What Is Bitcoin and What Is a Cryptocurrency or Digital Currency
With all the talk in the media about Bitcoin and cryptocurrencies, many people are wondering just what these new computer traded currencies are. First off, it is important to state what they are not. Cryptocurrencies, which are also referred to as digital currencies, are not currencies in the traditional sense. They are not backed by any country, hard asset, or central bank. Yet, they are currencies all the same, since people can use them to buy and sell products and services. To develop an understanding about what cryptocurrencies are, we’ll take a look at what BItcoin is and how it works.
The Incredible Rise of Bitcoin
Bitcoin has gone from being worth less than one penny in 2009 to topping $20,000 dollars in 2017.
Bitcoin's Chart Since Inception
How Bitcoin Started
Bitcoin’s origin is shrouded in mystery since the supposed inventor of this first cryptocurrency has never emerged. Bitcoin started when a person going by the name Satoshi Nakamoto released a paper titled “A Peer-to-Peer Electronic Cash System” in October 2008. To circumvent the traditional currency exchange system and provide a method for verifying and recording Bitcoin transactions, Nakamoto proposed public blocks of computer coded transaction information shared on numerous computers to serve as an ongoing ledger of Bitcoin transactions. Each new block of completed transactions (1 megabyte each) would be added behind the previous block creating a publicly viewable chain of blocks, thus the name “blockchain.”
Nakamoto has never revealed him or herself publicly, and there is speculation that this mysterious founder of Bitcoin may have actually been a team of computer programmers that came up with and started this first cryptocurrency.
Bitcoin officially launched in January 2009 when Nakamoto created the first block of the blockchain by mining 50 coins, which is known as the “genesis block.” In early 2009, shortly after the genesis block was mined, Bitcoin had essentially no value. Eventually, it commanded a price below one U.S. penny until the summer of 2010, when Bitcoins traded for up to eight cents. By early 2011 the electronic coins started to gain traction and reached a value of $1, and the valuation has never looked back since.
How Bitcoin Uses Blockchain Technology to Verify Trades
The power of the public blockchain is that the Bitcoin trades recorded in blocks are shared, verified, and recorded by thousands of computers around the world, so that no one person or group controls the ledger of transactions. This prevents fraud from occurring, since there are many different parties verifying and recording Bitcoin transactions at the same time.
When someone buys or sells Bitcoin, the transaction takes place between electronic Bitcoin wallets, which have digital signatures as a security measure. Since all transactions are shared via the public blockchain, a new transaction can be verified as being legitimate by tracing back the Bitcoins being traded to the block which contains their origin when they were first produced.
The Bitcoin Blockchain Is Designed to Secure Transactions
How Bitcoin Is Created and How Many Will Be Made
After the “genesis block” and original 50 Bitcoins were created, all subsequent Bitcoins have been and will be created by mining for the coins. Mining is a process done by computers, and is an effort to try to capture the next block of transactions and earn Bitcoins. Computers must solve a complicated math formula called a “hash” that is associated with the pending block of transactions. Once the hash is solved and the transactions are verified, the newest block is awarded to the computers that solved the hash and verified the transactions within the block are legitimate. The owners of the mining computers are then awarded newly minted Bitcoins, as well as processing fees associated with the transactions within the block that was added.
Originally, Bitcoin miners were awarded 50 coins for their successful mining efforts. By design, the maximum number of Bitcoins is 21 million. Nakamoto wrote this maximum amount in the Bitcoin code to ensure that endless coins were not produced. The coin awards for successful mining decrease by half over time as specific milestones in the number of blocks are reached, a process called halving. The awards have gone from 50 to 25 in 2012 to 12.50 in 2016. Eventually, they will drop to 6.25 coins until the maximum of 21 million coins have been mined.
Bitcoin Mining Has Become Centralized Among Major Computing Centers
What Other Cryptocurrencies Are Available
There are many other cryptocurrencies besides Bitcoin (BTC); in fact, there are well over 1,000 cryptocurrencies. Most are inconsequential; however, there are some major competitors, including two that are offshoots called Bitcoin Cash (BCH) and Bitcoin Gold (BTG). Litecoin (LTC) is a major competitor. It is nicknamed “Bitcoin Silver,” since it was one of the first cryptocurrencies to follow Bitcoin and is designed to have one quarter of the number maximum coins. Two other major competitors are Ethereum (ETH) and Ripple (XRP). Ethereum is an effort to use the blockchain model to decentralize computing, so that all sorts of computer functions are performed safely by thousands of computers around the world that are part of the Ethereum infrastructure. Ripple is building an extremely fast currency exchange system to trade cryptocurrencies around the world among individuals, businesses and major financial institutions.
How Bitcoin Is Traded and Purchased
Bitcoin is traded on a wide variety of exchanges throughout the world. There is no central trading exchange. As a result, prices for Bitcoin can vary from exchange to exchange, but they generally trade in tandem and within a similar range of prices.
Like stocks, Bitcoin’s price fluctuates in value based on the supply provided by sellers and the demand of buyers at any given moment. One aspect of this new digital currency that is interesting is that unlike stocks, which can have the number of shares increased at any time, the number of BItcoins is capped at 21 million. This means that eventually the supply of these coins will run out, and buyers will have to bid up the price sufficiently to entice coin owners to sell. Although it hasn’t yet reached its maximum issuance of 21 million coins, this pending cap on supply may help to explain the extraordinary moves higher that Bitcoin has made in recent years. There is plenty of demand and limited supply, which naturally causes the price to rise. In reality, the supply may never reach 21 million, since millions of coins are estimated to have been lost over the years by owners that failed to keep track of them properly by holding onto their private keys that prove ownership.
To trade Bitcoin, you must sign up for an account with a company that is able to execute trades on one of the exchanges. Once you have purchased coins,they are placed in something called a “digital wallet.” You can either keep your digital wallet with the company you have your trading account with or you can buy a physical digital wallet, and can download your coins to your own digital wallet to hold onto them. Just keep the private key (a long number) associated with your coins in several places that you will remember, since you will need it to be able to access your coins on your digital wallet in the future, if you wish to sell your coins.
The Future of Bitcoin
The question on many people’s minds as they delve into the world of cryptocurrencies is what is the future of Bitcoin? Of course, the answer to this question is open to speculation; however, using history as a guide, some clues can be found.
The first and initially dominant party to bring a technology to market is not always the dominant player in the long run. From personal computers to web browsers, the companies that originated many of the technologies and once had commanding leads in their respective niches are no longer anywhere near being leaders, or in some cases are no longer involved in the technology at all. This is because others often come up with better ideas and better ways of designing, providing and commercializing a technology than the parties who originally developed it. There are reasons to believe that Bitcoin may suffer this same fate.
Bitcoin is currently dominant due to the fact that it was the first cryptocurrency and has market presence and name recognition that others cannot come close to matching. However, as a practical currency that can be used to process everyday transactions from large currency exchanges to simple retail purchases, Bitcoin falls far short and may eventually be upended by competitors. This is because Bitcoin’s one megabyte block infrastructure and verification procedures are quite slow compared to emerging competitors. It also has much higher fees than many upstart competitors.
The wide adoption of an electronic payment method ultimately comes down to speeds that are fast enough to allow transactions to be processed quickly and transaction costs that are competitive with market rates. The lack of agreement among Bitcoin developers has hampered efforts to speed up processing of transactions, and the design of the platform skews the fee structure to the high side. For these reasons, it is reasonable to assume that while Bitcoin is currently king of the cryptocurrencies, it is likely that it will not remain in its dominant position once the demand for lighting fast transaction verification and small transaction fees drives adoption of other cryptocurrencies that are better in both regards.
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This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
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© 2017 John Coviello