(BTC): A Brief History of Bitcoin

Executive Summary

Bitcoin is a pseudonymous, decentralized, cryptographic currency that was developed by Satoshi Nakamoto (a pseudonym) in October 2008. The first Bitcoin block was mined the following year in January, 2009.[1] Since advent, Bitcoin has been both hailed and shunned by the media because of its groundbreaking, yet at times nefarious uses. Presently, 16 million Bitcoins are in global circulation, and many fiat currencies, like CAD, EUR, JPY and USD, accept exchange for Bitcoin.[2] Though Bitcoin has repeatedly been cast in a negative light because of its association with the dark web, the cryptocurrency continues to generate mass acceptance from the general population. Individuals and companies use it for its innate advantages. On forums, Bitcoin has been hailed by the cryptographic community as a real example of electronic cash, and has even been called, ‘… [At its] fundamental level a breakthrough in computer science.’[3] Bitcoin is rapidly increasing in popularity and usage, but does it have the potential to become an accepted currency, or is it just another technological fad?

This paper will:

· Explore Bitcoin’s tumultuous history.

· Examine Bitcoin’s strengths and weaknesses.

· Interject Bitcoin suggestions and potential improvements.

These topics are covered in a logical order that analyze the value, quantity, supply, security, anonymity, application and future of Bitcoin. This is primarily a factual report, however I do compare Bitcoin to current currencies and recommend ways to make it more competitive to fiat currency. Bitcoin is a new invention and after examining the above points, readers will understand the pros, cons, and overall excitement surrounding this new currency.

Introduction

The first Bitcoin was mined and sent from Satoshi Nakamoto to Hal Finney in January 2009. Satoshi, is credited with theorizing the Bitcoin project, and Finney was a senior engineering developer on the project team. In October of that same year, New Liberty Standard (NLS) was the first exchange service to accept Bitcoin. The exchange rate set by NLS was 1,309.03 BTC = $1 USD. This was the first Bitcoin to USD value, and since those early days, Bitcoin has and continues to vacillate in value. In December of 2013, Bitcoin was more valuable than an ounce of gold. According to Mt. Gox, one of the largest Bitcoin exchange services in the world, 1 BTC = $1,242 USD.[4] One ounce of gold was valued at $1,240 USD. This was the highest value ever recorded for a single Bitcoin and thought the exchange service, Mt. Gox, would be involved in a financial scandal the following year. The Bitcoin value attracted mass media attention because at that moment, an intangible asset was more valuable than a precious metal.

From its high publicity peak of $1,242 USD 2 years ago, Bitcoin’s value has increased and decreased until it reached a record low of $178 USD in January of 2015. At the time of this writing, a Bitcoin is worth $3,000 USD according to Coinbase.com, an online wallet and Bitcoin exchange service. Now, for a currency to be usable it needs to be stable, and Bitcoin is not stable. Historically, Bitcoin has been quite volatile, and its value fluctuates much the same way stocks on the stock market fluctuate. In addition to stability, a currency needs to be a store of value, a medium of account and a medium of exchange. Of those three requirements, Bitcoin’s strength relies on two of the three requirements. Bitcoin’s store of value is constant because it is inherently a scarce resource. As a medium of account, Bitcoin has a volatile history but in Fall of 2015, the value of Bitcoin stabilized around $225–250 USD range.[5] As a medium of exchange, Bitcoin is globally the best option for paying another party. It is fast when compared to its next best competitor–wire transfers–which can take days to process and clear.[6] Furthermore, there are only a few fees associated with transferring Bitcoins from one address to another address. Though Bitcoin’s volatility remains a weakness, as the currency stably increases in value, it will attract more users and be more widely accepted.

Economic Traits

Bitcoin’s strength as a store of value is unique because it is designed to be a deflationary currency. That means there are a limited amount of Bitcoin that will ever be mined, and when all of the Bitcoins are mined, there will be no new Bitcoins added to the economy. This is the opposite of traditional fiat currencies like the EUR and USD, which are simply printed by a bank or government agency. When more money is needed, these agencies print more money to facilitate the demand and growth of the economy. Bitcoin however, is not designed this way. Bitcoin is designed to mine a maximum of 21 million Bitcoins; and as of January 2017, 16 million Bitcoins have already been mined.[7] Based on Bitcoin’s source code, the last Bitcoin is expected to be mined in 2140. This is a strength and a weakness of Bitcoin. Since the quantity is fixed, Bitcoin is a finite currency much like gold or silver. As demand for Bitcoin increases, its value is forced to appreciate since that increase in demand can not be relieved by mining more coins. This is great for early adopters who bought the currency when it was new and cheap.

Though it may not seem like Bitcoin would appreciate because of its volatile first years. In the long run, Bitcoins are destined to vastly appreciate in value. This is bad news for Bitcoin as a currency because of runaway deflation.[8] Unlike runaway inflation, where a bank or government keeps printing more and more money that destroys the value of the currency. Runaway deflation occurs when no more money is added to an economy, and the value of that currency skyrockets until it reaches gridlock. When the currency reaches gridlock two things happen: current owners can not spend the currency because it is too valuable because there are not enough parties willing to exchange something of equal value, and current owners hoard their currency because they speculate it will continue to rise in value. In both cases of inflation and deflation, the currency collapses because either no one can or will use the currency. Another problem with Bitcoin’s finite design is the deletion of Bitcoins out of the economy. Users lose their coins due to sending coins to incorrect wallet addresses or forgetting their private key; overall human error. About 1 million coins have been forgotten and destroyed. These coins are called zombie coins.[9] The Bitcoin design capacity and the creation of zombie coins both limit and shrink the economy, respectively. As a currency gains more acceptance, it is traditional practice to print more money, but since there is a limited amount of Bitcoin, the only outlet for the currency’s growth is an increase in its value. This is a strength for early adopters, but an overall weakness for Bitcoin’s economic adoption.

Another problem is the hoarding of Bitcoin. Speculators who are cognizant of Bitcoins natural deflationary design, are tempted to hoard their Bitcoins. This is troublesome because much of the value of Bitcoin comes from its use as a near instantaneous mode of payment. Hoarders are in practice, detracting from the overall transaction volume of Bitcoin. If enough Bitcoins are hoarded, that transaction volume slows to a stop. Some economist believe that the Bitcoin currency will collapse in what they call “bit rot”.[10] Bitcoin appears ideal as a store of value because it does not lose value over time like traditional fiat currency, but it can still fail. Instead of runaway inflation like Zimbabwe and Argentina[11], runaway deflation can convert users into hoarders, which will stifle the economy and cause bit rot. At the end of both deflation and inflation, the same effect happens–currency collapse. Unchecked inflation or deflation is not ideal for any monetary system. In the case of Bitcoin, towards the end of its mining cycle, deflation will be a real problem for the future of the currency. A remedy to this issue would be to adjust Bitcoin’s source code, to allow the mining of more Bitcoins past the date 2140. This way, the currency may avoid runaway deflation and bit rot. Furthermore, Bitcoin mining is essential to the functionality of Bitcoin. By adjusting the design to lengthen the mining timeline, Bitcoin can be an accepted, sustainable currency.

Mining

What is Bitcoin mining? Bitcoin mining is the solving of mathematical algorithms that are paired with every Bitcoin transaction. Bitcoin transactions are coupled with these algorithms, and when solved, two things happen: The transaction is no longer pending and is published to the public ledger, and the Bitcoin miner is awarded a quantity of Bitcoin for their efforts.[12] This provides an incentive for Bitcoin miners to solve these algorithms and thus keeps the Bitcoin economy operational. New Bitcoins are generated at a fixed rate because of the mining process. However, as more Bitcoin are generated, the transaction algorithms become more complex to automatically slow the growth rate of the quantity of available Bitcoin. Furthermore, the reward for mining a transaction decreases every 4 years. In 2009, the reward for solving an algorithm was 50 Bitcoin. In 2013, the reward was reduced to 25 Bitcoin. In 2017, the reward became 12.5 Bitcoin. In addition, Bitcoin is not limited to a whole coin or half a coin. One of Bitcoin’s greatest strengths is its ability to be divided and combined with any denomination. The smallest value of a Bitcoin is 1/100,000,000 of a Bitcoin, and that number is called ‘One Satoshi’–as a way to credit the founder. Based on Bitcoin’s self-regulating supply design, the last Bitcoin is predicted to be mined in May of 2140. Though the self-regulating transaction volume of Bitcoin is a strength, the quantity cap is a weakness that will become even more apparent as the Bitcoin economy approaches that date.

Wallets

The Bitcoins that are mined, bought or sent to another address (a wallet) are stored in a file that is called a wallet. A wallet can either be online or offline depending on the preference of the user. There are many online wallet services like Coinbase, Blockchain.info, and Kraken, and there are many offline wallet services like Electrum, Armory, and Coinomi.[13] Having an online wallet (hot wallet) vs. an offline wallet (cold wallet) is subject to a user’s preference and how they anticipate their use of Bitcoin. An online wallet also known as a hot wallet, has the advantage of having your Bitcoins in the cloud hosted by an online wallet service’s servers. Your Bitcoin can be accessed by simply logging into your online account. From there, you can send Bitcoins to another Bitcoin address. This is convenient and provides flexibility for the wallet owner. However, a flaw is the chance that the online wallet service can hacked or infected with malware. In 2014, Mt. Gox, a Japanese Bitcoin exchange and wallet service, reported it was hacked and lost a value of $409 million in Bitcoin.[14] Similarly, mybitcoin.com lost 1.2 million in user’s Bitcoins due to a malware infection.[15] To prevent the chance of losing Bitcoins to online hacking or malware, many users use offline wallets. An offline wallet also known as a cold wallet has the advantage of greater security since your wallet can be stored on a hard drive, external drive, or paper. This increase in security, sacrifices flexibility, because users can only access their wallet from the location they stored it on. Thus, offline wallets have their own host of disadvantages too. Software or hardware failure can result in the permanent loss of an owner’s Bitcoin. Furthermore, forgotten private keys and lost flash drives with stored Bitcoin have also reduced the overall Bitcoin economy. Interestingly, there are a few instances in which users have forgotten their private key, and could only watch as their Bitcoin appreciate in their locked wallet. As previously stated, this is a problem that drives Bitcoin further toward bit rot. A possible countermeasure to this would be to have a split private key: a part of the key on a smartphone, another part on a desktop, and another part on a laptop.[16] This would increase the difficulty of stealing an owner’s private key, but it would decrease the ease in which to make transactions. Another solution against private key theft would be a super-wallet. It is essentially a bank where most of a user’s coins are stored, but instead of carrying around all of their Bitcoins, the user carries a sub-wallet that has only a few of their Bitcoins e.g. a conventional wallet. Most of a user’s coins would be stored safely away in the event of a lost key or theft. Furthermore, accessing the account would take more than a private key. Maybe a personal passphrase and security questions could be added, as additional security measures. Overall, the option to have online and offline wallets is a great feature for users who have different purposes for Bitcoin. Nevertheless, it would help to have the disadvantages reduced or ideally removed altogether. However, removing all the disadvantages of a wallet service would prove challenging given Bitcoin’s pseudonymous nature.

Cryptocurrency Anonymity

Bitcoin is not completely anonymous nor is it revealing. The design of Bitcoin allows users to have multiple addresses that they can receive Bitcoin from. The address does not have your name or any of your personal information so there is no direct trace to the user. However, when Bitcoin are sent to an address, the transaction is published on the blockchain and becomes visible to everyone. It is extremely difficult to determine who received a Bitcoin, without knowledge of their wallet address. Once an address is identified, all future transactions would be traceable and the wallet owner’s anonymity would be lost. This is why Bitcoin is considered pseudonymous.[17] Now, depending on your views of how Bitcoin should be designed, some users want more anonymity while others want less. Governments and banks would like decreased anonymity so that your usage can be more easily monitored and individuals who are using Bitcoin for nefarious purposes can be identified. Whereas the average user who would rather have less government oversight would like more anonymity. Advocates for increased anonymity feel that it is not the business of banks or government to have access to how they spend their Bitcoin. There are strengths and weaknesses to both increases and decreases to anonymity. First, increased anonymity protects the owner because no one knows individual addresses. It is difficult to determine how much Bitcoin is in your Bitcoin wallet based on looking at a string of code that identifies your Bitcoin address. This decreases the personal risks associated with each individual. However, increased anonymity makes it nearly impossible to dispute your Bitcoin if you send it to the wrong address or if you are disputing the right to ownership in the event of a deceased loved one and the rights to their Bitcoin address.

Conversely, decreased anonymity has the benefit of making transactions disputable since you would know who the other party is. Also, law enforcement agencies would be able to find criminals who use Bitcoin to buy and sell narcotics for illegal purposes on the dark web. It would also increase government oversight, which enables the collection of metadata about individuals much like the metadata that is used in targeted advertisements found n Amazon.com and Facebook.com. Overall, anonymity is based on preference. Bitcoin was designed to be pseudonymous and currently, it appears to fall in the middle of its users’ varying preferences. This benefits Bitcoin since it affects many users who have different tastes and preferences. Yet, if a user wants complete anatomy, they can obtain it through the Tor browser.

Deep & Dark Web

The Tor browser is a web browser that allows users to access unindexed parts of the internet–deep web–that can not be reached with conventional browsers like Chrome and Safari.[18] The Tor browser was designed in the late 20th century by U.S. naval scientists to hide their internet activity while they browsed the internet.[19] They did this through a system called onion routing. Onion routing is the encrypting of a user’s internet activity, called encapsulation, and then bouncing that activity from various nodes. Each time the capsule reaches a new node, a layer of information is peeled away which reveals what the next node destination is. When the last node is reached, the user accesses the data from the location of the last node. This technique is successful and is freely available to anyone who wants to download the Tor browser and access the deep web. Unfortunately, the deep web has a negative association with Bitcoin because of the dark web. The dark web is not the deep web. The dark web is a section of the deep web where illegal online activity is conducted.[20] Many media outlets skew the information about Bitcoin through its nefarious uses on the dark web. The dark web is home to online drug markets, illegal gambling rings, child pornography, hitman services, fake currency and more. To use these services requires a currency that is not easily traceable–Bitcoin. The ease, speed and relative anonymity Bitcoin offers is unrivaled by any other currency. When the illegal drug market ‘Silk Road’ was shutdown, law enforcement agents seized a value of $183 million in Bitcoin from Silk Road founder Ross William Ulbricht.[21] Since its seizure, multiple reiterations of the Silk Road have sprung up e.g. Silk Road 2, Silk Road 3, Evolution, Agora.[22] Detectives worldwide are trying to shut down these illegal markets but the anonymity of the Tor browser’s onion routing has proven difficult to overcome and find these servers. However, amid all this negative press, Bitcoin and the Tor browser do have legitimate purposes together.

Positive Bitcoin Case Studies

When Syria was in turmoil during the Arab Spring, the Syrian government monitored the Internet to discover organizers and supporters within the influence of the government. So instead of accessing the Internet via the clearnet, many of the separatist forces used the Tor browser to access chats and forums to organize demonstrations.[23] Furthermore, these groups posted their public Bitcoin wallet addresses to receive funds and donations from groups who supported their cause. Similarly, when Ukraine was occupied by Russia during the Ukraine Crisis, Ukrainians posted public Bitcoin wallet addresses so that they could receive donations to buy food and water.[24] This is evidence that Bitcoin is not the currency of criminals, it is a currency that can instantly reach people worldwide and provide support. When utilized with the Tor browser, it is a clandestine currency that can help oppressed people. This became even more clear in the May 2013 Edward Snowden case–what many Bitcoin supporters call one of the most pivotal examples of excessive government oversight.

After Edward Snowden fled the United States after exposing the NSA for spying on civilians, he asked for donations.[25] When the public learned about the situation, many people were furious that the government would spy on citizens but were relieved that whistleblowers like Mr. Snowden still valued citizen’s rights and did not turn a blind eye to corrupt government oversight. Thus Snowden supporters donated to him. What happened next was unexpected. At first, many popular financial institutions like Visa, MasterCard, and PayPal processed payments to Mr. Snowden’s bank accounts. But after the U.S government approached and pressured these agencies, payments to Mr. Snowden’s accounts began to bounce and were blocked. These financial institutions blocked all payments, however, PayPal took it one step further. PayPal, froze the accounts of account holders who tried to donate! Americans were outraged.[26] The U.S government had forced its hand on the American people and told them what they could, and could not donate to. Public opinion was already negative from news of the spying activity, but the government’s unchecked power on Americans financial capabilities brought a new round of disgust to the already negative image the government had achieved. So to bypass these unjust barriers, many whistleblowing supporters, donated Bitcoins anonymously through the Tor browser. This was the first time in recent history the American people were reminded that their money is not really their money. After this incident, a new wave of decentralized crypto-currency supporters emerged. Since there is no single owner of Bitcoin, the currency can not be pressured by banks or governments into extorting its users. People began to accept Bitcoin because of its decentralized design. As more people saw the benefits of Bitcoin, they thought of ways to make it better. Though Bitcoin is the first cryptocurrency, it is not the only one. There are other cryptocurrencies that fall under the category of alternate cryptocurrencies.

Alternative Cryptocurrencies (Alt-Coins)

Bitcoin was invented in January of 2009. After being made, other cryptocurrencies began to emerge in the following years.[27] In 2011, Namecoin, I0coin, and Litecoin all launched. Of those three, Litecoin is the most popular with a market value of over 1 billion. Litecoin is based on a similar code to Bitcoin. So similar that the official term is that it is a fork of Bitcoin.[28] Litecoin was developed by Charles Lee in October of 2011. Litecoin developer added features like a reduced confirmation time to 2.5 minutes instead of Bitcoin’s 10 minutes and a maximum quantity of 84 million Litecoins, which is 4x more than Bitcoin’s 21 million.[29] Charles Lee, and supporters from the Litecoin community also continue to maintain the currency. Though cryptocurrencies as a group are still in their infancy, they are fast, flexible and reliable. They are positioned to change the world and as Bitcoin gains more popularity and approval so do alternate cryptocurrencies.

Conclusion

To conclude, Bitcoin’s popularity lies in its simplicity, flexibility, decentralization, and pseudonymity, make it resilient and powerful. Though Bitcoin is a novel currency and the first of it’s kind, it is still young and has issues that need to be addressed. However, once the aforementioned issues are rectified, future cryptocurrencies will have a great chance of being robust global currencies. Bitcoin is a beta, and as a beta, it has done its job; it has set the groundwork for future cryptocurrencies. Even though it has flaws, Bitcoins continues to gain momentum as an accepted form of currency and has proven itself as not a transient fad, but as a global monetary innovation.

[1] Von Baldegg, Kasia Cieplak (9 April 2014). “This Trippy Video Explains Bitcoin in Under 4 Minutes”. Atlantic. Retrieved 10 December 2015

[2] Shin, Laura (11 December 2015). “Should You Invest In Bitcoin? 10 Arguments In Favor As Of December 2015”. Forbes. Retrieved 11 December 2015

[3] Andreessen, Marc (21 January 2015). “Why Bitcoin Matters”. Nytimes. Retrieved 11 December 2015

[4] Wood, Julia (29 November 2015). “As Bitcoin tops $1,200, does its fate rest in China’s hands?”. NBC News. Retrieved 14 December 2015

[5] Pesa_Mic (2 September 2015). “Bitcoin Price Analysis September 2nd”. Deep.Dot.Web. Retrieved 10 December 2015

[6] Weaver Nicholas (26 November 2015). “Once You Use Bitcoin You Can’t Go ‘Back’–And That’s Its Fatal Flaw”. Wired. Retrieved 10 December 2015

[7] Smith, Jhanile (3 December 2015). “The BitCoin Classification Debate Has Come to an End”. MiamiLaw. Retrieved 10 December 2015

[8] Cawrey, Daniel (31 August 2013). “Could deflation cause problems for bitcoin”. CoinDesk. Retrieved 13 December 2015

[9] Bal, Aleksandra (1 June 2013). “Stateless Virtual Money in the Tax System”. International Bureau for Fiscal Documentation (IFBD). Retrieved 11 December 2015

[10] Graf, Konrad (20 October 2015). “Commodity, scarcity, and monetary value theory in light of bitcoin”. Price and Markets. Retrieved 11 December 2015

[11] McGroarty, Patrick (19 August 2015). “Change Comes to Zimbabwe, Replacing U.S. Dollars”. The Wall Street Journal. Retrieved 11 December 2015

[12] Ramzan, Zulfikar (1 May 2013). “Bitcoin-The money supply”. Khan Academy. Retrieved 11 December 2015

[13] Anand, Priya (2 August 2014). “10 Things Bitcoin won’t tell you”. MarketWatch. Retrieved 10 December 2015

[14] Keng, Cameron (25 February 2014). “Bitcoin’s Mt. Gox Goes Offline, Loses $409M–Recovery Steps and Taking Your Tax Losses”. Forbes. Retrieved 11 December 2015

[15] McMillan, Robert (7 November 2015). “$1.2M Hack Shows Why You Should Never Store Bitcoins On The Internet”. Wired. Retrieved 10 December 2015

[16] Simon Barber, Xavier Boyen, Elaine Shi, Ersin Uzun (14 August 2015). “Bitter to Better –How to Make Bitcoin a Better Currency”. Palo Alto Research Center, University of California, Berkeley. Retrieved 10 December 2015