During a dinner party over the holidays one of our guests asked the question: “Did anyone use Bitcoin to buy Christmas presents this year?”
Most of the people at the table thought it was a silly question but the more we discussed the digital currency, the more we discovered how interesting it was. Everyone had heard of Bitcoin but no one really knew much about it, and no one in our group had ever owned any Bitcoin or ever made any transactions with it.
What is Bitcoin, where did it come from and where is it going?
Bitcoin is a peer-to-peer payment network and digital currency based on an open source protocol. It is crypto currency, somewhat like electronic cash for the internet.
Bitcoin is nothing more than a computer number (generated from an algorithm using special hardware) which users can access via a mobile app or a computer program. It provides users a personal Bitcoin wallet. One trades from one Bitcoin wallet to another Bitcoin wallet, like a cash transaction.
To buy something with Bitcoin, the buyer requests an update to a public transaction log called a ‘block chain.’ This master list of all Bitcoin transactions is a shared public ledger, i.e. a triple entry bookkeeping system which exists in the public (virtual) domain.
Operators – known as ‘miners’ – of a decentralized network verify and time stamp all payments and are rewarded with transaction fees and sometimes with newly minted bitcoins. Nobody owns or controls Bitcoin: no government services or treasury departments or central banks are involved. A transaction is a transfer of value between Bitcoin wallets that gets included in the block chain.
A private key is used to “sign” transactions proving the owner (mathematically), validating and recording the transaction which is broadcast between all users and confirmed through a process called ‘mining’.
Mining is a distributed consensus system that is used to confirm waiting transactions by including them in the block chain. These transactions are packed in ‘blocks’ that fit strict cryptographic rules. The Bitcoin network/protocol/users/operators/computer algorithms confirm each block, ensure the integrity of previous blocks (no modifications) and prevent any individual from easily adding multiple new blocks consecutively in the block chain.
Bitcoin was created by Satoshi Nakamoto (a pseudonym) in 2009. Since then, the founder has left the project and his/her exact identity is still unknown today. The community of developers has grown very rapidly. Bitcoin exchanges are being opened (and closed) all over the world every month.
Bitcoin (with a capital ‘B’) refers to the network and the protocol whereas a bitcoin (with a lower case ‘b’) is the currency itself. It still does not have a single logo as an official brand and is not recognized by any government as “legal tender”.
Bitcoin has already surpassed Western Union for transaction volume, and is competing with PayPal and other on-line payment systems for relevance. Although it is not the only digital currency being used today, it is the most prominent and has the best chance of becoming significant in the foreseeable future, possibly rivaling other fiat currencies before the end of the decade.
As a specialist in business alliance development, I find it particularly interesting that the entire system is powered by its user ecosystem – a virtual community – with no central authority (government) or middlemen (bankers or clearing houses).
Bitcoin can only work with a complete consensus among all users: open source code but every software program must comply with Bitcoin protocol, like the internet protocol but for this specific electronic money.
The total value of all bitcoins in circulation is already over US $2B. The total number of bitcoins which can ever be introduced into circulation has been per-defined by the framework architecture at 21 million bitcoins. Currently a little more than half that total number of bitcoins has already been mined and is in circulation, being used today.
The rate of newly mined Bitcoin is slowing down (production is cut in half every four years until the last minted bitcoin in 2140) so instead of creating more Bitcoin, it will be divided into smaller and smaller parts (by units of o.8 which should sound quite familiar to computer scientists).
Speculation is rife, which makes many wonder if the Bitcoin phenomenon is truly a game changer or just another Ponzi scheme. The value of a single bitcoin has varied from a few cents to more than a thousand of dollars over the past four years, and at this writing a single bitcoin is worth a little more than US $700 (the price moves up and down very quickly and very often, 24/7/365).
The extremely unstable nature of the peaks and troughs of the Bitcoin has some arguing that it is more about speculators than anything to do with main stream economics. There is some evidence that the recent banking crisis in Cyprus contributed to a huge spike in bitcoin value (as a hedge to protect the citizens in that country from additional taxation on assets in frozen bank accounts). One firm is now eager to introduce the first Bitcoin ATM on the island. Why would one need an ATM for a virtual currency?
Central banking authorities and treasury departments around the globe are paying very close attention to Bitcoin development. Some governments have immediately moved to outlaw the digital currency whereas others are adapting a more tolerant ‘wait and see’ attitude, letting the market decide Bitcoin’s future. It is not legal tender anywhere but if a seller and buyer come to terms, it can and is being used as currency to trade goods and services, or purchased outright.
Here are some of the arguments in favor of Bitcoin:
- Freedom to send and receive any amount of money, anywhere in the world, at any time – no bank holidays, no boarders, no maximum or minimum limits
- No or very low fees and better, faster service – no credit cards or bank transaction charges or delays, no international currency fluctuations, fewer administrative costs
- Security and control – no personal information tied to the transaction, back up and encryption are embedded in the digital currency to protect users and merchants
Here are some of the arguments against Bitcoin:
- Degree of acceptance remains low – most Bitcoin users are hoarding the digital currency in hopes of cashing in on future uptakes whereas the value will only increase as the digital currency circulates fluidly
- Volatility and risk are very high – a start-up currency, backed with no physical assets and supported by no government authority, Bitcoin is fragile to extreme fluctuations
- Susceptible in the early stages to fraud and money laundering – the nature of the pseudo-anonymity of the person-to-person transactions makes it a perfect medium for abuse and illicit activites
Rich in potential and steeped in controversy, Bitcoin is a radically new kind of money that operates without governments or banks. Everyone is starting to pay close attention including governments (legislation to tax capital gains) and banks (competitive threat) in the immediate future.
Did you use Bitcoin to buy your Christmas presents this year? Let us ask ourselves the question again next year, and the year after. Bitcoin will either become completely irrelevant and obsolete, or so ubiquitous that we will begin using the new digital currency sooner than we think.
Happy New Year 2014 to Everyone!