I’ve recently noticed that the financial equivalent of veganism is Bitcoin: people who understand it will not stop talking about it. So what exactly is Bitcoin, and why should we care?
After having a long and informative conversation with two supporters of alternative currencies, I feel fairly qualified to introduce you to some basic concepts regarding this new e-phenomenon.
Let’s start by reading what Milton Friedman, Nobel Prize winner in economics, had to say 19 years ago:
“I think the internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing but that will soon be developed, is a reliable e-cash: a method whereby on the Internet you can transfer funds from A to B, without A knowing B or B knowing A. (….) The way I can take a $20 bill, hand it over to you, and then there’s no record of where it came from. Off course it has its negative side. It means that the gangsters, the people who are engaged in illegal transactions, would also have an easier way to carry on their business. But I think that the tendency to make it harder to collect taxes would be a very important positive effect of the internet. ”
Now, I will attempt to walk you through Professor Friedman’s quote.
Why reduce the role of government through the internet?
If you’d rather stay at an Airbnb instead of a standard hotel, and call an Uber before hitting up your local cab company, then you have more in common with Bitcoin users than you think. This is because Bitcoin users believe and appreciate, to some extent, the power of technology.
In the same way that Airbnb, Uber, and other distributed technologies function, Bitcoin eliminates the intermediary between the buyer and the seller, thus facilitating transactions. What do I mean by this? Let me use professor Friedman’s example.
Imagine you and I are studying in the library and I decide to give you my london fog latte I brought from home. You now have one latte and I have zero lattes, right? My latte left my hand and it is now in your hand, so now you have full control over the latte. We did not need a third person to pass the latte from my hand to yours; a third person who could have potentially charged us fees for their latte-passing services, right? The elimination of this third person is what I meant when I said Bitcoin eliminates the intermediary in current money transactions, such as banks or governments. As this article published on Forbes magazine clearly states “Bitcoin, the ‘people’s currency,’ has the potential to become a new currency, free of the control of big governments and big banks”. With Bitcoin, you transfer the currency directly to the receiver, without the need for a middleman. If this concept is still not clear, I would encourage you to read the Forbes article cited earlier.
How could it be reliable?
Now, let’s get back to the latte analogy. If you wish, you can go down to the basement of the library and give the latte, which is now yours, to your friend. Once your friend has the latte, it is in their possession, and not in yours anymore. They can now give the latte to their friend, and so on.
Let’s now imagine the latte is in digital form and I am storing it somewhere in my computer. If we agree, I will give it to you and this digitized latte would make it easier for us to complete the transaction. I could sit in the third floor of the library while you sit in the basement and I could still give it to you in less than a minute – as long as we both have a computer with access to the internet.
Before we continue, we should shift this allegory into financial terms by replacing the term “latte” with “coin”.
The problem some of my readers might be thinking of regarding the digitized coin is called the double-spending problem. How could you be guaranteed that this coin is only yours, in the sense that it has not been replicated n number of times, and sent to n number of people before you? And wouldn’t this corrupt act on my part cause hyperinflation, which is an exponential increase in the money supply of a country?
Without going into detail about hyperinflation, the solution to these questions is pretty intuitive for financially literate people: a digital record of the transaction. And what is this, exactly? The correct term is Blockchain, which is basically a public ledger.
What Blockchain does is provide access to anybody interested in the record of the transaction, which means it can be tracked. It cannot be falsified, and once the digital coin is sent to a new user, it cannot be retrieved, so each transaction is final. In essence, I cannot send the same digital coin to more than one person because the extra transactions would not sync up with everybody else in the Blockchain system.
It is important to note that although the transaction is recorded and made public, the user is anonymous so we cannot fully track the transaction in the sense that we do not know who the users are. For more on this, read this article.
If you are still hesitant about the reliability of Blockchain – as I was when I first heard about it – I would encourage you to read this article.
So the takeaway of this section is that with fiat money you trust the bank to keep a record of the transactions; with Bitcoin, you trust the math behind Blockchain.
How did this all start?
I will now give my overwhelmed readers some time to let all of the information above sink in. While you do that, I will tackle a more relaxed side of Bitcoin; its history. Since my interest in Bitcoin is limited to its relevance today, and not its backstory, I will summarize it briefly.
First, we do not know who the Bitcoin and Blockchain creator is, but they’ve still been given a name: Satoshi Nakamoto. If you are interested in the speculations with regards to this perplexing entity, I would encourage you to read this article. Also, Bitcoin is not as new as you might think. In the 1980’s David Chaum invented an algorithm to keep online exchanges of money secure and unalterable. This means that before Chaum, the idea of e-cash, such as Bitcoin, had been seeping its way through cryptocurrency enthusiasts’ minds for a while.
Finally, to put things in perspective, the first Bitcoin transaction was made in 2009. Today, there have been more than 271,000,000 Bitcoin transactions recorded. This goes to show the relevance of the cryptocurrency and how fast it gained momentum.
What does the future look like?
Although I hate to be the rain in your parade, let’s not get lost in the hype of the moment and let us not forget the limitations of the cryptocurrency at hand. A crucial limitation of Bitcoin is that it is still not widely accepted. This means that either people have not yet learned about Bitcoin, or that the ones that have, including many governments, are still not so thrilled about it.
A second limitation is the risk attached to Bitcoin. As Professor Friedman claims in his quote above, cryptocurrencies try to compete with government currencies – maybe this is why governments are still not thrilled about it (refer to the first limitation pointed above). For this and for its anonymous nature, cryptocurrencies may be used for illegal activities or tax evasion. As a result, governments may regulate, restrict or ban the use of Bitcoin, for example, as seen in China, Russia and India. This is called regulatory risk and it could potentially render Bitcoin useless.
A third and last limitation I would like to mention in this article is the time it takes for a Bitcoin transaction to be made. Although one of cryptocurrencies’ intentions is to decrease the time it takes to make a transaction, the software behind Bitcoin will only allow about 7 transactions per second, as opposed to up to 10,000 transactions per second handled by VISA. This evidently positions Bitcoin at a great disadvantage.
Conclusion
Although I am in no position to encourage you to invest in Bitcoin, I hope this introduction motivates you to learn more about cryptocurrencies. One of these might end up being the currency of the future, and as this Forbes article argues, Bitcoin is also important for what it represents in political and economic philosophy; it stands as a revolution and should be studied as one.
Resources you might be interested on checking out
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The “Bitcoin Whitepaper” is a scholarly article which first proposed the currency, written by Satoshi Nakamoto.
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Andreas Antonopoulos is one of the most well-known and well-respected figures in Bitcoin, make sure to check out a couple of his talks.
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Mark Karpeles, also known as the only winner in the Mt Gox trial is also a highly relevant figure in Bitcoin today, check him out too.