer solutions, such as the Lightning Network, that are built on top of the blockchain. For example, advancements like the lightning network, improve network scalability, or the the speed of transactions, as they are not subject to the same constraints as the main highway.
Just as service roads and exits can help to alleviate congestion on the main highway, second-layer solutions can help to improve the scalability and speed of the Bitcoin network.
On-chain
The on-chain layer, or the core of Bitcoin’s ecosystem is where all the transactions are recorded. This is the decentralized ledger that stores all the information about every Bitcoin transaction that has ever taken place. Every node in the Bitcoin network has a copy of the blockchain, which allows all participants to verify and validate the integrity of the network.
The on-chain layer is the core - it allows the system to maintain its functionality, purpose and dynamism. It’s a very productive feedback mechanism. Miners are responsible for the growth of the system’s security, and are incentivized to continually contribute their work through subsidies. On the other hand, nodes make it difficult for bad actors to manipulate the network, giving life to the decentralized nature of this system.
Examples of the On-chain Layer:
The Bitcoin mining network: Miners validate and process transactions, adding them to new blocks, creating new bitcoins as a reward.
Wallet software: Wallet software allows users to create and manage their transactions. Some wallets include features such as fee estimation, which can influence the fee paid for a transaction and the speed at which it is confirmed.
Mempool: The mempool is a pool of unconfirmed transactions. It’s like a waiting room for blocks. The size of the mempool can influence the confirmation time of a transaction, as well as the fee needed to get the transaction confirmed quickly. Nodes are responsible for the verification of these blocks, which will inevitable be added to the subsequent chain of blocks. You can read more about this in my post.
How is the mempool reacting to #BTC exchange outflows ? Let's dive in! 🔸Brief mempool mechanics 🔸How this occurred? 🔸Effects on #BTC ? 🧵Thread 1/x.
Decentralized finance (DeFi) refers to financial applications and services that are built on blockchain technology and operate in a decentralized manner, without the need for intermediaries. DeFi transactions can take place on-chain or off-chain, depending on the specific application or protocol.
Off-chain
In contrast, off-chain transactions are the peripheries of the system. They stem from the core layer, finding ways to perpetuate- or expand- the current limitations of the fundamental layer.
They can be useful and progressive (lightning network), or damaging and regressive (centralized exchanges). Of course it’s never black or white, but you get the point. Nevertheless, these additional layers are somewhat disconnected from the blockchain, exposing some difficulties when trying to trace these signals.
Examples of off-chain transactions
Lightning network: This dynamic secondary layer is a payment protocol built on top of bitcoin's blockchain. This application works by creating a network of payment channels between users and allows them to transact directly with one-another, rather than having to go through each transaction directly. This improves network scalability and functionality.
Centralized exchanges: Not inherently toxic, and shouldn’t be; however, overtime we have seen the damage they can impose - such as the collapse of FTX. Understandably, people become skeptical of these systems, and will often misinterpret the ownership of their assets when exposed to these exchanges. This is why you’ll hear bitcoiners’ avidly advocating private ownership. As mentioned - this is not black or white.
Paper bitcoin refers to the concept of owning bitcoin without actually having possession of the underlying digital coin. This can be accomplished through various means such as a Bitcoin futures contract or Bitcoin exchange-traded fund (ETF).
The Grayscale Bitcoin Trust (GBTC) is a publicly traded investment fund that holds bitcoin on behalf of its shareholders. GBTC allows investors to gain exposure to the price movements of bitcoin without having to directly buy and hold the digital currency. Shareholders in GBTC effectively own a stake in the fund's underlying bitcoin holdings, which are valued and traded on the stock market. GBTC is considered as a paper bitcoin, as the shares of the fund represents ownership of Bitcoin without physically holding the Bitcoin.
It should be noted that GBTC is not an ETF, it is a traditional open-ended trust and it trades at a premium or discount to its net asset value (NAV) based on demand. GBTC is also not regulated by the SEC, so it's not the same as an ETF.
My two cents
Bitcoin has been able to remain such a dynamic force because of how well it solves the current problems we face in our monetary world. It effectively separates itself from the traditional monetary standard. To be realistic, I don’t see Bitcoin hijacking the fiat standard, it can offer refuge and options for those in countries with unstable currencies or those who are unbanked and vulnerable to fraudulent banking practices. Our individual experiences should not deter us from recognizing the potential of a system like Bitcoin.
Ironically, fractional reserve banking claims to provide stability, safety, and responsibility, yet few actually are aware of how over-leveraged banks can be. Although a free-banking standard may not entirely disconnect from the current model, Bitcoin could potentially gain traction as economic participants search for alternatives during times of adversity.
I see Bitcoin (independent from cryptocurrency) as a solution - a powerhouse asset class that provides real value. However, there is still limitations that hinder the adoption curve. I believe without addressing these problems, we leave a great solution unequipped to operate without addressing the problems early on.
There’s Limitations to Altruistic Assets?
Many economists and financial experts argue that Bitcoin’s inherent deflationary supply has negative consequences for an economy. When people expect the value of a currency to increase over time, they may be more likely to hold onto it as an investment, rather than spending it on goods and services. In addition, in a deflationary environment, the real value of debt increases over time. This can make it more difficult for borrowers to repay their debts, leading to higher default rates and potential financial instability. However, it should be noted that as adoption increases, volatility decreases, ultimately improving the utility as as a medium of exchange.
Lastly, concerns over energy consumption is a subject of debate and controversy, yet wildly misunderstood. Miners use excess or surplus energy from power plants that would otherwise be wasted. This helps build energy stability and efficiency of energy use. Miners also use renewable energy sources like hydroelectric, solar, and wind power to power their mining operations. This reduces the carbon footprint of Bitcoin mining and contributes to a more sustainable energy ecosystem.
I hope these topics shed some light on the fundamental conversations commonly talked about amongst skeptics, or advocates. From this article, we can gear our attention toward more in-depth discussions following Bitcoin.
Hope you enjoyed !
Twitter: Neuro__Invest
NeuroInvest Signing off…