Bitcoin is a cryptocurrency that has long been attracting the interest of the media, especially those relating to financial and economic issues. Each year, it is gaining a growing number of users. Is it possible to buy products and services using Bitcoin? How does Bitcoin differ from regular money? What opportunities does it offer, and will it become accepted on the market?
A brief history of Bitcoin
In the very first years of the 21st century, nobody has yet heard of cryptocurrency. Nobody even imagined that an alternative means of exchange to traditional money could be introduced to the market. However, with the development of the Internet, the situation has changed. Even before 2009, when the famous Satoshi Nakamoto created the most popular digital currency known today called Bitcoin, attempts were made to create virtual money. These attempts, as it later turned out, were futile. It was the worldwide success of Bitcoin that opened the way to fame for other cryptocurrencies. What is Bitcoin – the new payment system that has conquered the imagination of millions of people around the world. Although at the beginning it was rather just a curiosity and did not spark interest among economists, today even the most eminent specialists are wondering whether cryptocurrency will become a normality in the future. There is no denying that cryptocurrencies offer many advantages and are also free from the many disadvantages of the traditional monetary system. Using Bitcoin as an example, we will present what cryptocurrencies have to offer, how quickly they lose and gain value and why it is worth using them. We will highlight both their positive and negative sides, as well as indicate possible risks associated with the use of digital currencies. Of course, we will also explain How Bitcoin works.
Bitcoin – what is it?
The shortest answer to the question “what is Bitcoin” is: it is the world’s Most famous cryptocurrency. The Bitcoin cryptocurrency system was created in 2009. Its creator, working under the nickname of Satoshi Nakamoto, was actively involved in popularizing his work. The most significant “advertisement” of the new cryptocurrency was an article titled: “Bitcoin: A Peer-to-Peer Electronic Cash System”, in which Satoshi described in detail How Bitcoin works. We encourage curious readers to check out this article as it is an irreplaceable source of knowledge regarding all aspects of BTC. In the following article, we will only go through the most important issues concerning cryptocurrencies, which work in a completely different way compared to regular money in traditional circulation.
Bitcoin is a P2P (peer-to-peer) exchange network. Such networks do not require intermediaries. The subject of the exchange (which in this case is Bitcoin) goes straight into the pocket, so to speak, of another user. In the traditional money system, a bank (as well as non-banking institutions) acts as intermediaries between two parties. The Bitcoin network, in order for it to operate without any obstacles, has numerous security features based on advanced cryptography. Within its framework you can quickly, easily, and safely purchase products and services.
Bitcoins: is it worth investing in?
The most important and most obvious advantage of Bitcoins is their comfort of use. Transactions concluded between network participants are not mediated by any institution, which solves the problem of waiting for a transfer. In the traditional monetary system, this time may vary, depending on the hours of incoming and outgoing sessions in a given bank. Bitcoin transfers are made instantly. Fast transfer execution time is an important advantage. The general access to Bitcoin is also worth mentioning. This currency can be used by people all over the world.
Within the framework of traditional circulation, international trade involves costs. This involves the process of converting one currency into another currency which is valid on the territory of a country. Using Bitcoins saves both costs and time. The funds are immediately transferred to the seller’s wallet, regardless of the country of origin. Moreover, Bitcoin transactions are more secure than bank transfers. Theft happens more commonly among bank account holders. Statistically speaking, the use of a cryptocurrency creates less risk of losing funds.
Moreover, the Bitcoin system is equipped with a Special mechanism to protect against inflation. Its resources cannot increase indefinitely – the limit is 21 million. At present, there are more than half as many Bitcoins. The network does not allow the possibility of “copying” money, as it sometimes happens during economic crises.
The anonymity of persons participating in the transaction is an advantage worth emphasizing. Such anonymity has no place in the traditional financial system. Recent years in particular have shown that government institutions of many countries blatantly violate the privacy of internet users. This is one of the reasons why increasingly more people use cryptocurrencies. And you – do you feel comfortable knowing that government officials have access to your Confidential personal data?
Disadvantages of Bitcoin
Unfortunately, the Bitcoin virtual currency also has its disadvantages. They are not mentioned on the informative websites devoted to it, and yet they are not trivial. The Most controversial issue is the possible use of cryptocurrency in business. The Cryptocurrency network is not controlled by external institutions. There is no central bank that would guarantee the stability of this system, e.g. by defining currency rates. For the reason mentioned above the BTC value is susceptible to speculation. Some economists even believe that the Bitcoin currency is another speculative bubble that will inevitably burst one day. This opinion is shared by Alan Greenspan, former head of the American Federal Reserve, among others. In his opinion, it is enough to look at the graphs depicting the BTC exchange rate to confirm this conviction: the spectacular jumps upwards (in 2017 the rate exceeded $6,000) are generally followed by a drastic fall in value. It is therefore difficult to predict how the value of Bitcoin will develop. This uncertainty is deterring businessmen who might be interested in making transactions using a cryptocurrency.
Another disadvantage is the vulnerability of the network to hacker attacks. They are favoured by anonymity, instant transactions, and lack of supervision of government institutions. Despite advanced security mechanisms, Bitcoins are an attractive loot for cybercriminals. They are used to support illegal businesses, as evidenced by the case of the Silk Road black market, where users made hundreds of transactions using cryptocurrencies. Although it has been liquidated by government institutions, another such market could be created at any time, which would obviously threaten the economic stability of many countries. Therefore, some scenarios of Bitcoin’s further fate assume that the cryptocurrency would be made illegal. This is the price for anonymity, transparency, and a lack of institutional supervision.
Taking all this into account, Investing in digital currency instead of profits can result in severe losses. It is not clear how governments will respond to a digital currency if it becomes widely used. For example, in China, Bitcoins are not exchangeable in banks. In England, Bitcoin is considered private money, which has resulted in the abolition of the need for multiple VAT taxation of transactions made using Bitcoins. The same is true in Germany, where you can pay taxes and commercial transactions using Bitcoin.
Virtual currencies do not have the same legal status everywhere. This is therefore a serious obstacle to their development.
The use of Bitcoin in e-commerce (new money)
Despite the undeniable disadvantages of digital currency, many companies allow their customers to make payments using Bitcoin. These are primarily companies focused on online sales. If you are running an e-commerce business and want to benefit cryptocurrency users, the first step is to set up your own wallet. You can set it up using a mobile application or through a website. Then, you need to provide the e-shop website with a Bitcoin micropayment module. Such services are offered by companies such as BitPay, BIPS or BTC Merch. The way they function is analogous compared to payments made through mediated services such as PayPal, although individual modules may differ in the applied technological solutions. The only obstacle to making wider-scale investments is the Uncertain value of Bitcoin, a shortcoming we have already mentioned. However, this is a topic for a separate article.
How does Bitcoin work and what are blocks?
After discussing the main advantages and disadvantages of the Bitcoin network, it would be useful to describe how it works. We will try to do this in a simple way, so that even the greatest layman can understand how the digital currency functions.
To use an illustrative comparison, let us assume that each transaction in the Bitcoin network is recorded in a ledger. If we transfer Bitcoins to someone, the book will contain a record indicating that a certain number of BTCs have been transferred from our wallet to the recipient’s wallet. All transactions, without exception, are continuously recorded in the ledger, which every user can view. This makes it easy to determine how much BTC should be in a given wallet. Let us show this with an example.
Andrew has 25 BTCs in his wallet;
Andrew sends 3 Bitcoins to Mark;
Andrew sends 2 Bitcoins to Lucas;
Mark sends 2 Bitcoins to Daniel;
Daniel sends 1 Bitcoin to Andrew.
On the basis of these records, which form a block (or chain) of individual transactions, we can easily determine who should own a certain amount of BTC. In our block Andrew has 21, Lucas has 2 BTC, and Mark and Daniel have 1 Bitcoin each. Simple and transparent.
Such a book resembles a publicly available register of all transactions executed within the Bitcoin network, containing information on addresses and the number of BTCs transferred. It is referred to as a blockchain. The system calculates the Wallet balance on its basis. Each user has two keys: a Private and a public key. To check the account balance, it is enough to know the private key that identifies a given user in the transaction block. In each case, this mechanism works the same way.
Bitcoins: is it worth buying them?
The question arises: how does a Cryptocurrency network differ from the electronic banking system we are familiar with? Superficially speaking, everything appears similar. However, the mechanism of operation of both systems is diametrically different. This issue needs to be clarified further.
Traditional money circulation is Centralized. Ledgers, which record all transactions concluded between the network participants, are stored on the bank’s central server and are its exclusive property. The bank may freely modify the entries in these records, obviously within the limits of the law. An outside person can never be sure whether the information contained in the records is still up to date and whether it has not been subjected to any modifications.
This works differently with Bitcoin. The current copy of the ledger is available to all users. Unlike ledgers in a Centralized financial systems, where the records are kept in one place. It is a network created by hundreds of thousands of computers on which the Bitcoin client is installed (a special program that allows you to make payments within the network). Each member of this network has access to a current copy of the ledger. No changes can be made to it, as each transaction is stored once and for all in the block. The Only change allowed in the ledger is the addition of more transactions.
Bitcoin’s deCentralized system solves many of the problems associated with the traditional cash flow. Digital wallet owners do not have to trust any institutions, whether they are Banking or governmental institutions. The operation of the network is based on cryptography, mathematical data and the power of the servers that drive the network. This network is huge. According to estimates, the computing power of the Bitcoin network is several hundred times greater than the total power of the world’s 500 fastest computers. Additionally, it grows further with every new device that connects to it.
The publicly accessible register of all transactions (a blockchain) concluded using a cryptocurrency can be checked by anyone at any time. All you have to do is enter your address (the same as your wallet). After entering it, you gain access to all transactions in which the wallet was involved (whether as sender or recipient). The ledger is made up of the so-called blocks, i.e. single transactions grouped in a chain based on a time criterion (once recorded, the information cannot be removed from the system). Everyone has access to this, and so there is no room for Fraud or manipulation. There is no intermediary on whom you depend. You are only subject to mathematical laws. You can trace the history of every Bitcoin in the blockchain at any time. So we are dealing with a completely transparent financial system, which may be considered optimal in the future.
The Bitcoin wallet: how are transactions attached to a blockchain?
To perform transactions within the Bitcoin network, you must have a wallet that consists of two parts: a Private and a public key. The private key allows you to fully dispose of the funds in your wallet. Therefore, you have to keep it very secure. It is treated like a digital signature, authorizing you to make financial transactions using BTC.
Each Bitcoin is linked in the system to the ECDSA public key (see elliptical curve cryptography). When a “coin” is transferred to another user’s account, a transaction is created in the system where the public key of the buyer is linked to the transferred number of Bitcoins. In order to Complete the transaction, the private key must be used. So no one can send someone’s Bitcoins without knowing the private key that allows for this operation.
This raises another question: how are the recipients of transfers found? The Bitcoin network uses the RIPEMD-160 shortcut function on the public part of the ECDSA key, which serves as a unique address to which Bitcoins are sent. The address is in the Base58 encoding system, which makes it public. This allows it to be freely distributed among network users. It is worth noting that each user can generate any number of such addresses (wallets). You do not have to pay anyone for keeping an account! There is total freedom.
Do you want to earn money? Become a
In theory, any computer owner can “mine” Bitcoins. Mining Bitcoins has a lot to do with gold mining (which was an inspiration for the system developers). That is why the people (or servers) who “mine” Bitcoins are called miners.
To obtain Bitcoin, you need to make the computing power of your equipment available. If no one were to share it, it would be impossible to make transactions using the Bitcoin cryptocurrency. The uninterrupted operation of “server-miners” is essential to the existence of a cryptographic network.
For an average Internet user, who owns average-quality computer equipment, the chance of getting at least one Bitcoin is very low. In order to achieve optimal results, you need to have a Powerful computing power, obtained from a lot of cheap servers.
There are many companies that have invested huge amounts of money in advanced computer equipment and mining new Bitcoins. This process consumes a lot of electricity, so you have to reckon with huge electricity bills. It is not always successful. Mined Bitcoins may unexpectedly lose their value (e.g. from 13 thousand to 10 thousand USD), which entails financial losses. Furthermore, the developers of the system have provided it with a clever mechanism, which is that the more servers try to extract Bitcoins at the same time, the harder it is to do so. The task becomes simpler only when the “miners” become less competitive, which encourages more “miners” to work in a given “area”. Mining BTC is not a matter of chance – it is the result of measurable and verifiable server work that has to be done.
What is the reward for
Transactions in blocks do not save themselves. This is the responsibility of the “miners”, i.e. the server owners responsible for maintaining the network. Theoretically, you too can become a digital miner, although without high-capacity equipment it is impossible to mine Bitcoins effectively. For the network to work Smoothly and safely, you need machines that solve extremely complex mathematical tasks at lightning speed. The more computers with high computing power, the better the chances of profitable “mining”. Of course, this work must be easy to prove (proof of work) in order to rule out any apparent calculations. Currently, the salary of “miners” is reduced by half every 4 years.
A deCentralized Cryptocurrency network exists only because of their work. The bank’s money emission, a characteristic of the traditional financial system, is replaced here by mining, which Means creating (extracting from the system’s resources) more Bitcoins. This is how every new block is created (every 10 minutes on average).
How does this relate to the inflation prevention limit we have already discussed? (Note: there can be a maximum of 21 million Bitcoins in circulation.) How will miners be rewarded when they reach this limit?
The answer is simple: commissions for transactions. Or more precisely: for every block started. It is also a kind of reward – appealing enough to encourage people to maintain the system.
The Bitcoin cryptocurrency has undoubtedly great potential. It is already accepted in many sales and service points around the world (although it is still a very small percentage compared to all places where it could possibly be accepted). On the one hand, it is a pity that such a clever invention still awaits wider acceptance in trade, but on the other hand, it is hard to deny that the use of digital currencies involves some risk. The use of cryptocurrency raises many new problems, unknown to the traditional payment system. The future of Bitcoin is therefore uncertain, as is its value in a month or two (at the time of writing this article its value is $13011.40). Nowadays, cryptocurrency systems are a marginal phenomenon, although there is no shortage of people who believe that they will once become a common standard. But how realistic is this scenario? – We will have to wait and see.