In recent times, the terms ‘bitcoin’, ‘blockchain’ and ‘cryptocurrency’ have amassed an alarming amount of popularity. It has become a trend to keep oneself updated with the latest price of the bitcoin in the market, so as to grab the opportunity at the right moment and profit from this mysterious form of currency.
Does this make bitcoin like shares? Is it akin to any other digital wallet like PayTM or Tez?
Bitcoin is actually a different concept, unlike the ones mentioned, but has the potential advantages of both.
E-commerce has bloomed with the advances in computer technology. Cashless transactions and online banking have become a reality; where physical money is no longer a necessity. There is one advantage of using physical money, though. A transaction made by an exchange of notes is utterly private. There is no record of it happening once it is done unless of course, someone records the act through any means. You give someone an amount of money, and only you and the recipient know that you are now missing that specific amount while the recipient has received it. When you perform the same transaction through electronic means, there is an intermediary third party you have to rely upon to keep the transaction private. This entity knows everything about the exchange and is duty bound to keep it private to give an illusion of a direct hand-to-hand transaction. Internet banking and E-Wallets suffer from this disadvantage. Let us see why.
Net banking and E-Wallets follow a centralized system architecture, where there is always a centralized third party like a bank or a company like PayTM governing and ensuring the privacy of transactions. There is another system architecture called ‘peer-to-peer’ systems. These systems do not have any central governing authority, rather each participant in the system is equally privileged and potent. Bitcoin is a peer-to-peer system, consisting of a growing network of Bitcoin users. The creation of new bitcoins (we’ll get there) and the recording of all bitcoin transfers (called ‘transactions’) are performed by this peer-to-peer network. Bitcoin is a ‘cryptocurrency’ because the ownership of bitcoin units is established using cryptography — the methods of securely hiding data.
Now that we’re somewhat comfortable with two of the terms mentioned, we come to the last one: blockchain. Bitcoin is a virtual currency, which means that it is just a bunch of data stored on some computer in some part of the world. We know that paper notes cannot be photocopied and misused freely. Banks and E-Wallets also have their own protocols to prevent misuse of their services. What about bitcoin? If it is just data, why cannot it be replicated and used freely? That would defeat the purpose of it being a currency. A currency must be limited, secure and should not be reproducible. The blockchain is a public data structure which solves this problem, also called the ‘double spending’ problem. It is a continuously growing list, or chain of ‘records’, which are nothing but bitcoin transactions. These records are linked in a chain and secured using cryptographic techniques. It is often termed as an open, distributed, electronic ledger, which maintains a record of transactions as and when they occur and prevents the misuse of past transactions.
One of the major innovations in Bitcoin is that the maintenance of the blockchain database is linked to the creation of new bitcoins. The blockchain consists of a linked list or chain of blocks where each block contains a set of bitcoin transactions. Blocks are appended to the blockchain one at a time where each addition requires finding a solution to a computationally hard search problem. This requires an immense amount of computing power, usually requiring specialised hardware. Nodes (members or users) in the Bitcoin network which successfully add a block to the blockchain are rewarded with new bitcoins. Such nodes are called miners and their search for solutions of the computationally hard problems is called mining. This is like mining for gold with expensive machinery which, while rewarding you with gold, also brings new gold into the market for exchange as a currency.
Introduced in a white paper by the pseudonymous Satoshi Nakamoto in 2009, Bitcoin has gained the interest of both industrialists and researchers for its potential advantages. Several controversies have surrounded its use in the past years, yet it was the first of its kind and gave rise to several other cryptocurrencies like Litecoin, Ethereum and Zcash. It is yet to be witnessed how cryptocurrencies might alter the economic world, hopefully for the better.