I’m sure a few people (let me have my delusions of grandeur) have noticed that I am a tad involved in the world of Bitcoin. The funny thing is, when asked about what Bitcoin “is” I struggle to adequately find the words (or hand gestures) to encapsulate it all. This is my attempt to wave my metaphorical hands and digital words around into something amounting to “this is Bitcoin”. Now even when I say I am in “Bitcoin” I am incorrect as I am “involved” (meaning I mine, trade and keep up to date) in cryptocurrency in general, use blockchain technology, and have multiple different cryptocurrencies in digital wallets. I know that might be confusing, but there are literally hundreds of cryptocurrenies in the world, but only a few, like Bitcoin, which command the greatest notoriety and value. I’m sure you’ve heard some disparaging things about Bitcoin: that it’s used by drug dealers and terrorists and is extremely volatile in value.
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This is all true. Silk road 1,2 and 3 all made use of Bitcoin for illicit purposes, while the value of Bitcoin went from a low of $90 in middle of 2013 to a maximum of $1200 by late 2013, while crashing back down this year to a current price of around $350. The thing is, that is also very true reflection of many other currencies around the world. The Dollar is still the most preferred currency in use by terrorists and drug dealers. If you think FIAT currencies are not volatile, think again–our Zimbabwean neighbours to the north experienced a cycle of hyper-inflation, producing a 100-Trillion Dollar Zimbabwean Bill, while in Venezuela the local Bolivar has dropped nearly 60% against the US Dollar- quite strong cases for the argument that regular FIAT currencies are stable and not used for illicit purposes indeed.
So, if Bitcoin is to be considered a currency, and if we measure it according to the conditions and uses of regular FIAT currency, i.e buy drugs with it and fund terrorists while being volatile, I think Bitcoin satisfies those aspects well enough to be considered a currency–but a new, vibrant form of it, an Internet Of Money. Now, prepare yourself for a wall of text which will crit you for over 9000 where I discuss the what, why and how of Bitcoin. If you are not in the mood to gain some knowledge and want to get a very condensed TL;DR, just watch the very informative video above. Otherwise just watch it as a primer to this article.
A Satoshi
So, who created Bitcoin? A developer (or group of developers) under the name Satoshi Nakamoto were the first to introduce Bitcoin in 2009 as a decentralised payment system based on mathematical proof instead of a system or currency dependent on a central authority, like a bank or Reserve Bank. Its foundations are couched in the very basic idea that in our digital age money should be transferable electronically more or less instantaneously and securely, its creation and distribution should be decentralised, it should have relatively low transaction fees and it should be anonymous, yet transparent.
You must still be confused; I know I was when I first read about this internet funny money. Fear not, as I will attempt to navigate your understanding as best I can. So firstly….
“What is Bitcoin”
“What is Bitcoin” and what is its difference to regular currency? To put it as simply as I can, Bitcoin is a digital decentralised currency which only exists electronically-no one controls the “system” of Bitcoin; they are not minted or printed into existence by central banks, or controlled by governments like other FIAT currencies in the world. They are brought into existence through any person running software on computers to tackle and solve complicated mathematical problems–the reward for solving these problems is a current dollop of 25 Bitcoin distributed every 10 or so minutes, and distributed to peoples digital wallets relative to the amount of computing power people or groups of people contributed to successfully solve the mathematical problem. To control the supply of these coins over time, of which there will be only 21 million in existence, the rewards do decrease as time progresses, halving at set points in the system. The system started with 50 Bitcoins as a reward, while the current reward is 25 Bitcoins and in 2016 it will drop to 12.5.
So, in a nutsell, that is Bitcoin.
Still confused? If you are, I don’t blame you.
“Why Is Bitcoin”
Let’s take it back a notch; to really answer the question of “what” is Bitcoin, maybe we should pay mind to “why” is Bitcoin. Why Bitcoin exists is due to a number of things, namely coinciding with the rise of the internet and the financial crisis in 2008. Bitcoin addresses the central concern about who controls the economies of the world, and poses the question of who controls the supply of money, and by extension, who controls your money, as well as its digital form.
At the end of 2008, fueled by an abhorrent monetary policy and lax regulatory environment, the resultant effect due to the ability for private investment banks and reserve banks to simply borrow money into existence was becoming salient and dangerous. In the simplest form, people and institutions literally spent money they did not have, creating a massive credit dependent investment bubble, which subsequently popped with the banks getting bailed out by governments, aka, everyone else.
It is obviously much more complicated than I have described above, but one of the central factors leading to the crisis was that the method of currency creation and monetary policy rested squarely through the Reserve Bank’s ability to print money. If you thought that South African, or even American, Reserve Bank (the place that determines how many Mandelas or Washingtons to print) is owned by their governments, think again—they’re primarily private entities with shareholders, not even really accountable to the population at large in much the same way a publicly owned entity is.(much the same way Zuma and his few cronies conduct themselves). In this whole system the creation of currency as a store of value is centralised or “controlled” by one entity, and allows them to wield massive amounts of power which affect the value of your money and how you can effectively spend it.
By contrast Bitcoin is decentralised, meaning no single entity or institution controls the Bitcoin network or the creation and distribution of Bitcoin within the network–we can all participate in its creation by simply joining the network and mining them, although now the easiest way to get Bitcoin is to simply buy it from miners or exchanges. The distribution of Bitcoin into the network is set in digital stone as only 21 million Bitcoins will ever and can ever be created by miners. If one Bitcoin is “lost” it cannot be digitally brought back into existence. These digital coins, like a R1 being divisible into 5c pieces, are also divisible, although by 8 decimal points- 0.00000001 Bitcoin, reverently named a “Satoshi”.
What a typical Mining Farm Looks like now
The second aspect, related to the control of your money, is where some of the more enthusiastic arguments for Bitcoin can be found. You might think to yourself “Surely I am the only one who controls my bank account?” Well, no. You certainly control the physical money in your wallet, but even here forms of external control are present. Inflation, which is when the value of your money depreciates relative to the amount of money in circulation over time, is determined, again, in various ways by the Reserve Bank. This covert force of inflation is like a slow boil, with the effects only felt the longer you have been in the pot of life for some time. Case in point: I remember, when I used to smoke, that a box of Stuyvesant Blue cost R14 back in 2005. Now, nearly 10 years later, they are R28. If I kept R14 from 2005 in jar under my bed, today it would now only buy roughly half the amount of cigarettes=Inflation.
Although types and degrees of inflation are more or less a “natural” occurring phenomenon in money, with Reserve Banks manipulating interest rates to determine inflation, there are more overt forms depicting the lack of control of your digital money which are quite easy to encounter. Have you ever checked your bank account to see that you are being debited for some such service you never signed on for? Or have you simply woken up one day to see that most of your money has been used to recapitalise your bank? The people of Cypress fell afoul of that last year, with any account with over 100 000 Euros legally pillaged, effectively stolen by the bank. Hell, even something like the FNB double billing issue illustrates how fragile our control is over our own digital money.
This feeds into the idea that the money you have in your bank account is simply a bunch of numbers represented on a screen recalled from a digital ledger within a banks central database–these numbers, digital representations of money, are not really controlled by you in any real sense of the term, with a bank able to freeze your account or simply deny you service. The whole system is built on a sense of “trust” which effectively means that when you give a bank your money what those numbers on a screen actually represent is simply an IOU from the bank, a promise, based off of regulated trust, to pay you back in money when you withdraw your numbers. With Bitcoin, they’re still a bunch of numbers on a screen, however the difference is found in the trust-less nature of the records and recording keeping of real ownership: Instead of a central database with records of all our numbers “promised” to us, each entry is entered into a network wide peer-to-peer database in which a record of all transactions and balances of everyone’s “numbers” are stored on everybody’s computer who participates in the network, with each participant directly in control of their “numbers on the screen”. This then leads onto the next core function of Bitcoin…
“How is Bitcoin”
The “how” of Bitcoin is actually quite elegant. The method of generating Bitcoins—distributed mining—is also the same method whereby the network itself is able to securely process the transactions, and perform transparent record keeping of bitcoins within the network, which creates a very secure network, of which the first usage or “app” is to be used as a payment network. Mining, or the proof of work used to verify transactions, is essentially a means to mathematically solve, link and secure every transaction within a digital ledger which is stored on everyone’s computer with all transactions visible to everyone, but with all transactions and balances relatively anonymous. This digital ledger, the Blockchain, is one of the core values which Bitcoin is built upon- an immutable history of transactions and balances which cannot easily be rewritten or controlled by any one entity, but is constantly updated and controlled by all who participate within the network.
Now if we think about the value of transactions, I mean really get down to it, all it consists of is recording a set of numbers as a credit to one person or as a debit to another, then balancing them up to see if we are in the red or in the black. In a physical currency based system, the act of balancing your debt with how much money you have remains relatively simple as you only have enough what is in your possession. Now, once we move into the digital realm, it gets interesting. The problem is that all these transactions, all these credits and debits, are all recorded by a central authority- the bank, which can basically add or subtract the correct or incorrect amounts on the ledger, purposefully or by accident. Like I said earlier just this year I and many other FNB customers were double-charged on multiple purchases, and even though we were all paid back and apologised to, the idea that a banking system can just double charge transactions without my permission is worrying–what else can a bank do with my money, without my knowledge? This system based on “trust” basically failed me, since when I swiped my debit card to pay for R600 worth of petrol I trusted that only R600 was going to be taken from me. Clearly my trust was betrayed.
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This aspect of controlling your digital money is built into the mathematics and cryptography of the Bitcoin blockchain. Earlier I mentioned digital wallets, which are basically where you store your Bitcoin. It is more complicated than that, but for now it’s an adequate representation to think of a digital wallet as a physical one attached to you via a Prince Alfred. Now in the modern banking world the main way to receive or send digital cash is if you have an account at a bank. Beyond the agony that is sitting in a bank queue this also entails having to jump through various hoops of identification and documentation in order to get a bank account tied to a particular identity, i.e. YOU-home address, phone number, ID book- basically all the details needed for one to steal your identity. Bitcoin works similarly, just without the bank or any of your personally identifiable information being involved. To be able to receive or send Bitcoin all it requires is you to download some wallet software, sync up with the network and create yourself a “Bitcoin account” or “public address”(or multiple ones) which are then tied to your particular digital identity.
This “digital identity” is not made up of your home address or a mug shot, but is simply a cryptographically generated “wallet” which acts as the private key allowing the user to control whatever Bitcoin is tied to the “Bitcoin account” or set of addresses. Think of the private key as a pin code that is infinitely more secure that your 5 digit ATM password, and, just like an ATM pin code, whoever has the private key owns the money within the Bitcoin account. Yes, it’s a scary notion to take responsibility for your finances, but if you are the only one who has the ability to send money you control, then no one can take that money away from you without your permission–that double billing problem from FNB would never have happened because I only wanted to pay once, and FNB could not have just created another transaction to pull money from my account. Essentially a Bitcoin payment is a “push payment” system which basically means that the only way Bitcoin can be spent is if it “pushed” out by the owner of the private key. Credit card or debit card payments are called pull payments, which mean when you pay with them you are effectively giving permission to the vendor or retailer to pull money from your bank account. Push is based on individual control, whereas pull is based on trust–which one would you like when it comes to your money?
So, this ability to securely and digitally transact with each other, based on the security of the network to process transactions in a verifiable way, is one of the foundational characteristics of Bitcoin which does not need a third party or central authority to clear digital transactions-i.e, a bank. Let me try illustrating it in as simple a way as possible.
So, Why and How Do You Use Bitcoin?
Now I am no economist or even want to begin to delve into the Philosophy of Money, but in a very basic sense, money is simply a means for transferring value. Bitcoin, as opposed to a forced currency, benefits from the “network effect”, which means that the value something has as a means for exchange for an individual is determined, in part, by others willing to transact with that currency. The more people who want to use it, the more valuable it is, which then makes more people want to use it.
Now to explain using Bitcoin at its non-technical core is actually quite simple, since all of us who have ever paid for something with cold hard cash have already experienced much of what is involved when using Bitcoin. The simple act of opening your wallet at a fruit stand to give R100 for a bushel of apples is astonishingly closer to how Bitcoin works instead of modern day digital credit cards and banking–surprised? I’ll describe a scenario.
When you’re buying R100 worth of apples you physically take the R100 note out of your Prince Alfred Wallet, give it to the fruit vendor, and they allow you to take the R100 worth of apples. You have R0 and the vendor now has that R100; it does not reside in your wallet anymore-you have no control over the R100 as it left your possession completely. The fruit vendor owns it and can stuff it in a stripper’s underwear or snort some cocaine with it. It’s a really simple transaction, with no extra hoops to jump through.
Now imagine that every time you paid with cash you had someone sidle up close to you and stare-while heavily breathing- at the transaction between you and the fruit vendor and once the money was placed in the vendors hand the person audibly beeped and said “Yup, this dude paid, give em dem apples, thanks for using Steve’s Bank, we’ll take a monthly fee to keep beeping”.
That would be pretty weird, right?
Well, this is basically what is happening, minus the heavy breathing, when the process of using a third party, like a bank, is invoked for confirming a digital transaction between two people or parties. With digital cash in a centralised bank, this oversight is necessary since in systems connected to banks the numbers on a screen are monitored constantly, and we pay, directly and indirectly, for banks to keep monitoring those transactions. Do you think it’s free to have credit card or debit card facilities as a payment processor? Nope, there are costs involved to use these digital forms of money, costs which Bitcoin do not have. Clearly there are issues with digitally realised cash in its current form, even though the benefits of “the digital” are tangible, the current security and control of people’s money in banks is just lacking–credit card details are easily stolen, banks can freeze accounts at a whim, reverse or limit payments or they can just outright steal money from its customers-all because there is no actual “money” in banks, just numbers on a screen in a digital ledger which they can control and monitor–something that is not needed anymore with Bitcoin. Paying for apples with Bitcoin would just be sending numbers to a Bitcoin address which the apple vendor controls–the digital equivalent of paying with physical cash.
Bitcoin thus merges the properties of the digital with the “security” and “trust-less” nature the presence of cold hard cash contains in transactions. Bitcoin acts very much like physical money, but one that exists on the internet. You can literally hold hundreds of thousands of Rands worth of Bitcoin, or other cryptocurrency, in the palm of your hand–in a regular USB device or something a bit more robust storing your private keys.
There is so much more I could talk about regarding the features and potential of Bitcoin, but I think I have quite literally #mansplained it too much, to the point where if you have gotten this far, I applaud and salute you. By reading this far and learning, even a little bit, about Bitcoin you are quite literally participating in the biggest experiment to have occurred within the financial and technological space. As a reward for reading this far, and because I need some sort of “anti-slit my wrist” confirmation that some people read this, if you are the first 5 people to download a Bitcoin wallet, either on your desktop computer, on a secure website, or your cellphone, and paste your wallet address in the comment section bellow, I’ll send you a small amount of Bitcoin- just enough to buy yourself a coke! More often that not, simply using the technology makes people see that it’s not that scary, and is quite like internet banking, except without the bank!
I’d just like to leave this final notion in your mind: modern banking and markets derive a large chunk of value from the infrastructural support of the internet. I try to avoid grand sweeping statements, but I just couldn’t resist in this regard. If gold built empires 2000 years ago and oil built empires 100 years ago, then possibly the next great empire is one is leveraging the Internet? Time will tell.
The post Marco’s Musings: What Is Bitcoin? appeared first on #egmr.