To debunk some common misconceptions surrounding bitcoin, we will break it down into two primary components. The first is a piece of code which represents ownership of a digital concept – more like a virtual IOU, referred to as ‘bitcoin-the-token.’ The second segment is a shared network that keeps a ledger of balances of bitcoin-the-token, called the ‘bitcoin-the-protocol.’ Both are called “bitcoin.”
The system allows users to make transactions without having to go through a bank or other forms of central authorities.
The creation and holding of this new form of asset class known as cryptocurrencies are electronic based. Despite sharing some characteristics of conventional currencies like dollars or pounds, bitcoins are not printed. Instead, they are created by computers globally with the help of free software programs.
Who invented it?
In 2008, a software developer under the pseudonym of Satoshi Nakamoto – whose real identity no one knows till today – invented bitcoin as an alternative to traditional payment systems. The idea was to create an independent means of exchange that could be conveyed electronically in a secure, verifiable and immutable way.
At this point, you might find yourself wondering; well, what makes this bitcoin so unique? How is bitcoin different from the Dollars, Euros and other forms of currencies? How does it work?
Here are some essential characteristics that distinguish bitcoin from other traditional currencies:
1 – Decentralization
The most important characteristic of the bitcoin system is that it is autonomous and can’t be controlled by any financial institution. Volunteer coders on an open network of dedicated computers spread around the world run the system. This feature attracts people who people who are not feeling convenient with the fact that their money can be easily controlled by financial institutions.
2 – Limited supply
Unlike fiat currencies such as dollars, euros, yen and the likes that have an unlimited supply, bitcoin’s supply is tightly regulated by the underlying algorithm.
Every hour, a very few numbers of this cryptocurrency trickle out and will continue to do so at a decreasing rate rate until reaching a maximum of 21 million. That is why the process of Bitcoin creation is very similar to mining precious metals, when the supply of let’s say gold obtainable from the stream is limited within approximate range depending on the equipment used. This feature makes bitcoin much more engaging as an asset as it stays impervious to devaluation and valued in accordance with classic Supply/Demand curve. In other words, bitcoin value increases when demand grows and supply remains stable.
3 – Pseudonymity
While senders of regular electronic payments usually are identified, users of bitcoin, however, operate in slight anonymity. In the absence of any form of central “validator,” users do not need to identify themselves when transferring bitcoin to another user. The wallet address of each user is their only means of identification.
4 – Immutability
Unlike electronic fiat transactions, bitcoin transactions are irreversible.
Basically because there is no central “adjudicator” that can say “ok, return the money.” It is impossible to modify any form of transaction registered on the network after a time frame of one hour.
This implies that nobody can tamper with any transaction on the bitcoin network.
5 – Divisibility
A Satoshi is the basic unit of a bitcoin. It is one hundred millionth of a bitcoin (0.00000001) – about one-hundredth of a cent in today’s price. This could conceivably allow microtransactions that conventional electronic money cannot.
So What Bitcoin Is Really?
Bitcoin, which is also referred to as XBT and BTC, is one of the cryptocurrencies or virtual currency used for online peer-to-peer transactions.
– It is an open source software that runs on the blockchain technology.
– It was designed in 2009 by an unknown computer genius using the pseudonym Satoshi Nakamoto.
– He created it to let people conduct transactions without having to go through financial institutions that charge exorbitant fees and also bypass the bureaucratic processes related to these institutions.
– Bitcoin is virtual and can never be printed, and it’s therefore different from fiat currency. It is also accessible to everyone, as it is decentralized and not controlled by any institution.
Bitcoin operates on an incorruptible ledger known as the blockchain technology. On the blockchain, you can record financial transactions and anything of value. This technology permits distribution of digital information while restricting any chance of copying that data.
How to Get Bitcoins?
If you are interested in buying bitcoin, here is the process that you should follow;
Get a secure platform and create a digital Bitcoin wallet.
- This wallet will generate a Bitcoin address for you. This address will be unique to your account.
- Find a secure exchange platform and get a reputable merchant to sell you bitcoins. You can purchase a fraction of the coin, the smallest being one hundred millionths of 1 BTC referred to as a Satoshi after the coin’s founder.
- After sending fiat currency to the merchant, you will then give your bitcoin address so that they can load that value of bitcoin to your digital wallet. Bear in mind that transactions on the Bitcoin blockchain are irreversible, so once you send or accept bitcoins, they cannot be reversed.
Alternatively, you can render services or sell goods and demand that people pay you in bitcoins. You just give them with your bitcoin address, and you get the coins in your wallet. If you want to sell, the process is identical only that now you are the one receiving fiat currency first before transferring the digital coins. You can also use your bitcoins to pay for goods and services where they are accepted.
So, How Do You Send and Receive Bitcoins?
- You need a bitcoin address which is a sequence of a private key, numbers, and letters.
- The address is public, but the private key is secret.
- You hand over your bitcoin address to the sender who then signs a transaction with his or her private key.
- The sender will then issue the bitcoins of a specific value to the bitcoin network for verification.
- After the verification, your balance increases, and this transaction is recorded in the open ledger or blockchain.
Where Do Bitcoins Come From?
Bitcoins creators made sure that just a limited number the currency, about 21 million would ever be produced. Till now there are 16,808,737 bitcoins, and this 21 million cap will be reached at 2148. Bitcoin uses a distribution protocol named PoW (proof of work). A process termed mining is used to create these coins.
– The mining process involves solving complex mathematical problems to get a block that is then disseminated to the blockchain.
– The mathematical problems are so complex that it takes “super” computers to solve them while they get progressively more complex.
– Once a group of miners solves a problem, the miners are rewarded with around 12 bitcoins which must be confirmed by peers on the network.
– Currently, these machines consume a very high amount of electrical energy with just one trade consuming electricity enough to power a standard home for a month.
Bitcoins get their values as a result of this scarcity and peer confirmation. Unlike fiat currency that was once supported by gold, the difficulty in mining, the peer community, and their scarcity give Bitcoins their value. It is dependent on the complex mathematical problems.
What Bitcoin supposed to offer
- Decentralized– Bitcoin has no central controlling authority, in contrast to fiat currency that is controlled by governments and banks.
- Easy to set up– You only need a digital wallet, get a bitcoin address then receive your bitcoins from merchants in different exchanges.
- It’s anonymous– Instead of using real names like bank accounts, digital wallets use pseudonyms.
- It’s transparent– It is nearly impossible to fake a transaction, as peers in the chain must verify all transactions done on the blockchain technology.
- Reduced fees– Banks and other financial institutions charge high transaction fees. With bitcoins, exchange platforms only charge a small transaction fee.
- Its fast– Bitcoin transactions are fast and simple, unlike other financial institutions that usually have long procedures when conducting transactions.
- Non-reputable– This means that transactions are irreversible. After sending your bitcoins to another person, unless the person refunds you, the coins are gone forever.
- Not tangible– There is no tangible entity of Bitcoin, as it is a virtual currency. There are only transactions that either increase or reduce the coins in your wallet.
What has Changed Since?
Many things have changed since the introduction of bitcoins. For example
– The price of bitcoin has risen considerably. Thus, transaction fees have also increased up to 28$ to secure a spot on a block!
– Double payment is one of the challenges Bitcoin have faced. Once, transactions got slower, and people accidentally set double payments as a result of the slowness of the transaction.
What Does Decentralization Mean?
Regarding bitcoins, decentralization means that there is no central regulating or governing body. Transactions are directly among peers only without having to go through a regulating authority. Transactions are all registered in a public ledger where each peer must confirm to verify them. None of these peers has absolute authority. This implies that no one can ever control stakes in this community.
Are Bitcoins Taxed?
You might want to know whether or not you are supposed to pay taxes on bitcoin. The IRS (Internal Revenue Service) treats bitcoins as an intangible property or asset. Every US citizen is required to report every transaction made with bitcoin irrespective of its value. The IRS regards any form of buying or using bitcoins as bartering. You will incur the capital gains tax if you use bitcoins in such a manner.
There are many other scenarios that the IRS will tax you if you make bitcoin transactions.
- You will incur personal or business income if you personally mine and sell bitcoins to a third party.
- If you purchase bitcoins from another person, then sell them to another.
- If you use the bitcoins you bought from another person to pay for goods or services
- If you mine bitcoins and use the same to pay for goods or services.
- If you hold bitcoins for less than a year and then sell them, you’ll incur a short-term capital gain tax. If held for more than one year, it attracts a long-term capital gains tax.
However, determining what amount of tax is not straightforward since bitcoin prices are very volatile. IRS is asking investors to continually report these transactions to keep up with the changes in price. It has published a Bitcoin Tax Guide to direct people on bitcoin reporting and taxation.
Can Bitcoin be Regulated?
Bitcoin runs on a peer-to-peer system in which there is no central regulating authority. The transactions are listed in a public ledger where these peers can verify them. The main purpose of this technology was to bypass a third-party control to reduce expenses and bureaucracies.
China, Singapore, Japan and the US want to initiate measures to control cryptocurrency transactions. This move is in a bid to prevent widespread money laundering associated with anonymous digital transactions. Japan reportedly wants to put oversight on cryptocurrency exchanges, and initial coin offerings (ICO) used to raise money for crypto startups. China has already made the ICOs illegal.
How Governments and Banks View Bitcoins?
It is hard to control or stop cryptocurrencies due to the nature of their transactions. The founder and director of Kapronasia, Zennon Kapron said that the only definitive way of preventing bitcoins in China would be to shut down the whole internet which is not possible.
These currencies are encrypted, decentralized and transactions are pseudonymous which makes them difficult to trace. It is these characteristics that governments see them as potential avenues of participating in money laundering and funding criminal activities such as terrorism.
Bitcoin Energy Consumption
One of the ways people get Bitcoins is by mining. The process involves using supercomputers on a distributed network to solve a complex, open source mathematical problem. It is by solving this problem that the miners are compensated with a token that is then registered on the blockchain system after being verified by the peers.
– The device used to solve these problems consume a high amount of electrical energy. It is not totally clear how much electricity Bitcoin mining drains, but it is calculated to about 1% that of the United States economy. This figure is arrived at by looking at the total Bitcoin revenue at any time.
– It is figured that Bitcoin uses 60% of its revenue. Only 75 Bitcoins are mined each hour, so you multiply this by the price of bitcoin at any given time. This energy consumption will increase as bitcoin price increases.
– The system is planned in such a way that the mining figure decreases by half every four years (HALVING). This implies that if it is at 12.5 coins this year, it will be reduced to around 6.25 by 2020. If bitcoin price were to stabilize, miners would shut down some devices thus consuming less energy.
– Another way energy consumption will be diminished is if bitcoin price decreases. Miners activate their machines concerning the rise in bitcoin value. If for example, bitcoin price was to fall by half, then energy consumption will also drop by the same margin to regulate losses.
– Other cryptocurrencies have come up with different methods that consume less energy and more are developing.
For instance, Bitcoin Gold uses the “memory-hard” which drains less energy as opposed to bitcoin’s method.
Currently, most miners and mining companies are based in China as result of the low electricity costs. Some are in the Scandinavian countries. It would take a regulatory effort globally coordinated if governments were to try and stop the mining activities or control transactions with fiat currencies, which is not about to take place anytime soon.
Bitcoin and Criminal Activity
Bitcoin transactions are anonymous. This implies that it is hard to trace back the trades since the people conducting those transactions do not reveal their identities. Since its pseudonymous, people tend to use bitcoin to fund criminal activities like terrorism. There has also been an increase in money laundering activities as a result of the nature of bitcoin transactions. Even though all bitcoin transactions are entered in a public ledger, it is only the transactions, and not the identities of the people making them are recorded. Governments can try tracing back these transactions via IP addresses, but these can be hidden as well. Despite this huge downside in the use of bitcoin, the coin will still gain ground as the blockchain technology proceeds to grow and develop.
Why We Still Need Bitcoin?
For years now, governments and large financial institutions have been controlling world economies. Central banks have been managing the extent to which people can trade and have also been monitoring the value of money by printing fiat currencies to gratify their needs. The blockchain technology is set to dismantle that control by warranting that individuals only earn what they merit. Facilitating peer-to-peer lending will improve the world’s economy a great deal. People will save more money and evade bureaucratic procedures that restrained trade as well as additional taxes. It will also be possible to give real value to goods and services.
What is a Fork?
Cryptocurrencies are computer-generated codes. The developers of these codes can choose to update them for several reasons. A fork takes place when there are two ledgers of the same digital asset either by design or accident. When an accidental fork occurs, the ledgers become incompatible. If this happens, the developers must work painstakingly to join the two for the system to work normally.
– Hard forks occur when developers create forks intentionally.
– This process involves designing a new version of the coin such as bitcoin gold and bitcoin cash. In such case, investors must agree on the blockchain which transaction will be verified and recorded. They also must agree on the laws to be followed. It is pretty easy for investors to lose their coins and their funds if a fork happens.
– A hard fork can create a severe problem if the agreement between peers is not unanimous. A problem arises if a section of peers decides to remain with the older version.
– A soft fork happens when there is a reversible change. Usually, these transactions should not be reversible. If in a circumstance where instead of 1MB blocks, there arises a new rule that accepts 500KB blocks, then such a situation gives rise to two chains. Any node that is not updated will validate the new transactions.
Those nodes with higher hash power will soon overpower the ones with smaller and start to reject transactions from the nodes that are not upgraded. That node with lower hash power becomes the shortest chain and ultimately dies out.
Bitcoin cash is a hard fork of bitcoin that has sustained the primary idea of digital transactions. This currency increased its block size by 8mb letting users and miners process more transactions per second. It is now cheaper and faster than Bitcoin, whose prices and transfer time have risen significantly now taking hours and sometimes days.
Also a fork of the Bitcoin blockchain, Bitcoin Gold comes with the aim of maintaining peer-to-peer online transactions which was bitcoin’s fundamental idea. Bitcoin Gold will be a unique and distinct branch of bitcoin. It intends to decentralize the coin. Currently, some miners have a lot of control with specialized mining facilities. Satoshi’s initial idea was to have every individual PC equal power to the other. Specialized miners have breached this idea by having supercomputers outperform PCs in Bitcoin mining. This version of Bitcoin will be more decentralized and democratic.
Is Bitcoin the Solution?
Bitcoin began as a promising cryptocurrency for unregulated transactions. With increased transactions in its blockchain, however, the core purpose has waned. Here are some disadvantages of using bitcoins
– Transactions are now costly.
– Getting transactions verified now take hours sometimes days.
– PoW- the mining protocol Bitcoin uses, will soon vanish and be substituted with non-energy draining protocols like PoS.
Due to these and other shortcomings, Bitcoin slowly loses his monopoly over the digital currency market, and Other coins are coming up with more suitable technologies. These coins include Ethereum, Dash, and Litecoin among others.
Ethereum is an open software platform based on the blockchain technology. It lets developers and users create and distribute decentralized apps. Ethereum runs the code for decentralized applications, unlike bitcoin that only offers payment platform. Rather than mine like in the case of bitcoin, people work to earn ether.
This currency runs on smart contracts, a sort of code that facilitates automatic exchange of money or property when specific conditions are met. These contracts are not predisposed to censorship, fraud, or downtime. Ethereum lets users create operations of their choice, as opposed to bitcoin which is limited to processing codes. Thanks to the EVM (Ethereum Virtual Machine) developers can also run as many applications as they wish on the Ethereum blockchain.
Litecoin is another digital currency designed from Bitcoin’s source code. It was created by Charlie Lee. It takes much shorter time frame and less effort to transact, and it is thus faster than bitcoin. Also, Litecoin has low transaction fees, unlike bitcoin. Its supply cap is 84 million coins, which is higher than that of bitcoin which has only 21 million. Litecoin runs on a separate script from bitcoin called Scrypt.
Dash coin centers on speed and privacy. It uses a set of 11 algorithms that warrant fair distribution between miners. This algorithm is not like bitcoin and litecoin that only functions using a single algorithm. It is also called the ‘Dark coin.’
Bitcoin’s History So Far
The journey of Bitcoin started in 2008 with an anonymous individual called Satoshi Nakamoto. In 2009, creators of bitcoin released its software to the public for mining for the first time. These coins started being valued in 2010 growing to as high as $0.39. Like many products, it is supply and demand that drives the price of Bitcoin up and down. when the demand is high, the price increases and vice versa.
– The cost of mining hardware and difficulty in mining these coins has been pushing their price way up.
– Bitcoin mining is limited and decreases by half every four years making the coins rarer.
– Price is also driven up by speculators who try to cash in on this trade driving the price way up and then dropping after getting to a particular peak. Bitcoin has experienced two such bubbles in the past and is likely to witness more.
After bitcoin price had hit $1000 in 2013, it later plunged to $300. It took two years to 2015 for it to increase to that price level again. The bitcoin world lost 850,000 bitcoins in 2014 after the largest Bitcoin exchange platform was hacked. Those 850,000 coins would be worth around $4.4 billion today. In 2016, Bitcoin faced intense competition from a new digital currency known as Ethereum. There was also an influx of ICOs that were used to raise money for startups. The SEC in the United States cautioned people against them while they got a total ban in China. The negative undertone created around ICOs led to a slump in prices of cryptocurrencies.
However, in 2017, things have improved gradually for Bitcoin and other digital currencies. Increase in areas where they can be used, and extremely high hype in the online market space has seen Bitcoin increase by 1000%. Bitcoin’s price grew from $1000 to more than $15,000 striking an all-time high of nearly $20,000.
Lately, Bitcoin has suffered a little sitting at about $14,000 at the start of 2018. Whether this price will increase again is a mystery.
Whether Bitcoin and its sequential’s substitute fiat currency as a means of exchange and payment is still a long shot judgment, it is still difficult to determine their future, but they are clearly here to stay and keep dazzling us each day.