Bitcoins - should we care?
News has recently been dominated by the development of the value of Bitcoins. The price of the digital currency has risen from 250 USD from beginning November to a record high 1065 USD on December 8th only to drop half of its value in 24 hours again. Chinese government has prohibited national banks to trade in the currency as it indicated the Bitcoin has a high risk of being used by criminals and for money laundering. This has led to Chinese leading social network Baidu, which used Bitcoins as a trading currency, to stop excepting them. China's high powers evidently felt that the cryptocoin was getting too hot to ignore. So is Bitcoin here to stay or is it just another digital hype?
So for those who are not aware of the currency, what are bitcoins and what's it's use? Bitcoins were invented by a developer under pseudo-name Satoshi Nakamoto in 2009. Bitcoins are not tangible but only exist as a piece of code in a peer-to-peer payment network that is powered by its users with no central authority or middlemen. How are Bitcoins created? New bitcoins are generated by a decentralized process called "mining". This process involves individuals who are rewarded by the network for their services. Bitcoin miners are processing transactions and securing the network using specialized hardware and are collecting new bitcoins in exchange for their services. You can compare the function of this network of miners similar to a central bank, authorized to print and distribute the currency. How are Bitcoins used? From a user perspective, Bitcoin is nothing more than a mobile app or computer program that provides a personal Bitcoin wallet and allows a user to send and receive bitcoins with them. Behind the scenes, the Bitcoin network is sharing a public ledger called the "block chain". This ledger contains every transaction ever processed, allowing a user's computer to verify the validity of each transaction. As Bitcoin is a cryptocurrency; for each transaction, the bitcoin receiver shares a public address where the amount can be send to. With a private key, the receiver can then digitally sign the receipt. How do we know it's secure? The Bitcoin specification starts with the concept of a distributed timestamp server. A timestamp server works by taking a hash function of some data and widely publishing the hash. For Bitcoin, each timestamp includes the previous timestamp hash as input for its own hash. This dependency of one hash on another is what forms a chain, with each additional timestamp providing evidence that each of the previous timestamp hashes existed. To form a distributed timestamp server as a peer-to-peer network, Bitcoin uses a proof-of-work system often referred to as Bitcoin mining. Anybody can become a Bitcoin miner by running software with specialized hardware. Mining software captures transactions broadcast through the peer-to-peer network and performs appropriate tasks to process and confirm these transactions. For new transactions to be confirmed, they need to be included in a block along with a mathematical proof of work.
Bitcoins are created at a decreasing and predictable rate. The number of new bitcoins created each year is automatically halved over time until bitcoin issuance halts completely with a total of 21 million bitcoins in existence. When taking todays Bitcoin value (15 dec 2013) of 872USD, this means that the ultimate value in circulation is approximately 18 billion USD. One would consider this is as just a small amount compared to currencies such as Euros and USD's in circulation. But 2 important things should be considered. First the currency is only worth, when it's being used. When money is deposited on a savings bank and not spend, it's useless. Bitcoin payments are easy to make and can be used for small payments against minimum fees. If a bitcoin is being rotated from owner every day, the trading value per year can ultimately develop to 6 trillion USD, more than the Indian yearly GDP. Obviously, the circulation rate will not be once in 24 hours, but the advantages to do so are known. We will come back to that later. Second, a digital currency is a good replacement for national currencies that are non-tradeable or problem plagued. It's best example is the Chinese Renminbi which is only allowed to be exported or used in international transactions on a limit base, ultimately making it less advantageous for consumers to hold on to, unless they travel to China often and have the opportunity to spend it. For this reason Bitcoin is seen as a perfect substitution for Chinese consumers making payments outside of China. One third of all Bitcoin transactions are performed by Chinese. Also when a currency is plagued by volatility, the Bitcoin can be used to circumvent inflation, capital controls, and international sanctions. Bitcoins are used by some Argentinians as an alternative to the official currency, which is stymied by inflation and strict capital controls. In addition, some Iranians use bitcoins to evade currency sanctions.
Another major advantage of Bitcoin payments are that there are either no fees or extremely small fees. Users may include fees with transactions to receive priority processing, which results in faster confirmation of transactions by the network. Additionally, merchant processors exist to assist merchants in processing transactions, converting bitcoins to a currency of choice and depositing funds directly into merchants' bank accounts daily. As these services are based on Bitcoin, they can be offered for much lower fees (a payment of 0.0005 BTC for a 1,000 BTC transfer) than with PayPal or credit card networks (which usually request a 1 or 2% fee over the transaction amount)
Moreover, Bitcoin payments can be considered as secure, controllable and transparent - Bitcoin users are in full control of their transactions; The recipient holds a private key which is kept secret. Only the private key can decode information encrypted with the public key; therefore the keys' owner can distribute the public key openly without fear that anyone will be able to use it to gain access to the encrypted information. All information concerning the Bitcoin money supply itself is readily available on the block chain for anybody to verify and use in real-time. No individual or organization can control or manipulate the Bitcoin protocol because it is cryptographically secure. This allows the core of Bitcoin to be trusted for being completely neutral, transparent and predictable.
Even with the Chinese government banning the speculation of the currency by its banks or act as a middleperson for bitcoin payments, it seems like the Bitcoin use is unstoppable. Just todays issue of Business insider published that a Swedish company has sold 28 million USD worth of bitcoinminers, which has the processing capacity to mine around 4000 bitcoins per day. Techies show that bitcoinmining is lucrative and will stay lucrative until the last Bitcoin has been issued. And with its transaction processing advantage, more and more retailers are allowing customers to pay with the currency, it looks like the Bitcoin is here to stay. At least until a better, cheaper and more reliable currency is on the market.