What is Bitcoin and Why it Matters
It’s become a topic everyone is talking about so most people know bits of information, some facts and some misnomers about what Bitcoin is and will become. Not many know why it has become popular now or why it matters.
In early 2017 Bitcoin was showing signs of growth and by mid-February it had risen past it’s previous high of $1000 value and started climbing rapidly. It had spiked before in late 2013 but until now it has never been so popular or on the minds of so many.
Bitcoin hit the radar of the media this year, but the beginning was way back in 2008 when a programmer known as Satoshi Nakamoto (believed to be alias) posted a paper outlining a crypto-currency design to a cryptography mailing list. A few months later in 2009 the first release of software to exchange bitcoins used the schema. Today this run by a open-source community coordinated by three core maintainers.
Bitcoin works without the need for a third or multiple parties such as Paypal, a bank or financial regulator to process the exchange of money. It’s goal is to make sure the money you receive is real even when you can’t trust who is sending it. It’s also designed to replace these institutions and keep everything in an immutable ledger, this is known as the blockchain a key component.
You can get started many ways these days, but first educate yourself about What is bitcoin, how it works and most importantly how you can protect yourself. Remember there is no help desk, refunds, or fraud detection.
How does it technically work?
Bitcoin works by generating a pair of unique mathematically linked keys, which you use you exchange bitcoins with other clients. One key is private and never shared, the other is a public and has subversions known as a bitcoin address, it is given to other people so they can send you bitcoin.
The encryption makes it impossible for even super-computers to calculate someone’s private key from a public key making it so no one can impersonate you without first stealing your private key, so keep it safe. Your keys should be backed up and preferably kept offline and off of your devices. You generate and share a bitcoin address when you want to be paid for something.
When you carry out a transaction the computer performs a mathematical operation to combine the other party’s public key and your private key along with the amount of bitcoin that you want to transfer. The calculated result is then transmitted to the bitcoin network and the transaction begins to be verified by third parties.
The other bitcoin clients run two checks on the transaction, first it checks the public key is the true owner of the pair sending the bitcoin. It does this by exploiting the mathematical relationship between a public key and a private key. The second check is to check the blockchain ledger which is a store of every transaction on the network to validate that the bitcoins are available to spend.
When it’s done the results get pushed to the other clients in the network to check for themselves thus verifying the transaction until it is permanently confirmed. When the updated blockchain reaches your machine the payment is marked as successful.
What is mining?
I’ll write a future article on this but some of the bitcoin clients that validate transactions are known as miners because they try to add new transactions to the public blockchain by racing to solve a cryptographic puzzle. Once one of them wins the blockchain is updated and passed throughout the bitcoin network. They are rewarded with 12.5 bitcoins for their effort (this value halves every 210,000 blocks and started out at 50 bitcoins).
Bitcoins are generated by miners trying to solve the next block of the shared blockchain (transaction log). The bitcoin miners also have an incentive to solve transactions with a small fee taken from the verified transaction.
Mining is very computationally intensive, it relies on powerful GPU’s to solve the equations (CPU’s are not fast enough!) even then it can take a machine several years to solve.
Over time it has become impossible for a single machine to solve which is where we see miner groups fighting for the reward instead. This is a profitable business if you have cheap electricity and has taken on a whole life of it’s own, perhaps even bringing in the age of energy production decentralisation.
Can Bitcoin compete with cash?
Is it a safe investment?
At the moment bitcoin is very volatile and can increase or decrease in value very quickly, this is due to it being such a young economy and illiquid markets (meaning not easily converted to cash) this is because we are reliant on exchanges which are currently hitting technical growing pains due to high usage and sophisticated attacks.
It is inadvisable to use it for savings or assets you are unwilling to part with, remember bitcoin has no physical value and is not backed by any institution that can protect them. Buy what you wish to spend, trade and if your paid in bitcoin many exchanges will help you convert Bitcoin to your local currency.
Is it totally anonymous?
No bitcoin was never meant to be anonymous, it just does not display your identity. Every transaction is permanently stored publicly on the blockchain allowing for anyone to to see the balances and transactions of any Bitcoin address.
However, when you make a purchase your identity may be known and linked to your Bitcoin address and previous transactions. This is the reason why Bitcoin addresses should only be used once. There are ways to help protect your privacy and you can find many blog posts on the topic.
Are payments secure?
The nature of the mathematics ensures that is easy for a computer to verify the transaction while impossible to generate a fake one. This makes it mathematically impossible to spend bitcoin you do not own.
Also the blockchain ledger provides a immutable transaction log of every transaction providing a deterrent to money laundering. Contrary to popular belief you can trace every transaction and it’s history meaning detectives can try piece together identities and see where the funds end up.
Personal security however is up to you. First make sure you own your keys, keep them secure and never share your private key. If you don’t control your keys then you don’t control your funds and will be trusting the third party. Keep this in mind if your investing. It’s also bad practice to leave funds in an exchange wallet for the exact same reason.
Who controls Bitcoin?
No one. It is reliant on the bitcoin network, it’s existing infrastructure of miners, nodes, and clients as well as exchanges and communities.
The amount of bitcoins in circulation will be distributed at a ever-decreasing rate towards the maximum of 21 million. This is expected to take until 2030.
If for some unforeseen circumstances where over half of the bitcoin network computing power is provided by a single entity then they could manipulate the rules and force the network to record fake data to the blockchain ledger. It is very unlikely to happen or go unnoticed at this point in time.
Is it legal tender?
Bitcoin is not recognised as illegal by many countries. However, many countries do not distinguish it as legal tender (or a commodity). The rules vary with some countries publicly banning it’s use like China, others are met with regulatory implications and have yet to set a legal status of bitcoin or any other crypto-currencies. Various government agencies, departments, and courts have classified bitcoins differently.
The Central Bank of Ireland was quoted in the Assembly of Ireland as stating that it does not regulate bitcoins.
As of 2017, the government of the United Kingdom has stated that bitcoin is unregulated and that it is treated as a ‘foreign currency’ for most purposes, including VAT. Bitcoin is treated as ‘private money’. When bitcoin is exchanged for sterling or for foreign currencies, such as euro or dollar, no VAT will be due on the value of the bitcoins themselves. However, in all instances, VAT will be due in the normal way from suppliers of any goods or services sold in exchange for bitcoin or other similar cryptocurrency. Profits and losses on cryptocurrencies are subject to capital gains tax.
Why 21 Million?
Having a limit on the amount of currency available has never been tried before so it is met with a lot of speculation. The consequence will likely be slow and steady deflation, as the growth in circulating bitcoins declines and their value rises.
“Elaborate controls to make sure that currency is not produced in greater numbers is not something any other currency, like the dollar or the euro, has,” says Russ Roberts, professor of economics at George Mason University.
This means we would have to plan and expect that our money will become more valuable in the future. It would certainly be different and could bring with it many more complications than has currently been foreseen.
“That is considered very destructive in today’s economies, mostly because when it occurs, it is unexpected,” says Roberts. But he thinks that won’t apply in an economy where deflation is expected. “In a Bitcoin world, everyone would anticipate that, and they know what they got paid would buy more then than it would now.”
Is our current currency at risk?
At the moment we are in the age of crypto-currencies with new coins, tokens, networks and solutions popping up every-day. It is a interesting future but regulation has yet to be set by many countries and international law is far behind. As crypto-currencies become more popular this will change.
We will see use-cases for new coins, tokens or currency but competition has always been healthy, often bringing security benefits along with innovations. It is likely this will bring a revolution of our current monetary institutions, bringing in technology to help move them forward into the future. Many are investigating the use of blockchain technology internally as well as publicly.
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