What is Bitcoin?
Bitcoin is a digital currency or so called “cryptocurrency” introduced as open source software in 2009 by a developer or group of developers under the name Satoshi Nakamoto. With no influence of big corporations or central banks it is purely controlled by a mathematical algorithm. For online retailers, Bitcoins are an interesting proposition since they don’t attract the large fees associated with credit cards.
It is widely believed that the first Bitcoin trade for goods or services took place on May 21, 2010 when Laszlo Hanyecz, a programmer living in Florida, sent 10,000 Bitcoins to a volunteer in England who ordered two pizzas for Hanyecz at a cost of US$25.
How does Bitcoin work?
The system uses cryptography to control the creation and transfer of Bitcoins. Buyers of the coins known as miners verify and timestamp transactions into a shared public database called the block chain and send payments by broadcasting digitally signed messages to the network. The first client software, the so called, Satoshi client, has been enhanced by developers due to open source coding and is known as Bitcoin-Qt. It is sometimes referred to as the reference client because it serves to define the Bitcoin protocol and acts as a standard.
The system is maintained by a decentralised peer-to-peer database recording every transaction in the history of the currency and it uses public-key cryptography, in which pairs of cryptographic keys, one public and one private, are generated. Transactions do not explicitly identify the payer and payee by name and a transaction transfers ownership from one Bitcoin address to another meaning the system is anonymous with its obvious appeal for those with criminal intentions.
Bitcoin’s money supply is predefined by the Bitcoin protocol unlike normal currencies controlled by central banks such as the U.S. Federal Reserve which have the power to print money whenever they like. Currently there are over twelve million Bitcoins in circulation, with a creation rate of 25 bitcoins approximately every ten minutes. The total supply is capped by 21 million.
Users send and receive payments using client software, and approximately every ten minutes, a block of transactions is confirmed and added to a shared public ledger called the blockchain. This ledger prevents double spending and records every Bitcoin transaction by Bitcoin address. The process of confirming these transactions, known as “mining,” rewards participants with newly created bitcoins for their efforts.
When the Bitcoin network launched in January 2009, the block reward was set at 50 bitcoins. However, this reward is programmed to halve approximately every four years, or after every 210,000 blocks. Currently, miners receive 6.25 bitcoins per block, but after the next halving, this will drop to 3.125 bitcoins.
By the year 2140, the total number of bitcoins in existence will be capped at approximately 21 million. At that point, mining will no longer generate new bitcoins, and transaction processing will be incentivized solely by transaction fees.
When Bitcoin was created in 2008, we suspect very few people would have imagined just how serious the project would become. At first it was simply an elegant computer code set up to serve the interests of just a few computer geeks. The virtual currency then took on a life of its own, growing to the point of being an actual means of exchange to buy real assets such as pizza, technology and even casino chips (irony of ironies!). People started trading the Bitcoin in exchanges that popped up around the globe. Not surprisingly, all this increase in popularity brought a great deal of extra attention, but this time from both Central Banks and governments. At first, the US Government dismissed the Bitcoin as just another silly fad but, as its popularity grows by the day, the authorities are focusing in upon potentially regulating this bastion of free currency expression.
Of course, the basic premise for regulation is that they are looking out for the usual money laundering and illegal activities. By highlighting the risks of the digital currency and attaching it to an illegal field, the US Govt hopes it can hide the real threat behind the Bitcoin. Bitcoin is becoming an expression against unsound Government and Central Bank policies aimed at enriching the few while stealing from the many…
The Bitcoin was, of course, created by the mysterious and unknown figure known only as Satoshi Sakamoto, and with a very simple idea behind it. Sakamoto wanted a new currency, entirely independent from governments, which would put the creation of money in the hands of people and, importantly, be limited in its supply. This is the central idea behind Austrian economics. Austrian economists believe that unmanaged money supply eventually leads to better-formed investment decisions and to real wealth generation. Central banks cease to exist, meaning no one can control the money supply.
When it was traded for the first time, one Bitcoin was worth just 10 cents of the dollar. But as it grew in popularity, its price relative to the dollar also rose. In February 2011 it was already trading at parity. With central banks around the world engaging in devaluation policies with their massive money printing, the Bitcoin has continued its seemingly unstoppable rise, in fact just recently, at the time of writing, reaching the heady heights of $400 for one Bitcoin!
At this point, it is embarrassing for the US Government to let the Bitcoin continue to trade higher and higher against the dollar as it raises many issues…
First of all, though designed as on online transaction vehicle, in respect of stability, Bitcoins have been a failure with volatility caused by huge speculation and an insufficient amount of the currency. Additional problems are significant and one of the key areas of worry for users is theft by hackers obtaining encryption passwords through 3rd parties or using Trojan horse malware. It has been found that automated programmes, co called bots, are engaging in covert mining of bitcoins. Bitcoin has also been used by crooks to launder money. In 2013 the FBI shut down the Silk Road online black market and seized 144,000 Bitcoins worth $28.5 million at the time as the currency was being used to buy illegal drugs and firearms.
Second, the US Government is losing potential tax revenue, just like it was with online gambling a few years ago. If there’s a large market, they want to be part of it. First they rule it as illegal. Then, in the tried and tested form, they regulate and tax it. In fact many governments are reviewing their tax status. Britain’s HM Revenue and Customs has advised traders that it is looking at alternatives to the current 20 per cent value added tax on purchases of the coin.
Third, the Bitcoin threatens central banks as it is a substitute for fiat currencies. If people perceive the Bitcoin as a serious project, they will exchange their dollars for the Bitcoin as long as the wanton printing continues, just like they did during the gold standard whenever the Government tried to accelerate money creation.
Some argue one drawback is that bitcoins lack intrinsic value because their value is not backed by hard assets or the full faith and credit of a sovereign government.
In March 2013 a technical glitch caused a fork in the block chain with one half of the network adding blocks to one version of the chain, and the other half adding to another other. For six hours there were effectively two Bitcoin networks operating at the same time, each with its own version of the transaction history. The core developers called for a temporary halt to transactions, sparking a sharp sell-off.
10 years ago, Raoul Pal, head of Global Macro Investor, made a bold Buy recommendation on the Bitcoin. He analysed the Bitcoin in terms of demand and supply and came to the conclusion that 1 Bitcoin should be equivalent to 700 ounces of gold when one equates the underlying supply dynamics of each. That means the correct price for the Bitcoin would be $1,000,000! That’s right, one and six figures! Is he right? So far in December 2024 Bitcoin has been moving moving in the right direction. As ever, only time will be the ultimate arbiter…
Bitcoin – the Future of Money?
Satoshi Nakamoto’s dream of an autonomous currency is an interesting one with Central Banks around the world clearly keeping a close eye on developments. Is this a return to a system similar to the Gold Standard? Maybe, but a system based on a physical asset that can be sold to realise value is very different to a digital algorithm with all the risks of hacking and fraud. It is hard to see how the U.S. dollar, Euro and Yen are going to be displaced any time soon.
At the moment relatively few companies are willing to accept Bitcoins as a transactional currency and this is not surprising given their extreme volatility. Stability is key and the Bitcoin system has a long way to go in that respect. Still at least you know how many Bitcoins are going to exist in the near future unlike the U.S. dollar!
