What is bitcoin? All you need to know for beginners
News outlets can’t stop talking about it, an influx of merchants have been adopting it as a new payment system and big players have gone ahead and invested in it.
But what the heck is Bitcoin? This is a simple crash course for those who’d like to know more about this digital asset.
For students who are interested in the business landscape, this will be an extremely important topic.
The finance market is centralized. In Singapore, the Monetary Authority of Singapore (MAS) issues currencies while banks like DBS stores and records our assets. In other words, power lies with a centralized authority.
However, Bitcoin is a form of cryptocurrency that’s decentralized. And that idea has taken the world by storm.
As of 17 May 2021, according to coin market cap, Bitcoin’s market cap (how much it is worth) is around USD $812 trillion.
Touted as the future of money, it could potentially change the way we transact online.
In 2008, Satoshi Nakamoto along with a group of expert researchers published a document titled: “Bitcoin: A Peer-to-Peer Electronic Cash System”, today it is known as the bitcoin whitepaper.
In it, Satoshi came up with a radical idea to take away the middlemen.
In order to understand just how groundbreaking this is, you will need to understand the role of the middlemen.
We will use an example to illustrate.
John sends a digital token to Jane. This digital token is a form of money that’s made up of a string of ones and zeros. Alice gets the token and all’s good, right?
Unfortunately, in the digital world, there’s nothing stopping John from duplicating another token. After all, the token is just made of ones and zeros. Anyone can duplicate it if they know the code.
Furthermore, if both own the same digital token, who’s the real owner? If it can be duplicated, what’s to say that they can’t spend it more than once?
This is the double-spending problem. A problem that third parties have stepped up to solve.
As a neutral party, the power to modify or erase transactions from the ledger is removed from John and Jane. Let’s call this third-party Bill.
Surely now digital transactions can be conducted smoothly and fairly right?
What if Bill was bribed by John or Jane to change the ledger? Or what if Bill decided to impose an extra cost on John and Jane for overseeing the ledger?
These problems have led Satoshi to create a new system. Instead of a third party like Bill overseeing the entire transaction process, he decided that it should be run by all users of the system (like John & Jane) themselves.
Transactions that are conducted can be monitored by anyone on a digital ledger while maintaining the anonymity of its users. Also, it cannot be modified or erased once it’s conducted.
He proposed bitcoin as a digital currency and decided that there’d be only 21 million in supply.
1 year after bitcoin was launched in 2009, Nakamoto disappeared. To this day, no one knows who Satoshi Nakamoto is or why he left.
Whatever the reason, it doesn’t matter because Bitcoin doesn’t require his identity to operate.
How does Bitcoin work?
What is blockchain?
The bitcoin network is a network of computers that are peers to each other. This means they are all equal. In other words, there is no special computer with special powers.
Instead, these peer-to-peer computers run the bitcoin network protocol to ensure that transactions can be made and blockchain can run.
The blockchain contains every transaction made with Bitcoin and can be accessed publicly by anyone.
Transactions that have been made are compiled and recorded into a “block”, this block is then added onto the previous block to form a blockchain.
The more transactions, the more blocks. Thus, the longer the blockchain.
There are a few key reasons why Blockchain is used. They offer the following benefits:
These peer-to-peer computers that make up the Bitcoin network are called nodes.
In a centralized platform, a central authority could modify any specific transaction. Furthermore, all data is stored with this single entity making them more vulnerable to security attacks.
In a decentralized platform, power is distributed among its users and no one can modify transactions.
If one tampers with the transaction records in one node, all other nodes would cross-reference each other and identify the node with the incorrect information.
For somebody to hack transaction records, they will have to hack every node on the bitcoin network simultaneously.
This also means that any and every transaction ever recorded on the blockchain is irreversible (which unfortunately brings up another set of problems).
Although transactions can be viewed by anyone online, these transactions do not reveal any personal information about the senders and receivers. Instead, what is revealed is their bitcoin addresses.
Each transaction in Blockchain has a unique identifier code called a transaction hash or txid. A transaction hash is a 64 character string of letters and numbers that can be tracked by anyone on the blockchain.
You can track a particular transaction by typing the transaction hash on the blockchain explorer.
However, the Bitcoin network, unlike banks, operates 24/7. This means that you will be able to transfer funds anytime anywhere.
Furthermore, the average confirmation time for a Bitcoin transaction is only about 10 minutes.
One example is improving voting systems for citizens.
Blockchain makes it possible for citizens to vote on their phones while maintaining high security.
The immutability of blockchain ledgers means that voting information can’t be hacked or corrupted.
This means that citizens won’t have to travel far distances to cast their ballots anymore which eliminates the possibility of fraud or human error.
Now that you know how transactions are recorded, you need to know how transactions are made. And to do that, you will require a digital wallet.
What are digital wallets?
Bitcoin addresses are complex lines of code that contain Bitcoins. And users can have as many addresses as they want.
In other words, Bitcoin addresses are like your social media accounts and private keys are the passwords to be kept secret.
Digital wallets can be classified into “hot” and “cold” wallets.
Hot wallets store cryptocurrencies on a device that’s linked to the internet. While cold wallets store your cryptocurrencies offline.
When you make a transaction with Bitcoin, a signature from your private key is generated and transmitted to nodes across the Bitcoin network for validation.
There are 4 types of nodes of which only 2 are important for you to know:
Mining is an intensive process where miners (people who operate these nodes) solve complex mathematical problems.
The more full nodes there are, the more difficult for individuals to hack the system.
How are transactions validated?
Once validated, Miners will group the transaction with a collection of other transactions across the network into a block to be added to the Blockchain.
After the problem is solved, Miners get bitcoin in exchange for adding it to the blockchain. Bitcoins as a reward are what incentivises so many to mine.
This ensures Bitcoin continues to operate as a decentralized platform where no central authority, like Bill, has control over verification.
Why did bitcoin rise?
By 2011, it was worth around USD $3000. By 2017, that figure jumped to USD $17,000.
As of 17 May 2021, it’s currently valued at USD $43,270.
What could be the reasons for this ridiculous rise in price?
1.) Lack of trust in financial institutions
This positioned Bitcoin for a successful take-off. Transactions required cryptographic proof, not trust. This allowed any two parties to transact directly with each other without the need for a bank.
Soon after, the idea gained attention among programmers and unconventional investors.
Bitcoin then went on to be known as the face of all cryptocurrencies.
2.) The Big boys have joined
Large scale institutions like multinational corporations, pension schemes and investment trusts have started piling in their money into this asset.
On 30th March, according to Reuters, Paypal announced that it has “started allowing U.S. consumers to use their cryptocurrency holdings to pay at millions of its online merchants globally”. This service will be available for its 29 million merchants and is bound to increase the use of bitcoin.
Furthermore, famous investors like Paul Tudor Jones have even supported it claiming that: “it’s like investing with Steve Jobs and Apple or investing in Google early”.
While big banks like JP Morgan, which has called bitcoin a fraud back in 2017, have now been advising their clients to move 1% of their investments to Bitcoin, according to Bloomberg.
They justify that doing so will help to reduce the risk of fluctuations in traditional assets they hold like stocks or bonds.
Locally, we also see domestic banks like DBS entering the cryptocurrency field.
Last December, DBS announced that it will launch a digital asset exchange that will allow clients to tap on exchange services between fiat currencies and cryptocurrencies namely, Bitcoin.
Bitcoin has this function called Bitcoin halving. After every 210,000 bitcoin blocks are mined (happens every 4 years), the bitcoins awarded to miners are cut in half.
This causes Bitcoin’s price to skyrocket because it means that there’s a lower supply of bitcoins to be mined before it reaches 21 million in circulation.
At the start, mining a bitcoin transaction successfully could reward you with 50 bitcoins. Back in October 2010, where one bitcoin was worth 10 cents, you would receive USD $5.
Over time, as more and more bitcoins were mined, the number of bitcoins rewarded shrunk.
Today mining a bitcoin transaction will reward you with 6 bitcoins which are worth a total of USD $260,000.
4.) Fear of missing out (FOMO)
Like many volatile and hyped up assets, Bitcoin has gained wide attention from fear-of-missing-out (FOMO) Speculators.
Online Investment platforms have seen a surge in activity for cryptocurrencies. For instance, according to CNBC, Etoro had 61% more unique bitcoin holders on January 4 2021 than it did a year earlier.
Furthermore, Fintech company Revolut, says it “signed up 300,000 new cryptocurrency customers over the last 30 days as bitcoin rallied to fresh highs”.
With massive media attention, millions of merchants adopting it, and institutional investors pumping money, it shouldn’t be a surprise that your average joe investor is fomo-ing and getting into it too.
Disadvantages of bitcoin investments
1.) A market bubble
Famous stock broker Peter Schiff has stood strongly against bitcoin, tweeting that it is a bigger market bubble that “will get much bigger before it bursts”.
When there’s a market bubble, prices are inflated. Due to feelings of greed, prices continue to rise based on speculation.
This continues until it doesn’t. At one point, investors will realise its true value and a sell-off will occur.
A sell-off could lead to a crash in prices in a matter of minutes, and cause investors to lose a substantial amount of their investments.
2.) Government intervention
If Bitcoin were to replace fiat currencies as the new form of money, then governments should be extremely worried.
Governments are able to control their respective fiat currency through monetary policies. In other words, they have the ability to print as much money as they want. And when you can control the supply of a currency, you can control its value.
Governments also have the power to increase or reduce economic activity.
This is usually done in times of recessions when the government has to minimize the devastating impacts on their economies, stimulate investments, support businesses and create jobs.
For instance, just recently, Singapore announced a new fiscal budget worth SGD 11 billion dollars to support Covid vaccination efforts and support hard hit economic sectors.
As a digital currency that stands outside the financial system, bitcoin cannot be controlled.
As a result, if Bitcoin were adopted as the new form of currency, all of the control that governments have over their economies will be lost.
In a post titled “What I think of Bitcoin”, Ray Dalio, a famous businessman and hedge fund manager, suspected “that Bitcoin’s biggest risk is being successful because if it’s successful, the government will try to kill it and they have a lot of power to succeed.”
We see that happening now in countries like India. Recently, they proposed a ban on cryptocurrencies. Anyone who possesses, issues, mines, trades, or transfers cryptocurrencies will be criminalized.
3.) Environmentally harmful
Sourced from Akos Stiller | Bloomberg via Getty Images
Bitcoin is also one of the most environmentally harmful asset.
Because of the crazy amounts of electricity it uses from fossil fuels.
For some context, bitcoin mining requires the computer to consume a huge amount of electricity to process transactions.
Furthermore, huge fans are needed to cool the computer as it heats up from the vast energy used, using more electricity in the process.
According to Digiconomist, a platform that exposes “the unintended consequences of digital trends”, one bitcoin transaction has a carbon footprint equal to 428.4kg of Carbon Dioxide. That’s equivalent to 949,132 VISA transactions or 71,374 hours of watching Youtube.
In terms of electrical energy, it equals 901 kwh. That’s the power consumption of a household over 30 days.
Annually, the total energy that Bitcoin mining uses has a carbon footprint of 46.2 Mt (or 46 billion kg) equal to that of Finland and power consumption of 97.26 TWh (or 97.26 trillion watts per hour) equal to that of Kazakhstan.
Famous billionaire and philanthropist, Bill Gates, slammed Bitcoin in his interview with The New York Times. In it, he mentioned that “Bitcoin uses more electricity per transaction than any other method known to mankind”.
As a result of these climate concerns, Tesla recently suspended the use of Bitcoin to purchase its vehicles. A funny turnaround considering how they bought USD $1.5 billion worth of bitcoin in February.
However, these concerns aren’t something new. And people have been working to do something about this. For instance, Jack Dorsey, CEO of Square and Twitter has recently invested USD $10 million to drive the adoption of using renewable energy as a clean power source for bitcoin mining.
4.) Transaction fees
Originally intended to cut out the middle-men and keep costs of transactions cheap, Bitcoin has found itself on the other end of that promise.
According to data from Bitinfocharts, transaction fees went as high as USD $54 in 2017 during its meteoric rise. As of this date, the average transaction fee is USD $11.
The high transaction fees threaten its long-term viability as the new form of money. Imagine going to Mcdonalds intending to buy a McSpicy meal with bitcoin. But when bitcoin’s transaction fee is worth 2 times that of the meal, it doesn’t make sense to use it anymore.
But why are transaction fees so expensive? Well, the bitcoin network may be vast but only a certain number of transactions can be mined at any one time.
And with millions of bitcoin holders around the world, the volume of transactions has exceeded the number of miners. Those who want their transactions to be mined first will have to provide an incentive to miners. That incentive is the transaction fee.
5.) No Buyer protection
Satoshi, in order to protect the seller, originally intended to reduce fraud by making transactions non-reversible. For buyers, he suggested implementing escrow mechanisms to help protect them.
An Escrow is a third-party that stores the buyer’s money before being released to the seller upon confirmation from the buyer.
Once the buyer verifies the condition of the product or when the product is received will the money be transferred from the escrow account to the seller.
However, this would make escrow services no different from a bank. Therefore, making bitcoin no different from the traditional fiat currency.
Will Bitcoin be successful?
Despite Elon Musk’s recent tweet that caused a sell-off with the price dropping nearly 8.5% down to USD $44,395 a coin Sunday.
At the end of the day, no one can say for sure whether Bitcoin will grow into a legitimate asset recognised by governments and used by your everyday people.
For now the path is still unclear, but the people working to make that happen are increasing in numbers and more influential than before.
If anything, we hope that this article has given you the insights you need to make your own judgement on your stance with this cryptocurrency!