Investigating Blockchain — Bitcoin
By Jeff Tidd on ALTCOIN MAGAZINE
For years we’ve watched the meteoric rise of Bitcoin, followed by an 80% crash in value during 2018 and a substantial rebound this year. In the meantime, countless companies have pinned their fortunes to the technology underlying Bitcoin, called “blockchain”. Their marketing pitches are usually something like “We use blockchain technology to revolutionize X”, where X is any product category you can think of.
How does blockchain make all this revolutionizing possible? What does blockchain do?
A co-worker recommended I read “Blockchain Revolution: How the Technology Behind Bitcoin and Other Cryptocurrencies Is Changing the World”. As the book starts, it outlines the vast potential for blockchain technology. Not only is it good for cryptocurrencies, but also fiat currencies, digital identity, health records and more. PLUS, it’ll help solve global warming, income inequality, and with a not-so-subtle nod to Trump, bad government.
I felt like I had wandered into the camp of Jim Jones and the Guyanas. Pitchers of “blockchain Kool-aid” were everywhere and people have sprawled around with crazy smiles on their faces. Could a blockchain really be that good?
In the meantime, cryptocurrencies have crashed in value and a growing number of people are dismissing blockchain as a “slow, expensive database”.
Ardo Hansson, a member of the European Central Bank governing council recently said the “crypto hype has peaked and the collapse is underway” Things are getting so bad that true crypto believers are calling this the “crypto winter”.
So, which is it? The answer to all our problems or just hype?
Perhaps the first thing to recognize is that blockchain isn’t a single technology, but rather a combination of technologies. At its core, blockchain is simply blocks of data linked together like a chain…
The data on the blockchain can be anything. In the case of Bitcoin, the blockchain records bitcoin ownership and every time a coin is bought or sold.
Blockchain technology can also include…
- Maintaining copies of the blockchain data on multiple servers. Depending on the implementation, servers can contain the entire blockchain, or only the most recent blocks or blocks that are relevant to a particular server. There are an estimated 5,000 Bitcoin servers with full copies of the blockchain, which is ~200 Gigabytes as of this writing.
- Private keys to control assets recorded on the blockchain. Private keys are text strings like E9873D79C6D87DC0FB6A5778633389. In the case of Bitcoin, private keys are required to spend bitcoin and are therefore kept safe, typically stored on special websites or software programs called wallets.
- Preventing data deletion from the blockchain. Some blockchains don’t have this restriction.
- Controlling who can see the data on the blockchain. Some blockchains are publicly visible. Others are private.
- Determining incentives for server operators. Cryptocurrencies award new coins to server operators for adding new blocks to the chain. Alternatives include incentivizing via fees, or via benefits of being part of a community.
- Providing a clear indication when a transaction has been completed and won’t be reversed. Some blockchains like Bitcoin don’t provide 100% assurance that a transaction won’t be reversed.
There’s one additional blockchain feature ,“decentralized governance”, that is so important that many people feel it’s essential to be considered a true blockchain product.
Decentralized Governance is the ability for the blockchain to be run without oversight from any single person, corporation or government.
Some people feel very strongly that a “blockchain” that has a governing body lacks the essential benefit of blockchains and therefore should be called something else. In Part III of this article, we’ll examine this issue more closely.
Each combination of blockchain technologies has its own strengths and weaknesses, and this infinite number of possibilities makes it difficult to understand and analyze blockchain.
Let’s start by taking a closer look at the most popular blockchain implementation… Bitcoin.
BITCOIN
What is Bitcoin?
Remember when you sat in math class and thought to yourself… “this crap has no practical use whatsoever”? But sitting next to you was some geeky kid who totally loved it? Well, that kid has grown up and given a massive groin kick to governments and corporations everywhere. He hit em where it hurts… money. He turned something totally worthless (“digital coins”) into something that people will exchange for “real money”.
And he did it with math.
One of the main attractions to Bitcoin is described by Hal Finney, the recipient of the first Bitcoin transaction. He said “It seemed so obvious to me: Here we are faced with the problems of loss of privacy, creeping computerization, massive databases, more centralization — and (Bitcoin) offers a completely different direction to go in, one which puts power into the hands of individuals rather than governments and corporations. The computer can be used as a tool to liberate and protect people, rather than to control them.”
Specifically, Bitcoin is not owned or controlled by any single organization, whether it be a government, corporation or bank. It’s decentralized. Perhaps for the first time, trust is established with cryptography instead of by a governing body.
Strong decentralization cryptography should prevent meddling and influence from governments and corporations. They shouldn’t be able to print money to line their own coffers and devalue the currency in the process. They shouldn’t be able to seize the money. Or trace the money.
Strong decentralization cryptography should provide dependability and security. It should provide cost-savings from eliminating the middle man.
For these reasons, strong decentralization cryptography is immensely attractive to a lot of people.
Unfortunately, Bitcoin has failed to deliver on many of these promises. For example, a mind-boggling 20% of all Bitcoin is estimated to have been lost or stolen. In addition to that, billions of dollars worth of coins have been confiscated by governments. How could that be? Isn’t cryptography secure?
Where Are My Bitcoins?
Although the Bitcoin blockchain itself is fairly secure, bitcoins recorded on the blockchain can only be accessed via a private key, which is a unique string of text held by the Bitcoin owner. And if this key is lost, stolen or confiscated there’s no authority to help you recover it (especially if it’s an authority who took it).
Consider the British man who accidentally threw away a hard drive with the key to 7,500 bitcoins. Years later, when the value of the coins topped $100 million, the man tried to organize a search of the local landfill but was denied access by local authorities.
With that scenario in mind, some people turn to “exchanges” (corporations ironically) to manage their private keys for them. This has its own problems. This year, the owner of a crypto exchange died and no one else had the passwords to access the bitcoin private keys. An estimated $190 million in bitcoins may be unrecoverable.
Furthermore, private keys can be seized by governments even if those keys are stored on exchanges. The US government has seized an estimated $1 billion+ in bitcoins and sold them at auctions held by the Marshals Service.
One of the largest Bitcoin holders is the venture capitalist Tim Draper, who in 2014 bought nearly 30,000 bitcoins that had been seized by the U.S. Marshals Service.
Barron’s magazine reports that “Cryptocurrencies have also not gained traction in consumer payments because of relatively slow transaction times and the lack of recourse for fraud or stolen funds”.
$30 Per Bitcoin Transaction
One of the expected benefits of decentralization is cost-savings from eliminating the middle man. In reality, running the Bitcoin platform is extremely expensive — to the tune of $30+ per transaction.
When a new block of Bitcoin transactions is added to the blockchain, the server adding the block gets 12.5 Bitcoin. Each Bitcoin is currently worth ~$4K (note: the price of Bitcoin changed so much during the writing of this article I got tired of changing it) so the total is ~50K. Each block has 1600 transactions (on average) so each transaction costs $50K/1600=$31.25. That doesn’t count the transaction fee paid directly by the sender of the Bitcoin which can be anywhere from .02 to $35.
How does Bitcoin get away with such high transaction costs? Most of the cost comes in the form of new bitcoins which dilutes existing Bitcoin holders and therefore the cost is born by everyone.
Imagine if every time you bought something on your credit card the US government printed $30 and gave it to VISA. No one would notice the extra $30 in the money supply.
Big Brother Is Watching
Bitcoin transactions are supposed to be anonymous but in reality, Bitcoin has significant privacy issues. For example, if you spend Bitcoin the recipient can see your Bitcoin ID and therefore see all your other transactions. If you have a job where you get paid in Bitcoin when you spend them the recipient can see all your income plus all your transactions!
Furthermore, anyone can trace the ownership history of Bitcoin. Governments monitor Bitcoin transactions. If you buy a Bitcoin that was previously held by someone in Iran… not good!
Chinese Takeover
In theory, anyone can run a Bitcoin server, competing to add blocks to the chain, and maintaining the integrity of the blockchain. That may have been true a few years ago, but today special hardware and massive amounts of electricity are required and 75% of all new Bitcoin blocks are added by 5 corporations, mostly located in China.
Decentralized blockchains need a large number of independent server operators so that a majority of them won’t compromise the blockchain. If any group controls more than 50% of all servers then the blockchain becomes vulnerable to a “51% attack” which means the controlling group can steal coins and compromise the network.
In May of 2018, Bitcoin Gold suffered a 51% attack and $18 million worth of Bitcoin Gold coins were stolen.
Money Machine
Despite all these problems, decentralization is a powerful force behind the rise of Bitcoin. But perhaps an even more important feature of Bitcoin is the opportunities it provides to make money as it creates something of value out of something that initially had no value.
There are two main ways to make money from Bitcoin…
1) As described above, operators of the Bitcoin platform are compensated in new Bitcoin if they’re the first to add a new block to the chain. The current reward is 12.5 Bitcoin valued at ~$45,000 (at the time of this writing).
2) Bitcoin can see huge run-ups in value, making “Bitcoin millionaires”.
One of the best examples is told by coinreport.net…
“When Bitcoin first came out in 2009, a Norwegian electrical engineer named Kristoffer Koch decided to invest $26.60 (150 Kroner in Norway) to purchase 5,000 Bitcoins. Because Bitcoin was just developed and there were no practical applications or user base yet, Koch forgot about his investment and went about his daily life.
When he heard about the rising success of cryptocurrencies on the news and managed to recover his wallet, he discovered that his assets grew from $26.60 to $886,000 (5,000,000 Kroner)! With only 1,000 Bitcoins, he was able to purchase a nice apartment and held onto the other 4,000. Holding onto those additional coins proved to be a smart move as 4,000 Bitcoin would be valued at a staggering $15 million today.”
By far the biggest beneficiary of Bitcoins success is its creator Satoshi Nakamoto. He owns approximately 1 million bitcoin, currently valued around $5 billion.
Volatility
The downside of run-ups in value is that there can also be “run-downs” in value. The end result is volatility, which may be interesting if Bitcoin is viewed as an “asset”, but is less interesting if Bitcoin is viewed as a currency.
The U.S. central bank goes to a lot of trouble to keep dollar inflation in the 2% range. If the value of the dollar fluctuated wildly it would wreak havoc on the world economy.
Barron’s magazine reports
“There is no reason for the man on the street to use cryptocurrency for [store payments],” says Paul Lucas, IBM’s chief technology officer of payments. “It is a crazy fluctuating currency,” which repels merchant acceptance, he says.
PayPal’s chief financial officer, John Rainey, tells Barron’s that when the company allowed stores to accept Bitcoin a few years ago, it never got traction because of the price volatility.”
Scalability
Historically there have been concerns about the scalability of the Bitcoin platform — that it was too slow. Transactions typically take 10 to 60 minutes but can take as long as several days. The platform can process somewhere around 7 transactions per second as compared to the VISA network which is capable of processing 56,000 transactions per second.
However, some changes to Bitcoin’s blockchain technology are currently being rolled out and are resulting in throughput improvement. It’s likely that over time this will be a non-issue.
Stability
Having the Bitcoin servers run by a “community” of operators can be problematic. For example, Bitcoin isn’t a single cryptocurrency anymore. The Bitcoin community couldn’t agree on software updates so there’s now Bitcoin, Bitcoin Classic, Bitcoin Gold, Bitcoin Cash, and others.
Bitcoin Gold is particularly interesting because when it split from Bitcoin, the creators mined 100,000 coins for themselves. Sweet!
Compatibility
Bitcoin is avoided by banks, most likely due to regulatory concerns. Jed McCalleb, CTO of Stellar (and co-founder of Ripple) recently said:
“I think it’s true that most financial institutions are not going to use bitcoin.”
This makes it difficult to integrate and leverage the current US payment infrastructure.
However, numerous “exchanges” exist around the world allowing Bitcoin to be exchanged for traditional currencies or other cryptocurrencies.
Also, some companies allow purchasing goods and services directly with Bitcoin. A full list can be found here.
The New Gold?
Gold is the investment of choice for troubled times, periods of high inflation, or when there’s no confidence in fiat currencies like dollars, euros, rubles and so forth.
Bitcoin is independent of any fiat currency and may develop a reputation as having similar virtues as gold.
Bitcoin Summary
By any reasonable measurement, Bitcoin has been an incredible success. Powered by the allure of decentralization and the ability to make boatloads of cash, Bitcoin just celebrated its 10th birthday with a market value of ~$70 billion and approximately 325,000 daily transactions.
However, it hasn’t fulfilled everyone’s wildest dreams and aspirations due to the problems listed above. It hasn’t really disrupted the status quo of money. It hasn’t replaced your credit card or your checking account for everyday transactions.
Bitcoin is like a savings account located on a secret island away from government and corporate intervention, where you withdraw money with a very generous slot machine. Sometimes you get 10x your money, sometimes 1/10th. And you can only pull the lever if you have a key which you keep safely hidden under your mattress. And like any good gambling establishment, the house gets $30 every time you pull the lever.
Lots of people like the benefits of the secret island, some like the slot machine, and everyone watches their Bitcoin keys very carefully.
Next
Next, we take a look at other cryptocurrencies and discover money-making opportunities bigger than Bitcoin, learn one of the reasons Bitcoin saw such a big run-up in 2017 and see why the price of Bitcoin might see strength moving into the future.
