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Cryptocurrencies and the rise of Bitcoin

So much of our lives now exists only as digital information: photos, diaries, books; so it’s no surprise that money is heading that way also!

Bitcoin is the most famous cryptocurrency in the world: a form of money that has no physical form and is free of government regulation (at least, at the moment). There is no central bank printing the currency; there is no organisation deciding whether or not we need to print more.

So how does it work? Hopefully, this simple guide will explain.

Networks

Bitcoin works because of the internet. Today, millions of computers across the world can connect together and share information or pool computing power. They can form ‘peer-to-peer’ networks, via which information can be sent from one person’s computer to another.

Bitcoin utilises these global networks. Users across the world volunteer to use their computers to record each and every transaction involving Bitcoin. No one person has the entire record: instead, millions of people hold it, and because the information is shared everywhere, if one person tries to alter it, his or her records will be compared to those of everyone else, and rejected. If ten people record a transaction, and one of them tries to cheat, the data will not correspond to the other nine.

Blockchain

The ‘blockchain’ is a chain of blocks of information. When a series of transactions take place, this forms a block of information. These blocks can be compared, and if all information matches, they are added to the chain. Thus each and every transaction, right from the very beginning, is recorded. It’s a global ledger of the history of Bitcoin and all of its users.

Buying and selling

If you join the world of Bitcoin, you will get an account, which is called a wallet. This is where your bitcoins are kept, and from it you can send bitcoins to other people, or receive coins from other people. A special cryptic code (a key) is used to identify that it is really you who is sending or receiving bitcoins.

Volunteering

As should be clear, bitcoin and the whole blockchain rely on lots and lots of volunteers linked together in peer-to-peer networks. These volunteers are using the processing power of their computers to store transaction histories and sequences.

These volunteers aren’t doing this all out of kindness! There is a reward built into the system: for updating the blockchain, a user is rewarded with a number of bitcoins. This process of letting your computer be used as part of the bitcoin network is known as mining. By letting your computer’s power be used to deal with the extremely complicated mathematics and cryptic codes that bitcoin uses, your reward is payment in bitcoins for the amount of work your computer did.

However, as the network expands, the number of bitcoins awarded is decreasing. Indeed, it is expected that the last bitcoin to be ‘mined’ will be around 120 years from now. Thus bitcoin is rare: there is not an infinite supply, and this should help preserve value.

Problems

However, Bitcoin’s price fluctuates wildly for a reason. For something to be valued it should not just be rare; it should also have a use value. How many shops do you see actively accepting Bitcoin as payment? And the intangible nature of this cryptocurrency means to many people it will never be something they desire — ​why want what you can never touch or see? And what if a solar flare from the sun suddenly hit the earth, wiping all computer hard drives, or some other computer failure wiped your Bitcoin wallet? There would be no way of getting that ‘money’ back.

There is also the issue of regulation. States and governments are getting more and more interested in Bitcoin as its value and use grows. Who precisely is using the currency? Is it being used by criminals and terrorists? Are people paying taxes…or avoiding the payment of tax by using Bitcoin? Some form of government regulation cannot be far off — ​and what form this takes will greatly affect Bitcoin’s value.

And what about times of recession? When the economy crashes, people hoard their wealth. If there is only a limited supply of Bitcoin, those with the currency will soon hold a monopoly, while those without will have nothing. If the money supply cannot be artificially increased, will those without cryptocurrencies just starve?

And that is presuming a world of just one cryptocurrency: yet already there are Litecoin, Zetacoin, Peercoin and a host of other Bitcoin alternatives. Which one will have the most value? Which ones are most vulnerable to malware? Are any of them good long-term stores of value?

Limited market

Bitcoin is an interesting development, and the Blockchain technology and concept is bringing about much wider changes. While these cryptocurrencies might find a long-term use in high finance and electronic banking, it is unlikely they will enter into everyday use. This author doubts that, 200 years from now, people will be walking into antiques shops and finding little USB memory sticks full of bitcoins…

Glen Ruffle