Let’s start at the beginning… Hopefully by asking “What is a Bitcoin?” it is possible for you to begin to decide whether or not to be involved in this phenomenon.
In the last few years there has been a surge in what are known as crypto currencies or alt coins. A crypto currency is a form of digital money that uses strong cryptography to protect it. Just as a real bank note has a wide range of special features that are designed to make it difficult or impossible to copy or forge, cryptography makes it virtually impossible to fake a digital transaction.
In that last paragraph I described it as being “virtually impossible” to fake. The reality is that there are some very smart minds around the world that have focused on hacking and stealing Bitcoins and other currencies, with some success. So while at the moment, in early 2014 as I write this, it is not possible to fake crypto coins, that might change in the future. Your wallet ought to be secure if you take the correct precautions.
Bitcoin was the first of this new generation of crypto currency. There have been others in the past, such as egold, but they did not prove to be secure enough and ultimately failed. The history of those earlier currencies was one of fraud (the notorious HYIPs) and problems.
Bitcoin was introduced in January 2009 by someone named Satoshi Nakamoto. There has been much controversy since as to whether he is a real person, or a group of people, what his real name is and where he or they might live. There are reasons for this confusion.
For example, the initial published research papers that the currency was founded upon have been analysed and there seem to be some grammatical differences between the use of American and English English, leading some people to suggest that Satoshi Nakamoto is actually a collective name for more than one person. Additionally, the original Satoshi needed to have a very deep understanding of cryptography, technology and hardware, mathematics, economics and currencies. Understandably, many people feel that there can be very few people with such a deep understanding, so a group of people is more plausible.
In early 2014 there was significant progress made when a reporter for Newsweek claimed to have found1 the real Satoshi Nakamoto. There have since been counter claims and denials, so the truth may still be untold.
How does Bitcoin work?
His currency uses a complex algorithm that protects each transaction. The algorithm and cryptography are the underlying essence of what is a Bitcoin. This algorithm requires mathematical problems to be solved to authenticate transactions. Over time, the complexity of these math problems is increasing. Each time a group of problems is solved, the person or group of people providing the computing power earns a fee of 25 BTC.
Each of these puzzles enables a group of transactions to be authenticated. Since they are a group, they are known as a block. These Bitcoin blocks can be solved by anyone around the world, meaning that the currency and transactions are visible to anyone, making it impossible for one person, or a small group, to control the currency. Freedom is at the heart of what is a Bitcoin.
The original algorithm was designed to limit the number of BTC that can be created. That number is set at 21 million which does not sound like a lot for the whole world to share. The rate at which new Bitcoins can be created halves every year, meaning that new coins will be created for another 100 years or so. However, as the mathematical problems to be solved become harder and the number of coins being created slowly drops, the value of each coin can reasonably be expected to increase.
The breakthroughs made by Satoshi Nakamoto have enabled the other alt coins to flourish. There are now many more lesser known alternatives. The majority use similar architecture, but with slight modification. For example, Litecoin is one of the major crypto currencies and is almost identical in form, except that the total number of coins to be mined is much larger.
The solving of these maths problems takes some really serious hardware. At the very beginning, new Bitcoin mining could be done on most home computers, but this is not so any more. I have read estimates that suggest that now (2014) if a new miner were to spend US$50,000 on hardware that they might not be able to break even! The hardware is known as a Bitcoin GPU Miner, or a mining rig.
Should You Mine Bitcoins?
However, it is worth pointing out that there are many other crypto currencies in existence. Crypto currency mining is still very possible and profitable with some of the newer coins. This is actually quite a complex area because not only do miners need to understand the hardware requirements, but they also need to calculate carefully which is the best cryptocurrency to mine on a day by day basis. They need to do this by calculating the amount of coins they think they can mine in a day and the value of those coins, against the cost of their equipment and the high electricity bills they will need to pay. Not only do miners pay for to run their equipment, but they need to have some serious cooling in place. The power that runs through their mining rig is focused on the graphics card. A graphics card is expensive and if they overheat and die, they are costly to replace.
What is really interesting is that these new currencies have the potential to make a huge change in the world. Historically, each king and then each nation controlled the coins and supply of money used by their subjects. International trade has operated for hundreds of years between known banks, companies and individuals with national currencies.
Instead, crypto currencies are devolved and owned by no one entity or person – think peer to peer or p2p – and so it is very difficult to imagine exactly how any one person or government could control one. Since many coins are held by the earliest miners, it would take quite an act of will for any one entity to acquire Bitcoins in a large enough quantity to control the market or price.
Have People Got Rich Because Of Bitcoin?
The earliest miners have been able to amass incredible fortunes in just a few years. The earliest computational problems could be solved by using a normal personal computer and coins could be created at a fast rate. At the time, each coin was valued at a few cents, then tens of cents and then upwards towards one dollar. Those that mined and have held onto coins now have amassed personal fortunes as the price of one coin can sometimes swing wildly by one hundred dollars per day and the Bitcoin price is now in the hundreds of dollars each.
In fact, there are a few wallets that are watched very closely by the alt coin and mining community – they are the wallets believed to belong to Satoshi Nakamoto! I have read reports suggesting that the total value of these coins is over US$400 million.
With the early believers holding large blocks of coins like this, it is very difficult to imagine that any one organisation could own enough to control the price. However, if those blocks are never used or sold, they do act as a constraint on supply, supporting higher prices.
The peer to peer nature and the fact that they are virtual and exist on the internet which is now everywhere, means that in years to come they could be a direct threat to central banks and governments. The entire nature of politics, philosophy and economics (as studied at major universities), known as PPE, could be due for a change. While this seems fanciful now, the path of future development is unknown. There will be many business owners, politicians, policy experts, investors and members of the public that are still to ask, “What is a Bitcoin?”.
Is Bitcoin A Currency?
At the time of writing, the answer to that question is a qualified “perhaps”. The number of merchants that accept the coins on their websites is still relatively low, though their numbers are growing quickly. Additionally, the daily prices to convert from BTC to USD or from USD to BTC are still very volatile. Until the Bitcoin value is more stable – prompting users to feel more confident in it – and there are many more stores – both online and offline – that accept it, it’s adoption will be limited. It needs to be an easily spendable form of digital money to really take off. Until then, it will probably remain the techies and early adopters that are making money from this opportunity.
However, we probably judge these issues quite harshly. The major currencies of the world took hundreds of years to evolve into their current form and the first BTC research paper was only published in January 2009. For now, it looks as though it will become the money of the internet.
However, the role of gold was as an early medium of exchange that made transactions possible. In many places, gold was the first form of money. It has since evolved into something else – a store of wealth – and is only really used for transactions by governments. The overall evolution of digital and alt coins might involve something similar. Who can say? Perhaps Bitcoins are the first permanent and successful form of digital money?
One area that is often overlooked is that alt coins have the power to greatly reduce the role of banks. If their adoption were to really take off, not only are they a threat to central banks and political structures, but normal banks would also see their business models threatened. This is a huge opportunity for exchanges – because currencies can be traded into and out of BTC sidestepping the traditional banking system – but also for international transfers. Typically, international wire transfers take several days and the costs can be high, especially for relatively small amounts of money. Cryptocoins offer an alternative to that entire system. In the internet era, there is no real reason why transfers should take so long for most people.
Is Bitcoin Real Money?
This is the ultimate question and one that you will read online almost anywhere where crypto currencies are mentioned. There are certainly some very fanatical people in the BTC world and some equally hardcore deniers3 on the other side of the fence.
A quick visit to a site like CoinMarketCap.com will open your eyes. There are two things that will strike you immediately. Firstly, it is a crypto currency list that (at the time of writing) has 100 currencies. If it is such a flash in the pan, why are there more than 100 coins competing for attention? Secondly, the list shows the value (market capitalisation) of each entire currency in US dollars. Today, as I write this, the market cap of BTC is US$6,988,357,616. Yep, that is almost US$7 BILLION. This stuff is real.
Another great example of the faith being put into this world was shown when, in early February 2014, it was announced that the domain name BitcoinWallet.com had been sold for US$250,0004. Then in April 2014 it was reported that BTC.com had been sold for US$1m5.
Can You Trust Bitcoin?
While you might not feel that you trust Dogecoin, Ripple, Quark or any of the others yet, it is difficult to deny that there is nothing going on in this space. The world hasn’t really taken notice yet, but it will have to at some point.
There is certainly a trust issue for most people when it comes to digital currency. Having read about the subject extensively, my take is that this is simply a lack of understanding on their part. Governments complain that these new currencies are anonymous, but they invented cash!6 They claim that they are used mainly for illicit purchases, which might have been true initially, but is certainly not the case now.
To make a point about a lack of understanding, in early 2014, a man was stopped and searched by TSA in the United States7. The searchers were looking for his Bitcoins. There seemed to be a moment of confusion while the agents looked for something that does not physically exist and the man being searched couldn’t figure out what they were doing.
This level of confusion probably was not helped in March 2014 when the IRS declared that BTC is property and not currency, for the purposes of taxation8 in the United States.
Is Bitcoin Secure?
For the public at large, cash is almost certainly less secure – anyone can pick up a banknote or coin and steal it. However, we have a much better understanding of physical security, such as locks and safety deposit boxes, than we do of cryptography and digital wallets. It seems reasonable to presume that at some point in the future, the security of a Bitcoin wallet will be much more clearly explained to lay people and so trust will naturally increase. When that happens, use will increase, demand will rise and, one presumes, the price per BTC will go up dramatically.
For now, there is a growing but very limited number of merchants selling goods and services in BTC, with even less in Litecoin. There are a few Bitcoin ATMs in the world, but their use and acceptance will likely grow. Some of the earliest locations for an ATM were Austin Texas and Singapore.
Does Bitcoin Have Multiple Uses?
My own personal take on this is that the alt coin world has a lot of development still to come. If we think back to reading about the earliest uses of currency, it was mostly gold that was being used. Then silver and finally other metals such as copper and tin. These days, gold is far too precious to use for a normal everyday transaction. Instead, gold mostly sits in bank vaults and safes for security. To a large extent, silver is treated the same way, though there are industrial uses for silver that make it far more useful than gold. For example, there is silver used in every television set, every mobile phone and almost every other electrical device.
Perhaps it will be the same way with Bitcoin? Perhaps in years to come, one BTC will be far too valuable to use for actually buying goods and services and instead it will be a means of investment, speculation and a store or wealth. Since the algorithmic limit for Litecoin is much higher, perhaps it will serve the role that silver serves for us – partly usable and partly a store of wealth. In which case, there may be another coin that serves the purpose of enabling everyday transactions online. Who knows how this will develop?
Obviously, this will make life more complex for merchants. The current internet economy runs mainly on US dollars. Companies have simple choices to make: do they accept PayPal? Operate their own merchant account? Accept wire transfers?
In the future, they may need to have multiple sets of accounting in place to enable them to accept PayPal and credit card transactions in US dollars, but to also manage and run their own Bitcoin wallet and perhaps other alt coin wallets as well. In the future, shop assistants might need to understand computer and digital security! Can you imagine shop assistants discussing blockchain authentication to pass the time while they calculate a BTC to USD price?
It is worth highlighting that it is not currently possible to buy Bitcoins with a credit card. Since credit card transactions can be reversed but the BTC would have changed hands permanently, the major exchanges do not want to be hit by fraudulent payments. This means that it takes real money to make a purchase, so there is no debt held against the currency. Unlike most national currencies that have some gold and asset backing but much more debt, these currencies are known as fiat, the alt coin world is all wealth. This factor makes the true believers very keen that they are involved in a new ordering of the world.
Can You Make Money Or Even Get Rich Trading Bitcoin?
There are now many people worldwide that do the alt coin equivalent of day trading to earn their living. There has been so much money flooding into the crypto world and services have become more available, making it possible to buy and sell Bitcoins and other currencies during the day to make a profit. All of this sounds just like a real stock market.
For now, the market in these coins is very volatile. It is not unheard of for coins to move in value by 70% in one day. While it is hard to describe this as a bubble, each coin is different and has different characteristics (such as the total overall supply or rate at which new coins are being mined) making it possible to buy and sell with some understanding of the impact on price of supply and demand.
It must be said though that as an “investment strategy” this is about as high risk as they come. For example, during the meltdown of Mt Gox – the world’s largest Bitcoin exchange at the time – the price of 1 BTC fell from over US$1200 to around US$150 in about two weeks. That is a crash of epic proportions as fear and uncertainty gripped the market. There were many people that literally lost the majority of their net worth when Mt Gox crashed. Having watched the Bitcoin price rise further and further they bought more and more, but were unable to sell when the problems began.
Even ignoring that crash, the price of 1 BTC fluctuated wildly during 2013. In terms of a buy and hold strategy, the long-term economics look very favourable. However, literally anything could happen to the short-term price, at any time. Caveat emptor.