Analysis of Bitcoin: Cryptocurrency 


INTRODUCTION


Bitcoin is crypto-currency or software that forms a decentralized, peer-to-peer, world-wide payment system, without the control of any centralised authority. At present, most investors are not really using it like a currency to may payments, but instead, they’re using it as a speculative investment or ‘digital asset’, with the hope to turn it into profit in the future.

The unit of account in this system is ‘Bitcoin’. A ‘Satoshi’ (named after its creator) is the smallest amount within bitcoin, representing 0.00000001 bitcoin, i.e. divisible down to 8 decimal points. A ‘Millibitcoin’ equals 0.001 bitcoin or 100,000 satoshis.

As on date, ‘bitcoin’ has not been accepted as a legal tender in India. Japan and Australia have officially accepted bitcoin as a legal currency.

Advent of Bitcoin System

A domain name, called bitcoin.org registered on 18 August 2008. In January 2009, bitcoin network came into existence using the pseudonym ‘Satoshi Nakamoto’.

However, in spite of many speculations, it is not known who that was, and interestingly, that person or group does not have control over the bitcoin network today.

As per Satoshi’s blueprint, the total supply of bitcoin will eventually be capped at 21 million coins. Of the 21 million in bitcoin due to be mined, about 16.74 million, or roughly 80%, are presently in circulation.

Initially, most bitcoin trading was done in the west, but now the lion’s share is done in China (and traded versus the Chinese Yuan).

According to bitinfocharts.com, in 2017 there are 9,272 bitcoin wallets with more than $ 1 million worth of bitcoins.

Running of Bitcoin Operations

The bitcoin network runs on a software system called ‘blockchain’. The blockchain software can be used to store and send anything of value, so there are companies using it to store documents like property deeds, etc.

In fact, blockchain as a technology is becoming popular among banks and other big financial institutions, who want to use it to settle payments on their back-end systems.

Bitcoin blockchain is a public, decentralized ledger (no central party or institution is in-charge) that records every single bitcoin transaction. Think of it like a library card in the cloud (not the card you use to take out a book, but the slip inside a book that lists all the borrowers).

Hence, blockchain can be described as an unchallengeable digital “ledger.”

Creation of New Bitcoins

The blockchain software resides on thousands of computers, all over the world and is maintained by a mix of ordinary people and more sophisticated computer experts, collectively known as ‘miners’.

Miners use large, expensive computers to find and mine the blocks. Codes running on their machines create new bitcoins by solving complex mathematical computations, which also generates a great deal of heat.

The world’s largest manufacturer of bitcoin mining equipment is Bitmain, based in China.

It may be interesting to know that Bitman consumes about 1400 Watts per hour, similar to an average space heater.

Presently, 16.7 million bitcoins have been created. A fractional amount of new coins gets created every time a miner uploads a block to the blockchain, which is a reward for mining.

Recording of Bitcoin Transactions

All bitcoin transactions are permanently recorded by miners, who upload bundles of transactions, or “blocks,” to the chain, maintained on all those computers. The miners receive a small fee in bitcoin as an incentive to mine.

Miners keep the blockchain consistent, complete and unalterable by repeatedly verifying and collecting newly broadcast transactions into a new ‘block’.

A complex algorithm links it within the blockchain to the previous block through a system called proof-of-work (described ahead).

Blocks of transactions are validated on the blockchain network through computing “consensus,” which is a feature of the software.

Procedure to Buy and Transact in Bitcoins

The first step to buy bitcoin currency is to download a bitcoin wallet, which is a digital wallet that does not hold actual coins (since bitcoins are intangible) or even hold any files.

The bitcoin wallet simply stores (mainly for security purposes) your ‘private keys’, which are strings of numbers and letters that allow you to access your coins. A bitcoin key looks like this: 05GL56JDK45sv754HR7ac.

Next step will be to register with a bitcoin brokerage agency, like the ‘Coinbase’. While registering with the brokerage agency, it makes you answer a number of security questions to get set up with an account.

Once the account is approved by the agency, you can buy bitcoins using money transferred from a bank account and in some cases by charging a credit card.

What you are actually buying is a ‘bitcoin key’, as described above. You can transfer this asset to others for whatever the market price of bitcoin is, minus transaction fees.

Lastly, in order to make transactions you can visit any bitcoin exchange site and sell bitcoins, from your wallet, by entering in your key.

Bitcoin can be converted into ordinary currency based on its value on that date, or even used to make purchases from sellers that accept bitcoin.

Safety & Security Feature

In order to process new transactions in bitcoin, the miners using powerful computers solve complex mathematical problems that add the transactions in a block to the blockchain. This is called “proof of work” and is one of the core features of most crypto-currencies.

Multiple miners are required to verify the work through the process of computing “consensus,” which prevents fraud in bitcoin transactions.

Besides, certain brokerage agencies like Coinbase, asks to provide personal information of anyone who buys or sells bitcoin on their exchange. In case the law-enforcement agencies demand, the exchange will have to provide the info under the same laws that govern banks or brokerages.

The bitcoin blockchain by itself is very secure, but the bitcoins can be stolen from an account by stealing log-on and password info, i.e. ‘private key’ of the account holder and the bitcoin can be sent to another account controlled by the thief. Once bitcoin is transferred, it can’t be recovered.

Implications of Meteoric Rise of Bitcoin Crypto-Currency

Positive Implications

  1. The trend over the previous few years has made bitcoin a good long-term investment that has a long shelf life and whose value generally goes up over time.

  2. Bitcoin is being considered as a genuine innovation that will be around for a long time and help transform money.

  3. Governments across the world have already stepped in, to regulate trading in bitcoin, so that it can become a more established part of the financial system. Hence, it will actually legitimize the currency and broaden its adoption for investors.

  4. Some financial experts see the recent surge in bitcoin market as a bubble that may burst. But because the bitcoin market cap is very small, even if it crashed, it would not have a significant impact on the broader financial markets.

  5. In the recent weeks it has been seen that the global stock market rally has slowed down, but bitcoin has continued to surge higher, which is luring more and more investors to invest in this market.

  6. Slowly bitcoin as a currency is catching on among some retailers, mostly e-commerce: US companies like, Overstock accepts bitcoin, as does Microsoft’s Xbox store, and PayPal and Square allow merchants to accept bitcoin.

  7. The retailers might even encourage customers to pay in bitcoin in future if it costs them less in transaction fees than credit cards do.

Negative Implications

  1. Since bitcoin transfers cannot be traced, bitcoin is often used to purchase drugs or stolen goods or finance other types of criminal activity.

  2. It can become a major source for terror funding across the globe.

  3. It is believed that 40% of the bitcoin are owned by just 1000 people and hence, powerful people or ‘whales’ could collude to influence the price of bitcoin.

  4. Moreover, since there are relatively few buyers and sellers of bitcoin, this market is likely to remain volatility and the ‘whales’ could easily push the price around.

  5. There is a risk that the demand of bitcoin may go down sending its price plummeting. It can happen because of any unforeseen circumstances like, technical problem, regulatory interference, bad publicity arising from the massive amount of electrical power needed to mine for bitcoin, etc.

  6. Bitcoin offers both anonymity and the security of an electronic transaction. Hence, bitcoin can become a substantial gray or black market or a sub-economy where people could hide their income and evade government taxes.

  7. Bitcoin is not as liquid as other investments, firstly because settlement can take more than a week, and secondly, amid panic selling, some bitcoin holders might be unable to sell for a fairly long time, resulting in steep losses.

CONCLUSION

Bitcoin as a crypto-currency is gaining huge popularity. In fact, on 03 March 2017, the price of a bitcoin had surpassed the market value of an ounce of goldfor the first time as its price surged to an all-time high of $1,268.

However, big banks, brokers and financial institutions have warned that bitcoin currency should not be ushered in hurriedly without adequate transparency, regulatory mechanism and risk assessment. JAI HIND