Bitcoin

Bitcoin – a Primer

Bitcoin Understanding-What Is Bitcoin

Room 77 – A trendy bar in Berlin’s Kreuzberg district- suddenly shot to fame in 2011 on account of being the first place officially accepting payments using the Bitcoin.  Within a short span, the entire district was aflame with Bitcoin enthusiasts and paper currency was passé. Bitcoin, today has revolutionized the concept of currency as we know it. Commencing in 2008, it was developed by a person under the pseudonym Satoshi Nakamoto, who is now alleged to be Craig Wright- Australian businessman and computer god.

What Is BitCoin?

Bitcoin is the first completely decentralized crypto-currency in the world or simply put, it’s a payment system that is unregulated and is pseudo-money. In a typical transaction, a third party ensures safety and protocol- and is usually a bank or increasingly- an online payment service provider like Paypal, Visa etc. This is especially necessary in the case of online payments to tackle the double spending problem. For the uninitiated, the Double Spending Problem can be thought of as follows: I have a picture of a rose. I send it to you via mail in return for a real orange. Problem is, even after I have mailed you the picture I still have it. What stops me from sending it to other people in return for an apple and a peach? In a traditional exchange, the third party has a ledger in which notes down all transactions and ensures all entries are reconciled while the physical exchange of money and material too ensures safety. For the virtual world, Bitcoin takes this one step further – Instead of having a private ledger with the third party, Bitcoin has a public ledger. So essentially, all transactions are recorded real time and are available for everybody to see. This process is known as peer to peer distribution. It has transaction logs that can be verified building a block chain and can be viewed by anybody in the system.

Technically speaking, Bitcoin is not the first private currency. We have had digital currencies like Microsoft points/Xbox Live Points, Facebook credits etc for quite some time, although these were limited insofar they restricted the usage to a certain time period and for specific products. We also have payment systems like the Visa, Mastercard, Paypal etc. What sets Bitcoin apart is the scope and anonymity it offers.

How is Bitcoin different from the existing system?

Bitcoin differs from traditional currencies is in its issuance. Typically, a currency is centrally issued. Eg: the dollar, Euro, community currencies like the Arizona Dollars etc. Thus, a currency has the backing of a legitimate authority (typically the government) and is the only medium to settle contracts in, pay taxes etc. Bitcoin, on the other hand, is completely decentralized and depends on the faith of people. Also, there are three functions of any legit currency/ money in general-

  • As a store of value – Stability over a period of time while retaining its value. Money is also the most liquid medium.
  • As a medium of exchange- Tackles the difficulties faced by the Barter system and the issue of double coincidence of wants
  • As a unit of account – All goods and services can be valued in terms of money unlike in the Barter system

However, Bitcoin currently acts as an excellent medium of exchange but faces difficulties with the other two aspects. It is highly volatile and thus not a store of value. When it started off, Bitcoin was less than $1 cent in value but today (5th Nov 2016) it’s about $707! When the infamous Silk Road was brought down, Bitcoin lost 20% of value, which it regained the next couple hours. One of the major reasons for the wild fluctuation is its extensive use in speculative business.

Why have Bitcoins become the ‘in-thing’?

  • Ideological reasons: Surprisingly, more than the economic aspect, Bitcoin gained popularity, especially initially, as a sort of ‘rebellion’ against the ‘nexus’ of the government and the central banks. A very famous example is of Ron Paul –the US politician with his famous ‘End the Fed’ Then there were folks who didn’t believe in the stability of their currency and wanted something that could beat inflation. Most of the early adopters were libertarians, people who wanted to go back to the Gold system, had different political thoughts etc. However, it has also since then, attracted the Leftists- a case in point is Fight For the Future – a group that fights for removal of internet censorship and has become increasingly pro-Bitcoin.
  • Business transactions faster and cheaper: this is true especially of the smaller businesses. A store wanting to move to an e-payment method needs to sign up for different types of fees like the membership fee, merchant fee etc. This easily translates into a 4- 5% charge on the total amount. With Bitcoin, there is no membership fee while the merchant fee is extremely less- barely 1%.
  • Lesser of the two evils: A blanket ban on Bitcoin is virtually impossible and would do nothing but move it underground. At least this way it can be regulated. The authorities aim to regulate the intermediaries like the wallets etc as it is simpler. In fact, many governments across the world have introduced KYC norms for online service providers who deal in Bitcoin.
  • Recorded transactions: Many of us remember the Liberty Reserve shutdown case. Liberty reserve was a centralized digital currency service based out of Costa Rica and was shut down in 2013 over allegations of money laundering and opacity in operations. Sifting through Gigabytes of data is any authority’s regulatory nightmare, and that is if they manage to get the data in the first place. With Bitcoin, a public record is available although it is encrypted. Also, there has been extensive research done in the past few years with the result that many governments have the ability to unlock the user identities.

 

Pros:

  • Faster and cheaper
  • Challenges the duopoly of establishments like the Visa, master card etc, increasing competition and forcing them to improve services.
  • Makes Remittances easier: Bitcoin’s business model minimizes the huge fee (up to 8-9%) charged by service providers like the Western Union.
  • Resistant to Political Pressure and censorship: A case in point is when WikiLeaks released the Cablegates, there was a lot of political pressure which resulted ultimately in PayPal freezing its accounts. The same cannot happen with Bitcoin; The most a government can do is punish a person after the transaction but not stop it altogether.

Cons:

  • Can be used for Terror sponsoring and money laundering: In fact, ISIS is said to use crypto currencies like Bitcoin to fund its activities and bomb attacks.
  • The now closed Silk Road was a haven for drug dealers and used Bitcoin for payments. It felt like Silk Road and Bitcoin were made for each other- one providing an anonymous platform to trade illicit substances while the other used for funding it anonymously without a third party.
  • Even with the Silk road gone, there are plenty of options on the Dark Web, promoting child porn, weapons sale and many other heinous activities
  • Unlike credit cards, you cannot loan money with Bitcoin
  • Not insured against frauds while buying online unlike the regulated debit/ credit cards
  • A variety of services and offers on traditional products like the use of premium lounges while travelling, discounts on trips etc are not available with Bitcoin

What is the future with Bitcoin?

Although Bitcoin has emerged as a popular competition to the dollar, it is nowhere near overthrowing it and this would remain so in the future. There may be places like Argentina and parts of Germany where it is very popular with the community but the traditional money concept is here to stay. However, Bitcoin can be used for a number of innovations:

  • As a source of crowdfunding (similar to the famous Kickstarter service)
  • Micro payments for very small transactions which are not feasible with the current card system owing to the fees
  • Smart property
  • Allowing people to function outside banking purview
  • A decentralized notary service

In the end, we have to remember that Bitcoin provides just a platform and its resilience and growth depends on the use it is being put to. It can be used for taking out capital from a country – as happened in China leading to strict regulations and ban on the banks from dealing in it- or it can be used constructively to do some good – as had happened with m-pesa– a payment system launched in Kenya which uses the increasing popularity of smart phones among people to transfer money, especially in the rural areas having no physical infrastructure. What we do with the technology we create is in our hands and with Bitcoin, there is scope for a lot of good.

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