The time period we are living in today is often called the information age. It is a shift from the traditional industry to an industry where tons of data are digitalized and accessible online. Now there is a rather new development in this online world, namely Bitcoins.
What is a Bitcoin?
In short, Bitcoin is a decentralized digital currency. However, this does not explain a lot about the Bitcoin concept nor about the advantages it offers. Also, the concept of transferring money online is not exactly new either. Then what is all the fuzz about?
The Bitcoin system is based on an entirely different concept. When you make use of online banking, there are three parties involved: you, the receiver and the bank. The bank is an intermediary that facilitates the transaction. With Bitcoins there isn’t an intermediary party involved anymore, the transactions happen peer-to-peer and this has a few benefits:
- Lower transaction fees: there is no intermediary organization which requires part of the transaction as compensation.
- Not region specific: Bitcoins are not limited to a country and can be used anywhere in the world.
- Anonymity in transactions: since all the transactions are peer-to-peer, there isn’t an intermediary involved that records all the transactions.
How does it Work?
With a (partly) physical currency there is a central bank that is responsible for the money supply. Only the central bank can introduce new money into the economy. Since there isn’t a central bank in the Bitcoin system, that is not an option. Instead, Bitcoins rely on a piece of software that lets people generate their own Bitcoins, called mining. This is done by the use of so called blocks. A block exists of other Bitcoin transactions, a difficult math puzzle and a reference to an earlier block. There is only one block at a time that can be solved and the first person that is able to solve the block is awarded with a certain amount of Bitcoins. The mining industry has already become very popular and specific chips have been developed that are able to mine Bitcoins faster.
For an individual, it has become very difficult to obtain Bitcoins via mining. Therefore, people group together in pools to solve a block together and share the profit based on the input they gave. The software behind the Bitcoin system is open-source and is designed in such a way that the creation of new Bitcoins will eventually stop. When mining sounds like a hassle and might not be worth your effort, you can still obtain Bitcoins. Online exchanges have been opened where you can trade your valuable Euros or Dollars for Bitcoins.
Now you know how to obtain Bitcoins, but what we haven’t covered yet is how a transaction works. Transactions are send from and to a Bitcoin wallet, this wallet in its turn contains Bitcoin addresses. It might sound strange, but Bitcoins don’t actually exist, not even on a hard drive. The only things that exist are records of Bitcoin transactions between different addresses. All transactions are recorded and available online in the so called block chain. If you would like to know the balance of a Bitcoin address, you would have to look up all of the transactions. To set-up a Bitcoin transaction three pieces of information are needed:
- The Bitcoin address you originally received the Bitcoins from, this is called an input.
- The amount of Bitcoins that you would like to send.
- The Bitcoin address you would like to send the Bitcoins to, called an output.
To complete the transaction, it will be signed with your private key, which is secret. It can take up to ten minutes before the transaction is verified by miners.
This explanation of how a Bitcoin transaction works is simplified. The complete process is quite complicated and would require a much longer and more detailed explanation. At the bottom of this blog, you can find a link to a more detailed explanation.
What’s the Catch?
The advantages of the Bitcoin system have been discussed, but there are also some drawbacks of the system that deserve to be mentioned as well. One of these drawbacks is the vulnerability of the system, as there is no way to get your stolen or lost Bitcoins back. Bitcoin wallet providers are often the target of a hack and once the Bitcoins are gone there is no system in place to retrieve them.
While in theory Bitcoins aren’t limited to a country or region, there is still only small amount of businesses that allow you to pay with Bitcoins. Furthermore, the Bitcoin system is very young and it is likely that a successor will emerge that solves some of the problems that Bitcoin faces. Also, due to the uniqueness of the system there isn’t much legislation that covers all the aspects of Bitcoins, which could potentially influence the Bitcoin market a lot. Possible restrictions could cause a collapse in the value of Bitcoins. In fact, that has already happened when the biggest Bitcoin Exchange in China did not except the Renminbi??? What is this? anymore.
The system is also not completely anonymous, since transactions have to be verified. This is done by putting personal information in a block that miners solve to gain Bitcoins. Of course no personal information is disclosed, but your Bitcoin address is. All transactions are stored online and this information is available to everybody. However, you are able to create new addresses for each transaction.
The volatility in the Bitcoin market is very apparent and the obvious reason behind this is the uncertainty that surround Bitcoins. However, that might be about to change. The Winklevoss twins, known for suing Facebook founder Mark Zuckerberg, are planning to set up an exchange-traded fund for Bitcoins. This would allow easy access for investors and would increase the liquidity of Bitcoins.
We have seen that there is a good possibility that the Bitcoin hype will eventually die off and the value of the currency will plummet. Of course there is also a chance that Bitcoin will survive and continue to stay popular. The future of Bitcoin is hard to predict. What can be said though, is that its future is interesting and a lot will happen in the upcoming time!