Demystifying: Bitcoins
29 January 2015
Want to know a little bit about Bitcoins? Here’s a “non-techy translation” of why the new cryptocurrency might just make the mainstream…
Bitcoin is a decentralised virtual currency, meaning it neither exists in the physical world, nor does it have a central bank such as the US Federal Reserve or the Bank of England, nor is it controlled by any one entity. Issuing bitcoins and managing transactions is undertaken entirely by the bitcoin network via an opensource design which means that anyone can participate.
Introduced in 2009 by a mysterious programmer known only as Satoshi Nakamoto, bitcoin was initially the domain of tech-savvy. Its rise coincided with the tipping point of the financial crisis in Cyprus in March 2013, when individual savers faced a one-off levy on uninsured sums in order to recapitalise for Eurozone bailout to proceed. The threat of governments being able to “raid a savers piggy bank”, coupled with growing concerns about the online security of financial data in general, suddenly meant that the prospect of a currency free of government regulation became rather more enticing.
Many are however still under the misconception that bitcoin belongs in the criminal underworld, an anonymous instrument for money laundering intent. But just as with cash, the legality of your bitcoin activities will depend entirely on who you are, where you live, and what you are doing with it. Of course, bitcoin is of major – and indeed contentious – interest to tax authorities and legal regulators, all of which are trying to understand how the cryptocurrency fits into existing legal and fiscal frameworks but its usage is perfectly legal, and quite possibly inexorable. Indeed, one of the world’s biggest finance centre, New York, proposed a licensing scheme for bitcoin trading, and here in the UK this Summer, the FCA (Financial Conduct Authority) launched Project Innovate to drive innovation in financial services whilst Chancellor George Osborne announced a new study that will explore the potential role of cryptocurrencies in Britain’s economy – and also withdrew his first bitcoin from a Robocoin ATM!
So what are the advantages of being on board with the bitcoin?
– Speed
Whilst cheques and international wire transfers can take days, bitcoin transactions are generally far faster at less than 10 minutes – or instantaneous if they require “zero-confirmation”
– Low cost
Whereas card card merchants will charge a fee for debit card transactions too, as they have to pay a ‘swipe fee’ themselves, bitcoin transaction fees are minimal or free.
– Secure and private
The conventional banking system relies on trust – in the bank, the merchant, the third part payment processor, etc. We all know that credit cards are insecure – with every transaction you send all of your secret information into the world for hackers to peruse. Bitcoin transactions however require no such sensitive data. Instead, they use two keys: a public key (your bitcoin address) and a private one. When you send a bitcoin, you ‘digitally sign’ the transaction by combining your public and private keys together and applying a mathematical function to them. An unknown miner will verify it (and in doing so earn himself bitcoins) and then the transaction is complete. As long as you don’t do anything inane like posting your private key online, you’re safe.
Bitcoin also affords purchasing privacy. Imagine having a clear plastic purse – everyone can see what’s it in (i.e. the value of the bitcoins via the public key) but no-one knows who owns it…so no-one knows who’s buying what with it.
– Free from all external control
Since the bitcoin is decentralized, no central authority has control and therefore no institution – political or financial – can take it away from you (Suddenly it becomes apparent why Cyprus is home to Neo, the world’s first brick and mortar bitcoin savings institution!) Also, once bitcoins have been sent, they’re sent, and cannot be retrieved without the recipient’s consent which reduces the threat of chargebacks, the kind of fraud seen with credit cards where people make a purchase and then contact the credit card company to effectively reverse the transaction. Plus, the account is solely owned by you, not a third party provider. Anyone who has had their PayPal account arbitrarily frozen due to suspected misuse will know the hoops you have to jump through to clear up the issue and re-access your own funds. With bitcoin, you own the “keys” and no-one can take that access from you.
– Non-inflationary
The process known as quantitative easing means that, if a government does not have enough currency to pay off the national debt, it can print more and inject it into the economy. This causes the value of a currency to decrease – if you double the number of pounds in circulation, you effectively halve the value of the pound, creating inflation which causes the price of goods and services to increase. This can be difficult to control and can decrease buying power. Inflation is not an issue in the bit-world as only 21 million bitcoins will ever be created under the original specification (this does not however mean that the bitcoin is stable…)
– And…a license to print money…
You can buy bitcoins on the open market… but you can also make (or rather mine) your own if you have enough computing firepower. Bitcoins, in blocks of 25, are awarded to miners when their computer generates a 64-digit number from a complex algorithm to verify transactions – with little intervention required…you simply leave the machine on and the software running. Easy money…whereas you’ll probably find that the Fraud Squad will take a rather dim view of printing your own version of traditional currency in your bedroom…
Words of warning before you bite the bit…
The European Banking Authority (EBA), EU’s banking regulator, issued an investment risk warning statement in December 2013 and instructed financial institutions not to buy, hold or sell digital currencies until new rules are in place.
The other issue is stability with price having seen various cycles of appreciation and depreciation– at its peak in November 2013, the value of one bitcoin was $1242 but at the time of writing is currently $580. So there is no evidence that the bitcoin is a self-stabilising currency and some economists regard bitcoin as a bubble waiting to pop..
The bottom line: We’ll be following the market on this potentially game-changing cryptocurrency but for individuals it may be best to be prudent and see what transpires in 2015 as regards political and regulatory acceptance.
Read the full article which appeared in iNsight magazine here: Demystifying Bitcoins