By Brian von Knoblauch
Cryptocurrency and Bitcoin
Over the course of the last decade a new technology has been gaining in popularity and momentum: Cryptocurrency. Bitcoin, the first form of Cryptocurrency, has been mentioned frequently both online and in the media since its inception in 2009, particularly with its recent surges in value. Some have even made the bold prediction that Cryptocurrencies like Bitcoin will eventually become the new global currency. But what exactly is Cryptocurrency and how does this technology work with the current assortment of digital currencies such as the popular Bitcoin?
What is Cryptocurrency and where did it come from?
Simply put, Cryptocurrency is a form of digital money that can be used for transactions without the need for a middleman such as a bank or financial institution to complete the transaction. This new type of currency is designed to keep transactions anonymous and decentralized. The first and most popular form of Cryptocurrency is Bitcoin.
Cryptocurrency was conceptualized in 1998 by Wei Dai, a computer engineer who is well known in the Cypherpunk community (cryptography enthusiasts) for his work in cryptography and cryptocurrencies. Among other things, he is also responsible for discovering the critical cipher block chaining vulnerabilities found in SSH2 (SSH is Secure Shell; a cryptographic security protocol for communication between computers) (Wikipedia, n.d.).
Dai suggested that a new form of currency that relied on cryptography, rather than a central authority, should exist to allow the enforcement of contracts as well as provide a medium for these untraceable exchanges to occur (Dai, 1998). In 2009, an anonymous person (that some people suspect to be Dai) going by the pseudonym of “Satoshi Nakamoto” released a whitepaper (link) that detailed the Bitcoin proof of concept to a Cypherpunk mailing list and laid the groundwork for Bitcoin and the technology behind it. Nakamoto wound up leaving the project a year later but development has grown considerably in the time since then (bitcoin.org, n.d.).
Bitcoins and other cryptocurrencies like it are kept in digital wallets which are stored in the cloud on a network of servers. These wallets exist as a digital address that contains your balance of Bitcoins. According to Statista.com, there are approximately 68 million bitcoin wallets in existence. Much like a wallet in the real world, virtual wallets can be lost (accidentally deleted or forgotten password) or stolen (hacked/phished). Bitcoins can be acquired in two ways: by purchasing them through an online marketplace such as Coinone, Bittrex, and Coinbase, along with many others. They can also be earned by being mined (Chand, 2020).
How does it work?
The basis for cryptocurrencies like Bitcoin is based on a technology called Blockchain which can be described as a digital ledger that stores every bitcoin transaction across a massive digital network. When you perform a transaction with your bitcoins, you connect with one of these servers to perform the transaction. This process uses very complex math to verify the validity of each transaction as well as to authenticate each bitcoin wallet using special digital signatures that correspond to the entities making the transaction. (bitcoin.org, n.d.)
Imagine an Excel spreadsheet that is shared across millions of computers and is designed to be updated instantly whenever new transactions are made. Because it is so widely duplicated, it makes fraudulent activities such as hacking much more difficult due to the same records being stored and processed across millions of simultaneous locations.
The reason this technology is called Blockchain is because each block represents a single bitcoin transaction. These blocks are designed to reference the previous transaction resulting in the creation of a chain of transactions or blocks; hence, Blockchain.
When a transaction is initiated, the block containing the transactional information is sent to the network of miners and is verified. Once verified, the block is added to other blocks creating a chain of transactions. These transactions are then reconciled across the entire network creating a permanent record of the transaction (Dughi, 2018).
Where do Bitcoins come from?
As stated previously, bitcoins can be purchased or mined, but how can something virtual be mined? The answer lies in a distributed system of computers called “miners.” Because Bitcoin doesn’t have a regulated centralized institution that its transactions can go through, it uses this network of miners to process and verify these transactions. This is done by using a “Proof of work” which is a complicated mathematical puzzle used to validate each transaction. When a transaction is introduced to the network, many miners will compete to solve the mathematical puzzle; the first to do so is rewarded via a transaction fee (Arora, 2021).
Anyone who has the time and hardware can setup a computer to mine bitcoins, however, there are protocols in place to keep the distribution of bitcoins under control. New bitcoins are released every 10 minutes but the amount that is released is halved every 210,000 blocks, approximately every four years. When bitcoin started, 50 new bitcoins were released every ten minutes. It was halved to 25 bitcoins in 2012, 12.5 in 2016, and 6.25 in 2020. It is projected that the next halving will occur on March 12, 2024 By reducing the number of bitcoins released its value increases. Some speculate that when the halving occurs, many miners will leave the network due to the lower reward, however, many have factored these halving into their budget to allow them to continue mining (buybitcoinworldwide.com, n.d.).
Like currency based on Gold, there is a limited supply of Bitcoins that can be mined: 21 million. Currently, approximately 18.5 million Bitcoins have been mined (Hayes, 2020) and the 21 million limit is projected to be hit in 2140, however, at least 98% of them will be mined by 2030 (buybitcoinworldwide.com, n.d.).
While technically when the limit is hit there will be 21 million Bitcoins in circulation, the expected number of Bitcoins that will actually be in circulation will be somewhat lower due to lost or forgotten Bitcoin wallets. Even when all the bitcoins have been mined, there will still be incentive for the miners to keep processing payments as the transaction fees for each block processed continue to rise (Hayes, 2020).
Who uses it?
While not all companies currently accept this new form of currency, there are several that do, including some popular retail and food chains; you can buy everything from AT&T services to Pizza Hut pizza using Bitcoin. People also invest in Bitcoin as the value of a Bitcoin fluctuates. This can be done by purchasing Bitcoin fragments (as of this writing, one Bitcoin is currently worth $46,608) or through capital markets such as Greyscale’s Bitcoin Investment Trust (GBTC) (Bradbury, 2020).
Because of the anonymous nature of cryptocurrency, it does not come without controversy. Bitcoin and other forms of crypto currency have been used to finance everything from online black market narcotic sales through places such as the now defunct Silkroad dark web marketplace to donations to entities that the government is not fond of, such as WikiLeaks (McCombie, 2016).
The most common use for Bitcoin is speculation. Just like stocks, people purchase bitcoin when the price drops then sell it off at a profit once the price goes back up. Unfortunately, unlike investing in a company where you can analyze its growth potential, the same can not be anticipated with Bitcoin value. While its value is set by the open market, there is no guarantee that its value will go up (Dahle, 2021).
What does the future hold for Bitcoin?
Will Bitcoin and other Cryptocurrencies eventually replace the most powerful form of currency in the world: the dollar? It seems unlikely considering the instability of Bitcoin’s value. While the dollar does fluctuate and has an approximate inflation rate of 2% per year, Bitcoin has seen wild fluctuations; as much as 350% in its early 2018 surge (Ezrati, 2021).
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