As a technical writer with a Master’s Degree in Computer Science, I write educational essays to enhance understanding topics such as this.
What You’ll Learn
This essay examines how blockchain technology and cryptocurrency will affect banking, commerce, and your money.
- I'll begin with a discussion of Bitcoin and a detailed review of its technology so you'll understand the relationship between cryptocurrency and blockchain.
- Then we'll examine how blockchain is being used in various fields besides cryptocurrency to make business transactions more efficient.
- For completeness, I’ll explain the regulations for paying taxes on cryptocurrency transactions that the IRS enforced in recent years.
- I’ll conclude with a discussion of cryptocurrency becoming a practical means for commerce or merely a valuable asset for holding wealth.
What Is Cryptocurrency?
The main idea of cryptocurrency is to allow for transactions of digital payments between two people with no intermediary to oversee its validity. Blockchain is the software infrastructure behind it.
Bitcoin was the first cryptocurrency. There are over 1,600 cryptocurrencies listed on Wikipedia as of August, 2018.1
What Is Blockchain?
You could think of blockchain as a chain of blocks making up a ledger of all transactions. This ledger is a shared linear transaction log. Once a block is authenticated and accepted, it can never be altered. Due to that, the blockchain securely holds the recorded history of all transactions.
New blocks can be added to the end of the chain. The acceptance of new blocks is called mining and is done by a complex network of computers that analyze new transactions to verify accuracy. Once verified, the new block is accepted into the chain with a hash value representing all previous transactions.
If a hacker modified any block, all the following blocks would become invalid because the hash count would no longer match when the algorithm checks the new block. Therefore, no transactions can be falsified.
What Does 'Mining for Coins' Mean?
Note that I referred to the verification process as mining. Miners run that network of computers. They run algorithms to log new transactions and confirm their validity.
The algorithm they use is called Hashcash. It verifies Proof of Work by calculating hash values of prior blocks and compares that to the stored hash value in the last block in the chain.
If a hacker corrupted any block of data, all the following blocks would contain incorrect hash values and fail the Proof of Work test.
In return for this work, miners receive payment in Bitcoin for their effort. That's why they are called miners—they mine for Bitcoin.
The result of this continuous mining is that no one can arbitrarily modify transactions without the Hashcash algorithm catching the error.
Thanks to this technology, digital payments can be made without third party intervention because the miners verify the transactions. Once verified, the payments cannot be reversed. That eliminates fraud.
This technology is not only useful for cryptocurrency transactions. It can be used for any type of data sharing. I’ll discuss that later in this article under “Acceptance and Implementation of blockchain."
Read More From Toughnickel
Who Invented Bitcoin and Blockchain?
Nobody really knows. A person or a group using the pseudonym Satoshi Nakomoto published a Bitcoin whitepaper describing the idea in October 2008. However, based on forensic linguistic analysis, it’s possible a former law professor, Nick Szabo, is the author of the Bitcoin whitepaper. That had been reported in 2014 by a group of forensic linguistics experts at Aston University.2
The whitepaper solved the problem with digital payment transactions without trust by assuring the integrity of the transactions.
Trust is not a problem when making payments with cash. No one can reverse the transaction. However, when making payments online, a third party needs to be involved as a trusted intermediary. That is where blockchain solved the problem.
Bitcoin was simply the first item of value to use the technology. That soon opened the door for other Cryptocurrencies to follow, such as Bitcoin Cash, Ethereum, and Litecoin. There are many, and each one has its own blockchain with somewhat different structures.
What Causes the High-Volatility of Bitcoin?
Bitcoin reached a value close to $20,000 in 2017 and then fell to hover around $6,000 throughout 2018.
In March of 2020, Bitcoin fell to a low of $4,270, possibly due to COVID-19 uncertainties. However, by December of 2020, it bounced back and reached $24,000. Then, in November 2021, Bitcoin rose to $69,000 before dropping below $35,000 in May 2022.
It’s been a volatile ride, and I wouldn’t be surprised to see other extreme fluctuations. To understand the reason for its volatility, a little knowledge of “Debt vs. Demand” is necessary.
Fiat currency (such as U.S. dollars) is created from debt. The actual reason is beyond the scope of this article, but if you’re interested, I’ve included a link to a YouTube video about “Money as Debt” in the references.3
The point is that the value of cryptocurrency is based on supply and demand, not from debt as with fiat currency. The supply of Bitcoin, for example, is fixed at 20 million coins. Only the demand can change. As demand increases, the value of the Bitcoin goes up.
The reason why it dropped to less than half in January of 2018, in my opinion, is because it was not considered to be a dependable currency for commerce. The verification of transactions by miners is too slow. Therefore, demand has leveled off, causing the drop in value. That’s why Bitcoin Cash was developed, which I'll describe in a moment.
You might be wondering what made Bitcoin gain value again by the end of 2021. It could have something to do with the way the Fed is creating more fiat currency. First, to pay everyone in the United States $1,200 for the Coronavirus Tax Relief. And then in 2021 to continue spending.
In my opinion, people began to realize how the U.S. dollar shrinks in value as more is created. There is a fixed amount of Bitcoin in existence. That will never increase, so as more people purchase it, the price increases. That's how supply-and-demand works.
"Bitcoin Core" Vs. "Bitcoin Cash"
Due to its slow transaction process, Bitcoin has become an instrument to hold wealth, while Bitcoin Cash was designed to exchange value. It also provides a safe online payment system for commerce that does not require a middleman to execute the transactions, and its blockchain is designed for faster transactions.
The original Bitcoin is called Bitcoin Core for the sake of clarity. Its symbol is BTC. The symbol for the newer Bitcoin Cash is BCH. Notice the different letters in the symbol (BTC vs. BCH).
The problem with the original Bitcoin (BTC) is that its blockchain size is only 1 MB. That no longer is large enough to handle the volume. Therefore Bitcoin transactions take minutes, and even hours, to verify. As volume increased, that small size couldn’t handle the transactions in a timely manner.
The algorithms that the miners run to verify slowed down the process with a 1MB size limit. That caused transaction fees to increase, making the use of Bitcoin unsuitable for everyday commerce.
Bitcoin Cash (BCH), on the other hand, was created with a dynamic blockchain. It starts with 4MB but can increase in size as needed. That allows for faster confirmations and lower fees.
The Turbulent Hard Forks of Bitcoin Cash
Bitcoin Cash has had its heartaches. In November 2018, it was split with hard forks creating two individual blockchains. Anyone who had Bitcoin Cash had the same number of Bitcoin Cash and Bitcoin SV, where the total value was equal to what the Bitcoin Cash was worth before the fork.
Then on November 15th, 2020, another fork created individual chains for what is now called Bitcoin ABC (BCHA) and Bitcoin Cash Node (BCHN).
Not all platforms are supporting the forks. Coinbase, for example, only allows sending existing Bitcoin SV one might have to another wallet or platform. They don't support buying or selling it. The same might be true with Bitcoin Node, although at the time of my writing this addition (update), the forks do not show up in accounts.
Only the original Bitcoin SV is present. But the only way to sell it is to send it to another platform that supports it.
This latest hard fork has been the result of disagreements over the tax that miners need to pay.
An Analysis of the 2018 Crash of Bitcoin
I remember seeing Bitcoin with a value of $100 back in 2012. I wish I had bought it at that time, but I considered it too speculative.
Since then, it gained steam, and then in late 2018, Bitcoin and other cryptocurrencies crashed. There is a perfectly logical reason for this. The price had run up prematurely.
The value grew because of all the speculation. Investors saw the rapid growth, and they wanted to be on the bandwagon without understanding the underlying technology of the blockchain.
The design of the Bitcoin blockchain was too limited, as I discussed earlier. It couldn’t handle the high volume, which slowed down the transactions. Buying and selling Bitcoin took way too long to complete.
Using it to make commerce purchases was useless. When you buy coffee at Starbucks, you expect the transaction to be completed in seconds, not hours.
The technology needed improvement, no doubt, and the algorithm for blockchain had been redesigned to allow for future growth with other cryptocurrencies such as Bitcoin Cash and Ethereum.
Bitcoin Cash, for example, had a redesigned dynamic blockchain that can increase in size to allow for growth, as I discussed above.
As of 2018, there were only a handful of merchants accepting Bitcoin for payment. That needed to be widespread before people feel inclined to use it. The market for using Bitcoin in commerce didn’t grow as fast as it’s increasing value in 2018. That may have caused speculators to become worried, leading to a quick selloff.
By 2021, it looks like that's changing. More acceptance and more interest have caused the recent runup in value.
However, another problem may still exist for which I don’t see a solution. The Bitcoin blockchain has proven to be more energy-intensive than traditional payment systems. The process of mining to verify transactions takes enormous computing power. For this reason, miners have to rent office space in towns where the cost of electricity is very low.4