Oct 15, 2017
Bitcoin: Why the world needs a Decentralized Currency
Ooooh Bitcoin! A word that has divided opinion like no other in 2017. So, what exactly is it? That’s a question a lot of people have asked me after reading my previous post. I can understand your curiosity in trying to understand what it is or your confusion at what all the buzz is about.
Many people have the same set of questions:
1) What is Bitcoin?
2) How does it work? How does Bitcoin get created?
3) Who regulates or backs bitcoin?
4) How is it different from other currencies or assets?
5) What market drives the price of bitcoin?
6) Is Bitcoin legal?
7) Is Bitcoin anonymous?
8) How do I get a bitcoin?
I promise I’ll answer all these questions. But first I’ll have to deviate a bit and go into one of my classic philosophical rants. So please be patient with me for the next few minutes.
As you can guess, these were some of the biggest headlines during the infamous 2008 World Financial Crisis.
One of the worst financial crisis since the Great Depression of the 1930s was caused by the greed and irresponsibility of some of the world’s biggest banks. As we all know this crisis led to one of the worst cases of widespread unemployment and wealth loss to people and continued on for the subsequent years. One of the trailing consequences was the Greek financial crisis during which a Greek citizen couldn’t even withdraw his own hard-earned money cause the government had locked down everyone’s assets to prevent withdrawals and pay off their debt.
Don’t you think it’s sort of ironical that you place your faith in certain institutions and governments to handle your money and they are the very ones who let you down time and again cause of their mismanagement? You might be thinking, ‘But who cares! My government and its banking system is strong and it will never collapse.’ Sure! That’s great! But you can never say when a country is about to go on the brink of war as the current state of many countries are and how this might affect their economy; be it India vs Pakistan, US vs North Korea or whatever. You’ve got to care cause it’s your hard-earned money.
The internet brought about the necessary disruption to democratize information and make it accessible to the common man. However, all of the world’s banks still follow archaic banking systems and methodologies that make transfer of value very expensive. Heck! My dad has to pay around $30 in net transaction fees just to transfer money internationally from back home to my bank account here in the US. This just showcases how expensive and inefficient banking systems have become cause of all the intermediaries taking their cuts and commissions. Yet we all gladly pay up without questioning it because we trust these centralized institutions so much and because we feel there are no alternatives. Do we really need to though?
What if I told you there was a way to democratize value exchange in the same way that the internet democratized information and made a lot of age old newspapers and media powerhouses redundant in the process. Yes! I’m talking about Bitcoin, Cryptocurrencies in general and their underlying technology called the Blockchain (I shall talk more on other Cryptocurrencies and the Blockchain technology in future posts).
Now Bitcoin was started on January 3rd, 2009 by Satoshi Nakamoto as I had mentioned in my previous post. If you notice something, what’s interesting is that this date is right after the 2008 Financial Crisis. And what’s even cooler is what Satoshi embedded in the hash of the Genesis block of the Bitcoin Blockchain (I shall explain what a hash, Genesis block and Blockchain are in future posts. But just consider the Genesis block as the cover page of this ledger called the Bitcoin Blockchain and the hash as the summary of this cover page).
He embedded the following line from ‘The Times’ newspaper:
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”
This was Satoshi’s way of telling the world that he indeed started Bitcoin on January 3rd, 2009 and also as a possible poetic mock at the fractional reserve banking system.
Now enough gyaan and back to those questions!
1) What is Bitcoin?
First, so what exactly is Bitcoin? Well, one of the definitions for Bitcoin is that it’s a decentralized digital currency and payment system that uses a public and immutable cryptographically secured ledger. If you have no idea what any of those terms mean, that’s totally fine!
Let’s break it down. So, we got that it’s both a currency and a payment system and that it exists digitally. This means that there is no physical or tangible copy of bitcoin, i.e., any form of printed currency or minted coins.
Next, we say that it’s decentralized (Note that this is one of its most important properties). What exactly does that mean? It means that it runs on a worldwide peer-to-peer network and that there’s no central entity or administrator for the currency like a bank or government, such as the Reserve Bank of India for the Indian Rupee or the Federal Reserve for the US Dollar. Now you might be thinking, so who exactly enforces the rules of the currency? I shall be answering that in questions 2 and 3.
And finally, the public and immutable cryptographically secured ledger. Well this is your Blockchain which the Bitcoin protocol uses. I shall dedicate an entire future post to explain the Bitcoin Blockchain. Just note that this is what makes Bitcoin tamper-proof from external entities or malicious users.
2) How does it work? How does Bitcoin get created?
Since it’s a peer-to-peer payment system, there is no central authority to ensure that all transactions in the Bitcoin system are valid. So, all transactions are validated through a process called “Mining”. This is part of Bitcoin’s consensus protocol called Proof-of-Work which requires all mining participants of the network to spend computational cycles to solve a very difficult cryptographic puzzle (This is the mining process and it discourages random participants in the network from being malicious and messing with the transactions).
Now you might be wondering what are these people gaining by unnecessarily wasting their CPU Power and electricity. Well, here comes your answer to the second part of this question and which I personally believe is ingenious. To incentivize these random people to perform this “mining”, they are rewarded with Bitcoins by the protocol (Remember me mentioning about this in my previous post?) and that is how Bitcoins are generated and released into the system. So, if you think about it, it’s very similar to how you mine gold from the earth and release it for distribution.
3) Who regulates or backs bitcoin?
As mentioned above, no specific entity or organization regulates or backs bitcoin. It’s backed by pure Math and Cryptography. If that scares you, it’s fine. But just know that you can’t corrupt Math or Cryptography like you can physical entities. So just keep in mind that Bitcoin is tamper-proof.
On a side note, all those hacks such as the Mt.Gox hack that you hear about in the news are not cause of any shortcomings in the Bitcoin protocol or the Blockchain. It happens at any point where centralization happens such as an Exchange and where there are human points of vulnerability. You can truly only tamper with the Bitcoin Blockchain if you have invented a quantum computer in your backyard.
4) How is it different from other currencies or assets?
Bitcoin and other cryptocurrencies should be considered as a completely different asset class and should not be categorized as one of the existing fiat currencies or assets. This is because they have a mix of properties of different asset classes. It has the safe haven and limited supply property of gold and land. And it also facilitates easy exchange and transfer like regular fiat money. Further it’s backed by Math and Cryptography, unlike fiat currency which is backed by the faith on the government or bank issuing it.
Bitcoin can also be carved up like land into multiple sub-pieces (It has a lower bound though; 1 BTC = 10⁸ Satoshis). A common misunderstanding cause of the term ‘Coin’ is that you can only own a bitcoin as one piece, i.e., 1 BTC. But that’s wrong cause you can even own 0.001378 BTC.
5) What market drives the price of bitcoin?
Well, the free market drives the price of bitcoin. And it’s reached record heights. 1 BTC is now worth around $5790. This is nearly $1000 more than what I had written in my previous post a few days back.
And I feel it would be wrong for you to compare this rise of bitcoin to the ‘Tulip Mania’ and call it a bubble. Because, unlike Tulips, Bitcoin has a utility as both a payment mechanism and as a store of value. If anything, Bitcoin should be compared to Gold or Land, which also have utilities apart from a store of value and are considered as safe havens. The short-term volatility should subside once there’s widespread adoption.
6) Is Bitcoin legal?
Well it’s not been deemed illegal yet in any of the two countries that I’m interested in, i.e, India and United States.
· India:
On 28 December 2013, the then Deputy Governor of the Reserve Bank of India, K.C. Chakrabarty, made a statement that the Reserve Bank of India had no plans to regulate bitcoin.
· United States:
The U.S. Treasury classified bitcoin as a convertible decentralized virtual currency in 2013.
The Commodity Futures Trading Commission, CFTC, classified bitcoin as a commodity in September 2015. Per IRS, bitcoin is taxed as a property.
In September 2016, a federal judge ruled that “Bitcoins are funds within the plain meaning of that term”.
The legality of Bitcoin in other countries can be found here.
7) Is Bitcoin anonymous?
Bitcoin is not exactly anonymous, it’s rather pseudo-anonymous. There’s no physical identity associated with any of the addresses on the Bitcoin system. However, all transactions from any address can be tracked as it’s all public and transparent (Remember the definition of Bitcoin?)
So, if you’re planning on doing any shady business using bitcoin: Please don’t! You can be tracked the moment you come to any exchange to convert that Bitcoin to US Dollars or Indian Rupee.
8) How do I get bitcoin?
Well there are a couple of ways to get bitcoin.
- Get it Transferred:
The easiest way is for someone who already owns bitcoins to transfer some to you. It hardly takes a few minutes to setup a wallet where you own the private key (This requires some caution if you don’t know what you’re doing. You could easily lose access to your wallet if you forget your private key).
The best part of this is that no one knows you’re associated with that bitcoin address. You’re anonymous until you try to get that bitcoin out of the system into some fiat currency.
2. Exchanges:
The second method is for you to buy from some exchange. This is how most people do it.
In India, there are a couple like Unocoin, Zebpay and Coinsecure. In the US, the most famous one is Coinbase. In the Gulf and Middle East regions, there’s BitOasis. LocalBitcoins is a good peer-to-peer exchange and facilitates anonymity if you’re into that. Though there are chances you could get scammed. Shapeshift allows you to convert from other Cryptocurrencies. Some of the other notable ones are Kraken, Gemini and Poloniex.
There are some advantages and disadvantages to buying from an exchange that I may explain in a later blog post.
3. Mining:
The hardest way is for you to actually “mine” bitcoins. This is not at all recommended nowadays as you’re not going to get anything unless you own a Mining Farm in China.
I would like to sign off this blog post by stating one of the unofficial mottos of Bitcoin: “Vires in Numeris”. It means ‘Strength in Numbers’ in Latin. It’s an interesting choice for a motto because it alludes not only to bitcoin’s cryptographic nature but also to the fact that it’s a currency run by the people.
Goodnight folks!
