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You can't escape them. They're in the news, on entertainment programs or show up in Internet ads. Cryptocurrencies are ubiquitous. But how do they work and how can a single individual, that might not even exist, invent a new currency along with the technical foundation? Though there are now quite a number of cryptocurrencies available, I'll focus on the darling of the digital currency movement: Bitcoin.
It was the brainchild of Satoshi Nakamoti, obviously a pseudonym of someone who wants to stay anonymous. In 2008, he (or she) published his ideas in a paper on a mailing list about cryptography. Later, the first technical paper on the software basics behind the Bitcoin network was also published under the same name. That's where the trail about this mysterious thinker ends. Whether Bitcoin was born out of single mind or an entire group is unknown. The beginnings of cryptocurrencies were equally nebulous with Bitcoins having little monetary value and being used mostly for anonymous payments, e.g. on the darknet.
The concept behind cryptocurrencies is quite interesting with the basic idea being to establish a currency that is free from the influence of banks and states. There's no central bank to control the market and no reckless speculation by investors that so often create bubbles or sink money in questionable projects. Cryptocurrencies also aren't tied to any one nation and this decentralized approach (everyone can be their own bank and help promote the system) helps keep fees low - or do away with them entirely. Security is upheld through constant checks and counterchecks, encryption (hence the crypto in cryptocurrency) and anonymity. Like any other type of currency, cryptocurrencies live of the trust and appreciation of their users. Developing a new currency may be an unusual undertaking but, in the end, it's user acceptance that makes or breaks it.
Generally speaking, there's commodity and fiat money. Commodity money has a value in itself based on the material it is made of. Examples are gold and silver but also cows or cigarettes. These objects have an intrinsic value along with their use as money. Fiat money on the other hand only works because its value is either government enforced or agreed upon by the exchanging parties. In theory, fiat money should always be backed by actual state-owned goods but history shows that there is no definitive certainty or stability to this effect. A few wrong decisions made by governments or banks along with dwindling trust (both nationally and internationally) can quickly bring down monetary systems. In this light, creating a new currency isn't as bizarre an undertaking as it might seem at first. Why should only states and their regulatory bodies have that right? Once a currency is accepted and used by a large number of people, it exists.
The strong security underpinnings of cryptocurrencies are based on blockchains. These are decentralized and distributed digital ledgers that record transactions across multiple computers - a collective accounting system. It's like an association of traders that each record every transaction including those of their fellow traders and then compare their books for maximum consistency. Only when all the sums match is a chapter (block) closed and a new begun. A checksum is then calculated from the previous chapter and added to the next to ensure the correct order of all chapters. Together, the chapters (blocks) form a logical sequence or chain (blockchain). In more technical terms: the blockchain is a huge distributed forgery-proof database that meticulously documents all transactions. Every user owns a digital wallet and keys assigned to each individual credit amount. These private keys authorize users to spend said amounts and must never fall into the wrong hands. With their help, mathematical proof of ownership must be provided for every transaction. Pending transactions are then bundled into blocks and distributed across the network for approval. This highly resource-intensive process is called mining.
For each block, a hash is calculated that is then used by the next block to preserve the integrity of the entire chain. If one of the blocks was to be tampered with afterwards, the hash would no longer match the previous block and the manipulation would immediately become apparent. Since this procedure involves complex calculations including a mathematical puzzle for each iteration, potent hardware is required. As a reward, Bitcoin miners receive transaction fees for each successfully confirmed transaction along with any Bitcoins created in the process. This is a race between all participants, though, with only a single winner every time. Still, mining has become a lucrative business especially in Asian countries and has led to considerable price jumps with many graphics cards.
However, due to technical constraints, the reward halves every 210,000 blocks, i.e. roughly every 4 years. This limits the maximum number of available Bitcoins to about 21 million to guard against inflation and to generate additional trust. While some central banks simply start printing money in times of need, creating Bitcoins requires intensive calculations and becomes harder with every iteration especially since the mathematical puzzles also increase in complexity every time.
If you don't want to mine Bitcoins yourself, you can also buy them at various online brokers. Once you're registered, you can easily exchange "regular" money for Bitcoins. You'll receive a digital wallet along with a public key (similar to a bank account number) and a private key. As described earlier, you'll need the private key to make transactions. Further details like name or address are not required turning this into a very anonymous affair - and a thorn in the side of many governments the world over. Unlike regular currencies, cryptocurrencies are not yet accepted as valid payment methods everywhere but rather considered an object of speculation. If you wanted to buy a car with Bitcoins today, you'd first have to exchange them for regular money. This is slowly changing especially with online shops, however, and, as the level of acceptance rises, it's only a matter of time until you can pay with Bitcoins at Amazon.
Initially, cryptocurrencies were considered an exotic playground for computer freaks and trailblazing investors but the phenomenon has now reached the masses. New currencies sprout up every day only to embark on a roller coaster ride causing financial experts to proclaim the end of the cryptocurrency "bubble" on a daily basis. I for one am eager to see how this complex matter continues to evolve and will surely keep you updated and maybe touch on other related aspects in a later article.
What I would like to know: have you already dived into cryptocurrencies or do you take this boom with a grain of salt?
Just like the stock market, by the time the concept gets down to us, the rabble, the smart money has taken its profit and is moving on.
Someone here compared it to a triangle. A triangle is just a two dimensional pyramid, and that is pretty much what this is. It needs a constant infusion of buyers at the bottom so those at the top can keep feeding.
Like sitting down to play poker with strangers, if after a half hour you can't identify the sucker at the table, it's you.
To "the visitor". You need to explain why it might fall to zero. Being an investor in bitcoin, I see no reason why it would fall to zero other than a technological flaw that made it insecure. Absent that, and if developers can overcome its speed of transaction issues, then it will become an extremely useful medium of exchange. There's a lot of talk of people losing money, but no mention of the people who have increased their purchasing power. There is risk for sure, but given the upward potential if it succeeds, then there is no harm in putting in an amount of money that one is prepared to lose. People do it all the time with Lotto and you don't see lots of people warning everyone about losing their money. There is nothing stopping people purchasing $5.00 worth a week as if they were playing lotto. And it isn't over and done with as with the lotto draw. There's upward potential perpetually over the next 5, 10, 20 years. It might all come to nothing as the critics suggest. But then again, critics were saying the same thing about the internet when it first arrived on the scene.
Sven, I strongly advise you not to post any links that could encourage people to risk their money on crypto currencies. Provideing information about how it works is one thing, but to post a link that is likely to lead to people losing their money without a disclaimer is not ideal. Thousands of people have lost huge amounts of money with Bitcoin and other crypto investments. If someone wants to get involved let them search for it themselves.
You’re absolute right. I already wrote that the article is meant as an explanation not a recommendation to invest in cryptocurrencies. After all, you can never be too careful.
Very interesting, but how do you get it? Also what documents do you have to keep control of your account?
You can purchase Bitcoins through various online brokers.
Another point I'd lime to make is perceived value of BC.
I don't see why people thought buying BC @ 20,000 USD was good value when it was a 20th of that not long ago. It's like a shop selling baked beans at around 1 Euro last year and then selling them for 2,000 Euros the next. Who would want to buy those beans at that price? Many daredevils, I suppose.
Right now it looks like some people are trying to pick the bottom and buying again! Never try to catch a falling knife! BC is in a triangle shape now, with price movements getting compressed. It will break out of the triangle, but often price breaks out in the previous direction: down in this case. Of course it could go up, but never try to guess. Wait fot the price to show you which way it's going.
I agree that now may not be the time to be buying. Whether or not the move is a correction or a potential trend is yet to be seen, but I've heard the expression, "don't try to catch a falling knife", many times in trading webinars, and that's with regulated currencies. If you don't understand how or why something is happening, don't invest because you won't understand how or why all you money got burnt the day after putting it into the market.
A technical issue with bitcoin is that with more acceptance the .dag file gets bigger and bigger. It is larger than 2 gig already. What this means is that all my old graphics cards are now worthless as I cant build a mining rig. I would have to buy an 8gig gaming monster card and spend $800 just to load the ledger file into the program and start hashing away 24/7 at 48cents/Kwhr for 14 days. At least in Adelaide (Aust) where its 44 deg today and my aircon is brocken any mining rigs would be off.
And as Sven said its a race to complete the block, no second place money.
As with any mining boom selling shovels makes the money. Good in principle, but will become harder if billions of people use it.
Thats all I know about bitcoin....Regards Bernie
Eric Burrows, yes, you can buy a part of one.
These complaints about bitcoin, although valid in the immediacy of a short term view, do not necessarily hold up in the long term.
1. Its volatility is entirely understandable given how new and novel it is, and all the fear, uncertainty and doubt that goes with it. Coupled with greed, it cannot be anything but volatile, however, this is no indication of its future or sign that it cannot mature and stabilise as it becomes more widely understood.
2. The high fees are a consequence of the scalability problem, but again, this is no indication of the future. There is plenty of ongoing development in regards to scalability with blockchain. I read of one blockchain network in development that is currently achieving 300 transactions per second. I'm not sure what speed the lightning network aims to achieve with bitcoin, but speeding up the transactions would, without a doubt, lower the fees and bring micro transactions closer to the horizon.
3. That bitcoin is in bubble is not obvious. If it is made to work, then its price would still be low even at $20,000. With a long term view, the current 50% drop just represents a buying opportunity.
Hello Sven.
I like the article, and the depth that you discuss blockchain, but I find it odd that you should state there are no reckles investors speculating to create a bubble. Yet that is what has happened. Sure, maybe not bankers investing, but thousands of normal people with average jobs who may have been convinced by someone at a pub/bar, or by a reckless financial advisor to buy Bitcoin, just before it hit 20,000. I have been apporached by colleagues to open a wallet, and with every increase in value they posted how great it is on social media. That's reckless, especially when you consider the huge swings crypto currencies experience. Now those reckless investors (the normal people) have lost their investment, or at least the value of it. And what about the companies that accepted BC payments when the price was high (less coin needed per transaction), and have now lost half or more of their transactions' value?
While the recent surge in bitcoin price is good news for many bitcoin investors, it should be seen as a death sentence for the functional value of bitcoin. As the price continues to reach new record levels, it becomes obvious that bitcoin is useless for anything else than speculation.
Looking back at Satoshi Nakamoto’s original White Paper, Bitcoin is presented as “a peer-to-peer electronic cash system”, an “electronic coin” that would replace money transfers that are currently controlled by the financial system, and which would be almost immune to fraud.
The extreme value fluctuations of bitcoin effectively make bitcoin useless for its original purpose. Some may remember the world’s first real-world bitcoin transaction where one bitcoin enthusiast bought 2 large pizzas for 10 000 bitcoins. I hope those were tasty pizzas because with the bitcoin price as of today they would be worth 150 million USD. This level of currency fluctuation is usually associated with failed currencies that exhibit extreme inflation levels. An indication of bitcoins lack of usefulness as a currency is that Steam, announced that it would stop taking payments in Bitcoin. Valve, the service’s owner, said it had become “untenable”, owing both to its extreme volatility and the rising costs of using the network.
The latter is also an area where bitcoin is underperforming as a means of payment. In the early days of bitcoin, processing fees where at such low levels that bitcoin was a promising way to process microtransactions. This quickly changed as bitcoin increased in popularity, and where a bitcoin payment cost approximately 20 cents one year ago, the processing cost has now increased to an average of 7 USD, with peak fees as high as 20 USD.
Compared to government-issued currencies, bitcoins wild ride proves that it lacks the necessary predictability to act as a currency. If we take off our tinfoil hats for a while we should acknowledge that currencies are regulated for a reason. To provide financial stability.
I tried to buy fuel and groceries yesterday but all my bitcoins drifted into the ether through a hole in my smart 'phone.
Thanks for your insightful comment! If I ever get to write a second article about it, I'll likely touch on similar points or simply have you write the article for me. :)
So far, cryptocurrencies are a collective mindless swamp of techy narcissists, engaged in shallow mere thinking instead of manifesting BEing Aware. BEWARE !!! It really IS a stinky swamp.
Far be it from me to tout the virtues of cryptocurrency investments. The article is meant to shed some light on cryptocurrencies in general. It's up to the reader to decide what they'll do with the knowledge. :)
Thanks
Importantly interesting
There is nothing like the feeeeel of gold when the power goes down, especially after a massive solar flare. Or just to handle a pound coin. Give me a ducat or sovereign any day. I could buy some coal to keep me warm and a loaf to eat. Then watch the hackers and computer experts with their electronic money begging. Hey ho, I could write this on a slate with a bit of chalk
I felt a great disturbance in the Force, as if millions suddenly resorted to sarcasm and gloated over stock market crashes. :)
QUOTE :"The concept behind cryptocurrencies is quite interesting with the basic idea being to establish a currency that is free from the influence of banks and states. "
Am I the only one seeing the irony here; a system devised to circumvent traditional exchanges ends up being manipulated by the traditional exchanges for rapid profit.
It was to be expected that neither government agencies nor banks would want to observe this trend from the sidelines and it’ll be interesting to see whether the existing degree of freedom can be maintained. China and Korea are currently pressing ahead on this matter.
Hi Sven,
As always, a most interesting eye-opener :)
One thing though: are you sure that [s]he published the first article in 2018 (i.e.: NOW)?
Keep on the good blog-work,
Eric
I’m still getting used to writing 2018 as the current year in my mails. It obviously left a mark on me. :) Fixed!
Thanks for making some sense out of a complex subject. With a bitcoin now valued at around $10000 can you buy a part of one?