Bitcoin is a cryptocurrency and worldwide payment system. It is the first decentralized digital currency, as the system works without a central bankor single administrator. The network is peer-to-peer and transactions take place between users directly, without an intermediary. These transactions are verified by network nodes through the use of cryptography and recorded in a public distributed ledger called a blockchain.
Bitcoin, which can be termed as the face of cryptocurrencies in general, is becoming a powerful catalyst for innovation that is challenging the financial world to revolutionize the monetary ecosystem of the world altogether. According to Bill Gates, the co-founder of Microsoft, Bitcoin is a technological ‘tour de force’. What sets Bitcoin apart from the other 1300-something cryptocurrencies and why is it being termed as the currency of the future? Let’s find out!
What is Bitcoin?
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“Bitcoin was created to serve a highly political intent, a free and uncensored network where all can participate with equal access”. This quote by Amir Taaki, a British-Iranian hacker and programmer who has contributed significantly to many open source projects including Bitcoin, mildly elaborates the important role of Bitcoin and its powerful potential. Bitcoin has taken the economic universe by a storm, thanks to the insane appreciation in price and a corresponding increase in acceptance by the masses.
Bitcoin, in the simplest of terms, is a digital currency. It has a very well established and sophisticated trail that even fiat money does not have- the Blockchain, and is monitored and accessed through a system of codes termed as ‘keys’, which grant access to digital wallets, which can either be stored online or offline, depending on the preferences of the users. The technology behind Bitcoin, and other cryptocurrencies is the phenomenal Blockchain, which enables users to carry out transactions discreetly and digitally, without the involvement of third parties.
What sets Bitcoin and fiat money apart is that the former is unregulated by any government or financial institution. This is a virtual currency, created with a set of software protocols for generating and monitoring digital transactions. In short, they work on the concept that states that they only have value if the user agrees they do.
How does one obtain a Bitcoin? One option is to buy them from various online exchanges, however, that just might cost a fortune, thanks to the soaring prices due to its popularity and wide acceptance. Another option, through which Bitcoins are circulated and issued, is ‘mining’ them.
The opening price of one Bitcoin, which was less than 1 Cent in 2010, and is now stable at US$7,985 after a bumpy journey,as bigger financial players such as corporate hedge funds enter the picture. With greater investments and a higher demand for this cryptocurrency it is competing against traditional international currencies such as Euro and Yen. Bitcoin recently crossed 1 Million in Yen.
How and when did it all start?
In 1999, a Nobel Prize Laureate in Economics, Professor Milton Friedman stated, “I think the internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing but that will soon be developed, is a reliable e-cash.”
Roughly a decade later, Bitcoin was born.
1998- 2008 ‘Before Bitcoin’
There had been several attempts to formulate and create online currencies with ledgers secured by encryptions and keys. B-Money and BitGold, are two of the most prominent examples. They were formulated but never fully developed. Hence, Bitcoin became the first fully-established cryptocurrency for years to come.
2008 ‘The emergence of an ambiguous Mr.Nakamoto’
In 2008, a paper called ‘Bitcoin- A Peer to Peer Electronic Cash System’ was posted to a mailing list discussion on the topic of cryptography. Satoshi Nakamoto was the ‘author’ of this mysterious paper, whose real identity is still not known, even today.
2009 ‘Bitcoin is born’
On January 3, 2009, Satoshi Nakamoto generated the first block of transactions for Bitcoin, called Block #0. This became the foundation of the blocks to come and was subsequently called the Genesis Block.
Bitcoin Version 0.1 was released and was compiled through Microsoft’s Visual Studio for Windows, and first transaction with Bitcoin currency took place on January 12, in Block 170, between Nakamoto and programmer Hal Finney.
On October 5, a Bitcoin exchange rate was established New Liberty Standard, establishing the value of Bitcoin at US $1 = 1,309.03 Bitcoin or BTC.
On December 16, Bitcoin Version 0.2 was released.
2010 ‘The first real world transaction’
On February 6, The Bitcoin Market was established with Bitcoin as currency exchange. An encryption pattern application, which was filed back in 2008 by Kin,Oksman, and Bry was approved.
A Florida programmer, Laszlo Hanyecz, offered to pay 10,000 Bitcoins for a pizza on the Bitcoin Forum, and made history by marking it as the first real world transaction. The estimated value of the currency paid for that pizza has now exceeded $100 million.
The cryptocurrency garnered interest of tech elites, as well as many merchants online. In 2012, Cameron and Tyler Winklevoss purchased $10 million worth of Bitcoin, and in a span of a year, their investment tripled. It’s been calculated that the Winklevoss twins own about 1% of all available Bitcoin.
Blockchain- The genius behind crypto
Bitcoin is powered by the Blockchain Technology, a contraption by a person or a group of people under the pseudonym, Satoshi Nakamoto. Blockchain allows digital information to be circulated, instead of being copied, and has started an internet revolution. According to Don & Alex Tapscott, authors of Blockchain Revolution, the blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions, but virtually everything of value.
Information shared on a blockchain pertains as a shared and a constant acquiescent database. The blockchain database isn’t stored in a single, specific location, which means that the records are accessible to the public and can be verified with ease. It is hosted by millions of computers simultaneously, and its date is available to anyone with an internet connection and the required hardware.
Online ‘mining’ of this virtual currency is the process by which miners confirm and validate the transactions on the blockchain. Hence, Bitcoins can be ‘mined’ online, which serves a dual purpose: it creates new bitcoins to aid the money supply, and also secures and verifies the entire blockchain, which can be summed up as a public ledger of every transaction. This can also serve to confirm and validate non-Bitcoin transactions, and enables the application of decentralized public ledgers for purposes other than digital currencies. For example, if a company wants to go public, which is an extremely expensive process, they can issue shares directly via the blockchain, which can be bought or sold on a secondary market.
The process of Bitcoin mining
Since Bitcoins are not regulated, controlled, and created by a central government institution, it is not distributed like paper money. Instead, it is ‘mined’ by users who use special software to solve arithmetic equations and puzzles, and are rewarded a certain number of Bitcoin in exchange. Anyone with access to the internet and suitable hardware can participate in mining. The mining process involves the compilation of recent transactions into ‘blocks’ and the participant who first solves the puzzle gets to place the next block on the blockchain and claim the rewards. This is a complex but smart way to issue the cryptocurrency, as it also lures in new users to start mining.
The amount of new Bitcoin released with each mined block is known as the ‘block reward’. The block rewards halve every four years, for example, it started at 50 in 2009, and decreased to 25 in 2014. This will continue to fall, until all 21 million Bitcoins are mined, which is estimated to be done by 2140.
Difficulty in Bitcoin mining
Bitcoin mining is purposely designed to be resource-intensive and difficult, so as to keep the number of blocks found by the users each day remain steady. The difficulty of the puzzles that have to be solved to mine a Bitcoin is relative, and depends on how much effort or strain is put into mining across the network.
The difficulty of the mining is modified by the protocol every two weeks, or 2016 blocks, with the aim of keeping the rate of block discovery constant. If more computers are employed for mining, the difficulty will adjust upwards to make mining harder, and if the computational power is reduced, or taken off the network, the difficulty adjusts downward and mining becomes easier.
Technological requirements for mining
In the initial years following the invention of Bitcoin, mining was done by Central Processing Units from normal desktop computers. As Bitcoins gained popularity, Graphic cards, or Graphic Processing Units (GPUs), became more effective at mining than CPUs, and became more dominant. Now, hardware known as ASIC, which stands for Application-Specific Integrated Circuit and is designed specifically for mining Bitcoins, is the most popular way to mine them. The first ones which were released in 2013, have been innovated and improved, with more efficient designs coming into market.
Since mining now is absolutely competitive, it can be done profitably only by the latest ASICs, since using CPUs, GPUs, or even older ASICs results in the cost of energy consumption greater than the actual revenue generated.
Is it practical to mine Bitcoins?
As of December 2017, 16 million of the total 21 million bitcoins have been mined. The level of difficulty in mining them will only increase, as more and more Bitcoins are mined. Most transactions take place with already mined Bitcoins, as mining has now turned into an elusive and tedious process, and is becoming more competitive, due to the sudden rise in the value and popularity of this Digital currency.
It is not advised to attempt to mine Bitcoins individually, and instead, users join ‘pools’ to form a group for mining together, with expensive and sophisticated hardware, and an enormous investment, as it requires a colossal amount of electricity, 24/7.
Another drawback of mining Bitcoin instead of just buying it, is that there is a barrier to the entry of new users, by a few dominant groups that are in control of the mining operation. Hence, the process of mining has become more exclusive and competitive, and a rookie miner does not stand a fair chance to get the appropriate return against the investment they make.
Hence, unless a user has already been mining for a certain period of time and holds a dominant position in the ‘pools’ of Bitcoin mining, and is ready to invest in expensive hardware and additional costs that are incurred in the process, it is best to buy a Bitcoin instead, which is comparatively easier, given that it is bought from a credible source.
What makes Bitcoin so expensive?
One of the biggest reasons why Bitcoin has witnessed a monumental appreciation in its value over the last decade is the technology behind it. Blockchain itself improves the functionality and applicability of this cryptocurrency, making its price soar.
The limited supply also contributes to the surging price of the Bitcoin. The term mine comes from mining of valuable metals such as gold. Bitcoin–even though mined digitally–has a limited and finite supply. In fact, only 21 million Bitcoins can be mined, in total. This is one of the biggest reasons why this cryptocurrency is getting more expensive by the second, and currently the total number of mined Bitcoins has crossed the 16 million mark.
As the laws of demand state: an increased demand leads to an upswing in the price of a good. Cryptocurrencies work because people accept and trade in that cryptocurrency. It only has value as long as the people believe it does. The factors which increase the demand for this digital currency are many! As enthusiasts see it as a new way of carrying out business, and costs can be lowered significantly due to absence of a central middleman doing the task of tracking transactions and charging for it. Since it is a decentralized currency, it is not regulated by any financial institution. Hence, in the words of Sunil Subramaniam, Bitcoin is a perfect example of demand-supply dynamics, which is one of the biggest reasons why it is so expensive.
Perhaps one of the most significant reasons why Bitcoins are on the rise, is due to its widespread availability and reach. New users are testing the limits of a system, which for almost a decade, had gone untested due to various inhibitions associated with it. One of the biggest reasons why more and more people are investing in Bitcoins is due to improved security and anonymity.
The new and smaller denominations of Bitcoins have made them accessible and affordable to the common people. Thus bringing in more players into the market. Small amounts of Bitcoin used as alternative units are millibitcoin (mBTC) and Satoshi, named after its creators, which is the smallest amount within Bitcoin, amounting to one hundred millionth of a Bitcoin.
Hence, Bitcoins are not out of reach of small investors. That’s why capital is flowing in from new sources and everyone wants to be a part of this revolution. With more demand and more capital this cryptocurrency has become more profitable and desirable.
How can Bitcoin be used?
“Bitcoin enables certain uses that are very unique. I think it offers possibilities that no other currency allows. For example the ability to spend a coin that only occurs when two separate parties agree to spend the coin; with a third party that couldn’t run away with the coin itself.”
The ways in which Bitcoin can be used can be categorised into the following-
1. Spending money discreetly
One of the most awesome qualities of Bitcoin is its anonymity, where members are identified by the ‘public keys’ and not their real world identities. This provides a suitable level of privacy for many users who do not wish to disclose details of their identity, which other traditional digital payment systems do not. For example, people fleeing from dangerous situations, people desiring controversial health procedures, or operating outside the confines of an oppressive government. Hence, Bitcoin can be used to carry out these useful transactions discreetly without the danger of being exposed.
However there is also a flipside to this anonymity as it can be used for unethical and criminal purposes too, the most infamous example being the Silk Road- a massive Deep Web marketplace, that primarily uses Bitcoins and a software known as TOR, to allow users to buy and sell firearms. While this wasn’t the original intent when it was conceived, users are still free to illegally purchase contraband such as illicit drugs and forged identity documents.
2. Cheap money transfers and transactions
One of the main motives behind Blockchain and Bitcoin was to eliminate ‘third parties’ and additional costs incurred while carrying out transactions, which could be avoided. When compared to other electronic payment systems, Bitcoins have a significantly low transaction fees, and is not nearly as costly as the fees on money transfers brokered by banks, credit card companies and commercial softwares such as PayPal.
This low cost of transaction using Bitcoin is especially beneficial for immigrants sending money to families in their home countries, and this is a huge potential demographic for Bitcoin, because the ‘remittance transfer’ industry if quite huge.
International transactions, due to fluctuating and varying exchange rates for different currencies, can be extremely expensive and can take long spans of time to be verified by financial institutions who broker these. Hence, Bitcoin provides a more feasible and quick alternative to the traditional systems of money transferring.
3. Purchasing ‘normal goods’ for day-to-day use
Bitcoins are not limited to a certain section of users who only use it to transfer funds or carry out exotic online purchases. The most unique feature of Bitcoins is that it is widely applicable- it can be used by anyone for purchasing anything.
Bitcoin can also be termed as ‘a natural successor to the fiat currency models’.
As the Bitcoin market grows, users can now use it to simply purchase goods from online retailers, which will stabilize the monetary value of Bitcoin, as consumers will want to spend their Bitcoins, and retailers will see the advantage of accepting it as payment. This is possible due to the low transaction fees, which will cut out additional costs incurred while using traditional digital payment systems, such as authorisations, statements, and customer service fees.
The other unique feature about Bitcoin as a currency is the fact that it has properties such as micro-payments, which are generally not found in other financial systems, and hence, extends the potential to create and develop new financial opportunities and drive for new online marketing strategies and business models.
After all, the first ever real world transaction using Bitcoin was carried out to buy a pizza!
History of Bitcoin for Investors
The controversy that Bitcoin is merely a ‘bubble’ has been circling around ever since its contraption, still affects its price till date, and has labelled it as ‘highly volatile’. Since its introduction over a decade ago, it has encouraged and spurred the growth of entrepreneurial activity and small businesses.
Here is a brief and turbulent journey of this cryptocurrency:
The Meltdown of April 2013
In 2013, the price of Bitcoin crashed for the first time ever, from $233 to $67 overnight, which was a 71% drop in its value, and a loss that took seven months to recover from. This crash came after Bitcoin’s first brush with the mainstream financial market. The currency had never crossed $30 ever since it came into existence, however, due to extensive media coverage, it reached the $200 mark. Some attribute this crash due to rumors about a bubble, which others blame Mt.Gox, the most popular exchange for dealing in Bitcoins at that time.
The Bubble Pop!
For most of 2013, Bitcoin remained at about $120, then the prices jumped and multiplied in November, with an all-time high of $1,150, with another crash in December, bringing its value down to less than $500. It took more than a year for Bitcoin to reach $1,000 again.
Mt.Gox disaster of 2014
The price of Bitcoin was rising consistently after the summer meltdown of 2013. However, in February 2014, the price fell from $867 to $439, a steep 49% drop in price. This created a tumultuous period which lasted till late 2016.
This crash was a result of an announcement made by the operator of Mt.Gox, a trading place for long-time Bitcoin owners, claiming that the exchange had been hacked. The exchange halted withdrawals, and later revealed that hackers made off with about 850,000 Bitcoins!
This incident created existential doubt about the reliability and security of Bitcoin, and its high volatility, and hindered the currency’s value for years.
Selloff of Summer 2017
In early January, Bitcoin crossed the $1,000 mark for the first time in years and saw an abnormal increase in value. By June, it tiptoed to the $3,000 mark, but then fell by 36% to about $1,800 by mid-July.
This was due to speculations and inhibitions about the cryptocurrency, and Bitcoin was comparatively slower than other cryptocurrencies such as LiteCoin and Ethereum. Another reason which contributed to its slow development was that its core developers couldn’t come to an agreement on how to update the software, which in turn gave rise to market jitters and a huge fall in price.
The Chinese Freeze
After insecurities over the fork subsided, Bitcoin went climbed up like crazy yet again, this time touching almost $5,000 at the start of September 2017, before plunging by 37% by September 15, axing over $30 billion from Bitcoin’s total market capital in the process.
The prime reason for this crash could be blamed on China, after it cracked down the ‘Initial Coin Offerings’, there were widespread rumors that the Communist government was going to ban cryptocurrencies altogether.
In response to this, the most prominent exchange in the country, BTC China, announced that it will halt trading within the month itself. This made the prices of Bitcoin fluctuate and flicker.
- A look back at bitcoin price swings in the last five years, which include several stomach-churning tumbles of 40% and even 50%, makes it clear the world’s most popular cryptocurrency was—and is—extremely volatile.
- It’s also apparent that most of the bitcoin crashes coincide with speculative run-ups coupled with exogenous shocks, such as a major hack or a government crackdown.
- Also, in most cases, bitcoin has bounced back from the crashes in months or even weeks—suggesting nervous bitcoin buyers will be okay if they are holding for the long run.
- On the other hand, the crashes of late 2013 and early 2014 are a cautionary tale—recall it took years for those who first bought bitcoin at $1,000 to see their investment recover.
As for whether bitcoin could fall all the way to $5, note how Lee (who wrote an earlier history of bitcoin crashes) said in 2013 “it’s simply too early to tell.” Today, the cryptocurrency market is so much bigger, and has proved so resilient, it appears a safe bet that bitcoin’s floor price will always be well above $5.
Investing in Bitcoin? Here are a few tips to help you make the most of it!
Bitcoin might seem intimidating for fresh and inexperienced investors, however, there are several tips that newcomers can use to maximise their profits and returns:
Buy and sell early
One of the most successful approaches with Bitcoin, for long term returns and holdings, is to buy and hold, and not worry about short term fluctuations. However, if you plan on making instant returns on your investment, the popular phrase used in trading, “Buy the rumor, sell the news” comes into play.
You can be greedy, but don’t be too greedy, as Bitcoin is highly volatile.
Research, Research and Research!
Do your homework, as the more you understand, the better are your chances at actually making a profit. One of the most effective ways of doing this is to look into the technology, that is, Blockchain, to fully understand how Bitcoins work.
Risk is inherent to investment, and enthusiasts should keep in mind that digital currencies are at an early stage of development,when compared to the traditional stock and bond markets. Investors are advised to start small, to test the waters, and as they gain experience in the field, they can slowly, with calculated risks, increase their investments.
Choose the correct Wallet
Bitcoins, like paper money, are stored in ‘wallets’. The primary difference however is that the wallets in which they are stored are digital – and can be offline or online. They also require certain codes or ‘keys’ to be accessed. These passwords are discreet, to keep the expensive Bitcoins safe.
One important factor that comes into play when we talk about Bitcoin wallets is that their passwords or keys can not be guessed by brute force. They use up to 12 characters – a combination of alphanumeric characters and symbols – which means computers of today would require more time than the age of the universe to guess them. Hence, they can only be hacked or stolen – which is not that big a reassurance – considering the fact that Bitcoins are now becoming a hefty investment.
Prevent Wallet thefts
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Although there is no perfect solution to this problem, there are certain calculated precautions users can take to secure Bitcoins and prevent theft:
1.Set up a unique email: before setting up an account with cryptocurrency exchanges like Coinbase, create a separate email that is going to be used for operating that account.
2. Strong password: Be imaginative and unpredictable while creating a password. Use as many alphanumeric characters possible and try not to fall into a pattern or series. Make it as complex and random as possible.
3. Diversify: Don’t store all your currencies in one account. Chances are if one of your accounts does get hacked, the others won’t, due to different emails and passwords.
4. Offline storage: store your access keys and passwords offline, preferably in hard copy and store it in a secure position, as it is nearly impossible for hackers to gain access to passwords stored as hard copies.
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Bitcoin roughly constitutes 45% of the total cryptocurrency market and has seen one of the biggest rises in value. However, there’s plenty, plenty you can do with the blockchain without having to delve into bitcoins. Some popular cryptocurrencies are:
- Litecoin (LTC)
Litecoin was launched in 2011, and was one of the earliest cryptocurrencies to be formulated. It is often referred to as the ‘silver to Bitcoin’s gold’.Created by Charlie Lee, an MIT graduate and a former engineer with Google, it is a global payment network that uses ‘scrypt’ as a code of work, which can be decoded using a CPU’s consumer grade. It has a faster block generation rate than Bitcoin, and hence proves to be a worthy competitor.
- Ethereum (ETH)
Ethereum was launched in 2015 and is a decentralised software platform that enables Smart Contracts and Distributed Applications (DApps) to carry out transactions securely, and prevent interference by third parties. Applications are run on the token Ether, which is a platform specific cryptographic token. It performs more functions, as compared to Bitcoin as it is not merely restricted to carrying out transactions, but can also be used to codify, decentralise and secure trade of almost any commodity.
- Ripple (XRP)
Ripple was released in 2012 as a ‘real-time global settlement network’, and it is aimed to facilitate instant, cheap international payments. One of the distinctive features of this cryptocurrency is that it doesn’t need mining, and hence reduces usage of computing power and minimizes network latency. Ripple believes that ‘distributing value is a powerful way to incentivize certain behaviors’ and thus currently plans to distribute XRP primarily “through business development deals, incentives to liquidity providers who offer tighter spreads for payments, and selling XRP to institutional buyers interested in investing in XRP.”
To conclude, this quote by Edmund.C.Moy, sums up the why, how and future of Bitcoins, as it paves way for many more cryptocurrencies and a more liberal way of carrying out transactions and other forms or trade:
“Bitcoin, and the idea behind it, will be a disrupter to the traditional notions of currency. In the end, currency will be better for it.”