Without going into the economic details about whether or not you should invest in Bitcoins, here is a layman’s guide to Bitcoin and CryptoCurrency. The terminology and examples have been over-simplified to explain how the system works.
What is Bitcoin?
Bitcoin is a “CryptoCurrency”, which is just like any other currency in the world, except that it is intangible. There is no physical form like a coin or note. Every Bitcoin is stored or transferred in electronic form. Bitcoin is basically a globally agreed value for trading. Launched in 2009, the Bitcoin system uses cryptographic security to prevent counterfeiting or fraud. Cryptographic security uses mathematical algorithms to create a unique set of digital keys that are used to identify a person or transaction.
The Bitcoin system aims at reducing administrative costs, government influence or interference and eliminating the middle-man. To ensure integrity of transactions, Bitcoin uses a Blockchain system, which acts as a public ledger of transactions. Just like “BitTorrent” is used for sharing files, movies, games, etc, the same peer-to-peer technology is used to share the Blockchain or public ledger. There is no central server or authority that maintains this system.
Why should one learn about CryptoCurrencies?
Bitcoin flags the start of a new technology. This virtual currency is gaining wide popularity. Even if you just know the basics of computers and mobile phones, CryptoCurrencies will be a technology of the future. If not today, you will have to learn about it in the near future.
Information technology has transformed the world by bringing in transparency and efficiency in the way things work. It has been exceptionally effective in exposing government policies and their working. Not only has it made life simpler, but it has also reduced costs of routine tasks.
CryptoCurrencies aim at facilitating almost-anonymous transactions, which are secure, verifiable and cheap, without having any one central agency or authority that controls the functioning or monitoring of the system. Unlike our coinage and currency notes, no single authority or government can control the issue or creation of Bitcoins. The down side of such a system is that there are no fraud checks or in case of fraud, there is no legal remedy available at the moment as it is not recognized as legal tender.
How does Bitcoin work?
Bitcoin works just like other commodities. Just like gold or diamonds or grains and pulses, Bitcoins are transferred directly to the buyer from the seller.
Payer and Payee
Each Payer and Payee is identified by a unique code or address. To start transacting, each party has to generate a unique cryptographic key pair, which has 2 parts, one Private Key and one Public Key. The Public Key also known as the address is published to anyone and everyone when making a transaction, it is not secret. The Private Key is a secret key, which is linked to the Public Key. When making a transaction, the sender of Bitcoins needs to know the unique address or Public Key of the person who has to be paid.
Public Ledger (Blockchain)
Since there is no central authority that maintains Bitcoins, the record of these transactions are maintained by volunteers in a public ledger called a Blockchain. These volunteer ledger-keepers (known as Bitcoin Miners) are spread out all over the world. Each of them keeps a copy of the full ledger, thereby preventing any fraud or manipulation by one or a group of people. The entire public ledger is a one-way ledger i.e. transactions can only be added to the ledger, you cannot remove any transactions from it. The public ledger simply contains the ledger of who owns how many bitcoins. It is called a blockchain, because transactions are grouped into “Blocks” and sent to the network in bunches. Everything related to this public ledger works on mutual agreement of all the parties involved. Only if everyone agrees to a change will the system adapt to that change. More of this is explained later.
Adding Transactions to the Ledger
To prevent fraud and prevent any one set of people from controlling the public ledger, the only way of adding transactions to the ledger, is by solving a complex mathematical problem and sending the solution of the problem to the Blockchain system. If the volunteer has correctly solved the mathematical problem, he / she is allowed to add a block of transactions to the system. The problems are so complex, that they each take about 10 minutes for a powerful computer to solve. This means that a person cannot flood the network with his / her own transactions.
Prize for Bitcoin Mining
As transactions get posted to the network, Bitcoin miners compete to add these transactions to the public ledger. To allow them to add an entry to the blockchain ledger, each miner is made to solve a challenge question. Once a Bitcoin miner has successfully solved this complex mathematical problem to add a block of transactions to the blockchain, the miner is rewarded with 2 things. The miner is firstly allowed to add a transaction block to the ledger, and secondly, the persons making the transactions also reward the miner with a prize, which is in the form of a Bitcoin. The prize for solving the problem varies with the difficulty level of the mathematical problem and also with the size of the network. This means that as time passes and more volunteers join into solving math problems in exchange for adding transaction blocks, the reward for the volunteers will reduce. The prize is more like a tip to the volunteer for pulling the transaction from the network and processing it.
Storage of Bitcoins
Since there are no banks to keep a track of your Bitcoin stash, Bitcoins are stored in a virtual wallet which is similar to creating an email account with a company. The wallet systems allow you to monitor your Bitcoin transactions and easily request or pay others using Bitcoins that you have. They also work as an added layer of security or a check on the spending of your Bitcoins.
What is the current price of Bitcoin (BTC) in terms of Indian Rupees?
1 BTC = 6,98,460.56 INR
1 BTC = 10,999 US Dollars
Who governs Bitcoin and its prices? What are Bitcoins’ Monetary policies?
No one person or group of persons govern Bitcoin or its policies. Bitcoin is based on mutual consensus i.e. everyone has to agree to every change or transaction made in the system. The system is designed to work only if everyone agrees. It is a revolutionary system that breaks the conventional control of our modern currencies. Bitcoin works on the market forces governing demand and supply. Just like Gold, Diamonds or other precious metals, Bitcoin has been designed to be limited to only 21 million Bitcoins in total. This means that as time passes and more and more Bitcoins are mined, the price of each Bitcoin will go up, due to the lack of supply. After 21 million, Bitcoins will just be circulated amongst people, thus controlling the rate of each Bitcoin. As of January 2018, About 16 Million Bitcoins have already been mined or are in circulation.
Bitcoin is not backed by any government or nation. There is no sovereign guarantee or interference and this means that Bitcoin has its pros and cons. Unlike the Reserve Bank of India controlling the Indian Rupee, Bitcoins are not controlled or monitored by a Central Bank. Due to this there is no effect of any political decision or any government control on the rate of transactions or amount of spending. Bitcoin’s Blockchain has no monetary policies as such. It is simply a ledger of transactions and rules for maintaining that ledger. This means that it works equally well across borders – in countries where there is a Dictator ruling the people as well as in war-zones where there is no established government. No government can freeze your Bitcoin account or prevent you from making a transaction, if there is consensus of its use on the Bitcoin network.
Our conventional payment and banking systems rely heavily on many “middle-men”. Credit Card transactions go through either Visa or MasterCard gateways and hence are subject to great scrutiny and heavy transaction fees. Bitcoin is “middle-man free” as there is no dependence on banks, payment processors, third party vendors or brokers for making or completing a transaction. Bitcoin aims at lesser administration costs, but the transaction fees for Bitcoin are still a talking point.
How can one obtain a Bitcoin?
Before you start out with buying or earning your own Bitcoins, you need to get your unique address or “account” on the Bitcoin Network. These accounts are known as “Wallets” and are just like conventional Virtual Payment Wallets like PayTM, OlaMoney, etc. They contain your unique Private and Public Key and are facilitators for your transaction. Your Bitcoin address where money will be sent, is linked to this wallet account.
Buy with conventional currency
The simplest way of getting Bitcoins is to buy from a reputed Bitcoin provider, using your conventional cash. Bitcoins ATMs are also a source of getting Bitcoins.
Mine a Bitcoin
You can also earn Bitcoins by mining them and becoming a volunteer on the Bitcoin Blockchain. For this you may need to invest a significant amount of time and money in buying specialized hardware and software to earn anything significant. However, you can also join a “mining pool”, which is a pool of shared resources that are used to invest in Bitcoin mining.
There are numerous exchanges that allow you to trade Bitcoins. These exchanges, like any commodity or stock exchange are a meeting place of buyers and sellers.
Can Bitcoin transactions be monitored? Is it really anonymous?
Bitcoin is pseudonymous and NOT anonymous. This means the sender and receiver in every transaction are identified by a unique alphanumeric address. Eg: 1KzTSfqjF2iKCduwz59nv2uqh1W2JsTxZH.
This alphanumeric address is published publicly in the Blockchain and is used to identify the transaction. If you publicize your Bitcoin address or tell people about it, your entire transaction history can be seen in the Blockchain and everyone will know how much money you have earned or spent using that Bitcoin address.
Example: The user with the ID 1KzTSfqjF2iKCduwz59nv2uqh1W2JsTxZH has made about 50 transactions and has received about $ 852,734.66 worth of Bitcoins.
As long as your Bitcoin address is kept secret or away from your real identity, it is impossible to trace you. However, most Bitcoin Exchanges and Wallets which allow you to transact using conventional currency have to maintain KYC / Regulatory Compliances of the country in which they are operating, to prevent money laundering.
How much time does a Bitcoin Transaction take?
For your transaction to be put out on the network and to be initially accepted by the Blockchain takes a few seconds. Once the transaction is put onto the network, it has to be “confirmed” to get wide recognition and to be added to the public ledger. As of January 2018, the Bitcoin “confirmation” time has been drastically fluctuating due to the huge hype about Bitcoin and the lack of proportionate increase in Bitcoin mining. In December 2017, average time for confirmation of each transaction was about 70 - 80 minutes. In January 2018, average transaction times for Bitcoin went up to 10,000 minutes per transaction. This means that a person who made a transaction on 21st January 2018, had to wait for about 1 week for the transaction to be adequately confirmed on the Blockchain. While these times drastically vary from time to time, this is indicative of the demand for the Bitcoin system. If you pay more fees, you can get your transaction at the top of the queue with more confirmation. More about “Confirmation” will be dealt with in the next part of our article.
Problems with Bitcoin:
Size of the Blockchain
The entire Blockchain or public ledger contains every transaction right from the inception of the Bitcoin system. The Blockchain has to be downloaded several times on each machine that is adding transactions to it or is verifying a transaction.
At the time of writing this article, the Blockchain size was about 153 GB. This means that it is both expensive and time-consuming to download this public ledger every time, for a Bitcoin miner. This is a major factor in determining the transaction time and fees.
While VISA and MasterCard can process up to about 1667 transactions a second, Bitcoin lags far behind. As mentioned earlier, Bitcoin transactions in January 2018 peaked at taking about a week to get confirmed. This was totally contrary to the aims of the Bitcoin founders. The current transaction speed to get your transaction onto the Bitcoin Network is about 2 transactions per second which in comparison to VISA is miniscule.
While the Blockchain is a self-healing and mutual trust based system, there are always ways in which it can be manipulated or fooled. Unfortunately, the cost of being pseudonymous and eliminating the middle-man is that there will be fewer checks and balances on the overall system. If you do have a dispute about a transaction, there is no Helpdesk, call center, or office that you can turn to, that will be able to effectively redress your issue. Even if fraud is proven or a court orders seizing of the assets of the culprit, there is no mechanism by which you can enforce asset recovery on the Bitcoin network, especially if the person’s identity is hidden.
If your computer gets hacked or your wallet key stolen, there is very little recourse to any legal action. The hacker will be able to continue to use your Bitcoin address and will be able to continue transacting using your identity.
This, we will cover in more detail in the next part of our article.
Reduction in mining
As more Bitcoins are mined and discovered, there will be a reduced need for miners. Till then, there will be a race for mining Bitcoins and mining equipment will become more expensive. Several Bitcoin mining units have shut down due to very high overheads and restricted output. More on this will be covered in later parts of the article.
Can Bitcoin be Demonetized?
Bitcoins cannot be “Demonetized” unless everyone using them agrees to do so. However, countries may prohibit the use of Bitcoin, just like they ban the use of certain websites.
What are the alternatives to Bitcoin? How are they better?
There are over 1350+ CryptoCurrencies in the world. All these alternatives to Bitcoin are known as Alt-coins. Alt-coins use the same crypto systems. Ripple, Bitcoin Cash, Ethereum, Lite Coin, Cardano are all popular CryptoCurrencies that are giving Bitcoin tough competition. Although Bitcoin was the pioneer in CryptoCurrency, the long-term winners will probably be from the list of Alt-coins as they are constantly learning from the Bitcoin’s mistakes and adapting.
In the next part of this article we will deal with:
Bitcoin Exchanges, The Blockchain system, Bitcoin Transactions, Bitcoin Mining and the Indian perspective of Bitcoins and the Diamond World.
This article is © Ruthenium IT 2018. All rights reserved. Publication requires a license.
|- By Ruzbeh Raja, Proprietor at Ruthenium IT|