We have all heard the word over the past few years. Some have spoken about how amazing it is and what a lucrative investment opportunity it has proven to be. There are also those who preach the existence of a Bitcoin bubble and warn against investing further in such a volatile instrument. Companies in the United States have now started trading Bitcoin futures with the added result of Bitcoin rising even further in value. Of course, there are those of us who read all of this and ask one question.
I get you, my friend, I totally do. Terms like these mean nothing to a lot of people and it’s time for some educating up in here. So fasten your seat belts as I take you on a journey and explain to you what the humdrum is all about.
Crypto-currencies and Bitcoin
This is the real question. To understand what Bitcoin does, one needs to first gain an understanding of the term ‘crypto-currency’ and why it even exists. The answer to both these questions is simple.
Crypto-currencies are exactly what they suggest – an encrypted form of currency. Currencies like these are not centralized or run by any bank or government agency. Their value and volatility is determined purely by the people who use said currency. It is not hard to see why many would find something like that alluring. Having lived through the 2008 financial collapse, all of us know what could happen if banks and investors are allowed to run rampant. The government isn’t too far behind, either.
Thus, a currency like this sounds like a good alternative and why shouldn’t it? The power lies with the people here, as any communist worth his salt would applaud; as he should. A currency is like this incredibly secure on its own and is vulnerable to hacking only when third parties are involved but more on that later. Right now let’s talk about how safe crypto-currencies are. Rather, let’s give you an introduction on HOW they’re made safe.
Blockchain and Mining
If you haven’t been lying in a drunken stupor for the past few months, then you have heard this little word accompany Bitcoin as well. But what the hell does a Blockchain mean? And what does it have to do with mining? Wait, what in the living hell is mining?
Calm down, let’s take a step back.
Any transaction that happens involving Bitcoins, is nothing but a change in numbers. A lot like the money you transfer using your online banking tool. If I give Person A (let’s call her Amrita) a million bitcoins, for example, then her Bitcoin balance is updated by a million while mine is reduced by the same amount. So much for poverty, right? But you see what happened here? I haven’t physically given her anything, all I have done is change the numbers in my holdings and hers and there you go, a Bitcoin transaction has taken place.
Mining is basically the validation of a BitCoin transaction.
The process seems simplistic, although let me tell you that it is leagues from anything remotely close to simple. So how does it work?
First of all, anyone can be a Bitcoin miner. (Note that I am now using Bitcoin as my example because it will just make it easy for me and isn’t that what life is about?) To be a miner you need a lot of computing power and a significant amount of time on your hands, not to mention money as well. In fact, many programmers and developers perform mining as something of a side business. Once you’ve got that ready, wait for a transaction to take place. In fact, we can go back to Amrita and me.
Now that I’ve paid her a million of my Bitcoins, my transaction is added to a pool of unverified transactions that the miners will have access to. Once a miner sees my transaction, all they have to do is solve it. When I say solve it, I mean solve a major cryptographic puzzle that will verify the transaction. Don’t ask me how it’s done, I have no clue. It just happens. Once that puzzle is solved, the transaction is verified and a new copy of the main Bitcoin ledger is created.
What is the main ledger, you ask? Well, people don’t have separate ledgers by themselves as many of us would probably like. There is ONE MAIN ledger that is maintained and updated. So, when a transaction is verified by miners, a NEW COPY of the main ledger is created that has the new transaction added to it. The new transaction is known as a block and hence, it stands to reason that entire chain of different blocks verified over time is known as a BLOCKCHAIN.
Here is a cute little info-graphic to explain to you how stuff goes down in the Crypto-currency world.
Why Mine and spend so much money, though? Well, because one of the major rewards from mining is the awarding of freshly minted Bitcoins. That’s right. Every time these people mine, new Bitcoins are created and that alone is incentive enough. Initially, when it was created, since no transactions actually existed, miners would just solve the same complex puzzles on the Bitcoin network to create more coins. It forms a symbiotic relationship, hence. Miners are required to verify transactions and that increases Bitcoin security. Also, generation of more Bitcoins requires miners as well. Round and round the world goes, in such fashion.
Let’s also not forget about the private key that each and every Bitcoin user or holder possesses. A private key is a number that is around 1 to 78 digits in length. It’s extremely important to have a private key if you are thinking of using Bitcoins. Existence of such a key also helps in security, as it is so randomized that it cannot be hacked into. Another reason for it being hack proof is that they can be stored online as well as physically. So if you are paranoid, all you need to do is write down the number on a piece of paper somewhere and use it only during an online transaction, thereby ensuring the lack of online record for any of it.
I guess you do have a rudimentary-at-best understanding of what Crypto-currencies are, what Bitcoin is and how it is made so incredibly secure. We will talk about the drawbacks a little later, but for now this should be enough.
History of Bitcoin
We have finally reached the interesting part. Now that all of you know how Bitcoin works, let’s get into why and how it even exists. If you need the full and detailed timeline then you can read about the history of Bitcoin.
However, if you want me to make it interesting for you, then I can. Let’s go back, all the way to October, 2008. An anonymous man named Satoshi Nakamoto publishes a paper or a manifest, as many people call it. It is titled, Bitcoin: A Peer to Peer Electronic Cash System.
In the paper, Nakamoto clearly mentions that “with the possibility of reversal, the need for trust spreads”. He goes ahead to state that “transactions that are computationally impractical to reverse would protect sellers from fraud,” and therein lies the basis for Bitcoin and the blockchain. Amazing, isn’t it? But, who is he? The answer to that is amazingly mysterious. Nobody knows. Nobody knows who Satoshi Nakamoto is. There have been many investigations into it but no one really knows for sure. One of the most prominent theories is that the name is a pseudonym for a group of people.
Three individuals, namely Neal Kin, Vladimir Oksman and Charles Bry, filed an application for an encryption patent on August 15, 2008.
They obviously deny having any involvement in Bitcoin and everything to do with it but who really knows. A few days later, on the 18th, Bitcoin.org is registered on a website that allows you to register anonymous domain names and voila, history has been made.
What happened next, you may ask. Well let’s shorten it all down to the most important events. On January 3, 2009, the first ‘block’ was created. I am sure you are jumping with excitement as you now understand what the word really means. It was known as the Genesis block, which seems like the appropriate term. Of course, the first actual transaction between two human beings took place on January 12, between Hal Finney and Nakamoto himself. In October 2009, an exchange for Bitcoin was established i.e. the rate at which you could exchange one Bitcoin for currency of different countries. The rate was $1 = 1309.3 BTC. Today the rate sits at $16,000(approx.) for 1 BTC. You do the math.
The road from there has been rocky, to say the least.
In 2010, Bitcoin Market, a currency exchange was established.
That was also the year when someone, for the first time, bought pizza using 10000 Bitcoins. Another exchange, arguably one of the most famous ones, Mt. Gox was established the same year. However, in August an exploit in the system led to the generation of 184 billion Bitcoins. The value of Bitcoin kept increasing from then on and its market cap was 1 million USD by November. A few months later, in February 2011, it reached parity with the US dollar i.e. 1 Bitcoin was now worth 1 dollar. By June, it was 10 dollars and in the same month, it reached 31.91 USD. It also plummeted back to 10 within the same month, marking the first ever bubble of 2011.
At the time I write this article, Bitcoin stands at 15,868. You know what that means don’t you? If you’d spent 1 dollar all the way back in 2009, you would have around 21 million USD right now. Think about that and weep, my friend.
The Bitcoin Bubble and Other Drawbacks
One of the greatest shortcomings of this particular asset is that it is limited. In theory, governments and central banks can print as many notes as they like. Of course they have pay attention to a myriad of factors but the underlying principle is clear here. The concept of a fiat currency rests on the fact that there isn’t any limit. Central banks can increase or decrease currency in the economy at will and they use this power to manage economies. Bitcoin, on the other hand, has a limit. Nakamoto specified in his paper the limits placed on this particular crypto-currency. In terms of numbers, there are to be 21 million Bitcoins produced till the year 2040 and none thereafter.
This presents a problem. The Bitcoin bubble is evident today. The prices of one Bitcoin are skyrocketing and there don’t seem to be any limits. Imagine situations in which all Bitcoins have been mined successfully and there are no more to come. While the concept of a cryptographic currency is novel, its limited quantity is the very essence of a bubble. Prices will continue to soar until one day the dominoes fall and the currency’s value deteriorates radioactively.
Another problem arising from limited quantity is volatility.
The points I made above are not exactly novel and many investors consider things like these before buying or selling Bitcoin. As a result, investors are extremely wary, giving the asset a somewhat unique form of variability. Within a span of two weeks, the value of Bitcoin has jumped up and down, despite showing an overall increase. Many central bankers, economists and fund managers have advised against speculative investments in Bitcoin while there are those who continue to bank on steeper returns on their investments.
Also, anything online is vulnerable to hacking. Bitcoin is practically impossible to hack into. There is no way to gain access to the block chain without a private key and you can never obtain something physical through a hack, provided the end user is smart enough to keep a copy of their private key physically and not online. However, many users store their Bitcoins in online wallets and as we know, no wallet can ever be truly safe. There are innumerable examples of Bitcoin being stolen, like the attack on Mt. Gox that resulted in 60000 user accounts being compromised. Linode, another such company, was hacked resulting in a loss of 46000 BTC. This is, to date, one off the largest thefts of BTC.
The anonymity of said currency is accompanied by many advantages, especially to those disillusioned by banks and government.
However, it also brings along entities with agendas that are probably more on the nefarious side. Websites like Silk Road used Bitcoin as a way to pay for many illicit activities, goods and services that were available on their site. Think of it as an Amazon for crime, where you could get drugs, prostitutes and all the works with total anonymity thanks to Bitcoin. It’s one of the primary reasons the law went after companies that dealt with such currencies in August 2013. Senate hearings were conducted on how risky such currencies were and the threats Bitcoin posed to the financial market and society in general.
Since then, Bitcoin has been through many a price bump although nowhere as close to the unprecedented leap it currently enjoys. If you’ve been a long time investor in Bitcoin, you’re resting happy by selling off all that you had. If you’re a new investor, some people are screaming themselves hoarse and crying bloody murder at the very thought of putting your hard earned money on something so volatile. There are others who don’t, of course, but isn’t that the case with everything.
I have little or no knowledge of investment so I can’t tell you what’s going to happen. But things like Bitcoins are a sign of revolution and the revolution is coming, my friends. While the drawbacks are there for all to see, it cannot be denied that a currency that isn’t centralised or controlled by banks and governments is something to think about. Here, I believe is where our little knowledge session ends and I bid you farewell, having you given much food for thought.