By now you’ve probably heard about Bitcoin. Some weird, new online money system that people either use to get rich quick or to buy drugs on the internet. Those things are both true, but here in the UK we use the Great British Pound for those exact reasons and many others.
Bitcoin is currency, just like the pound.
If we have a currency like the pound already, then why do we need a new one? To get to the bottom of that, we have to take a look at the currencies we’re using.
Do you ever ask yourself what gives our money its value? There was a time when the sterling you have in your pocket could be traded with the bank for a set amount of gold. Your money was your gold, that was the guarantee that the banks had with their customers.
Now, however, most currencies are nothing more than numbers on a screen. Your gold is gone. The banks have sold it.
The UK’s currency is issued by the Bank of England, a central authority. The American Dollar is issued by the Federal Reserve (a private company). Both the pound and the dollar, and indeed most Western currencies, keep their value because their governments support American imperialism. The threat of American violence is what guarantees Western currencies.
These currencies, with no real guarantees, are called fiat currencies, and I don’t mean to worry you, but civilisations with fiat currencies don’t usually end too well.
Take the Romans for example, the Roman denarius was almost pure silver at its inception. By the time the Roman empire was ready to collapse, there was only around 0.02% silver in each coin.
Successive Roman Emperors had stolen the silver from the coins to pay off their own debts, and by the currency’s end, no one would accept it because it had been devalued so much.
The same thing is happening with Western currencies through quantitative easing (the process of pumping incomprehensible amounts of money into the economy through the stock markets), whether that comes from the British Bank of England, the American Federal Reserve or the European Central Bank.
So while the public are barraged with cuts, the Bank of England has been able to print £375 billion to give to already wealthy corporations. All this does is increase the wealth gap between rich and poor, and devalue the currency considerably.
How can fiat currencies be fixed?
Currencies need a commodity or some sort of trusted third party to guarantee their values and process transactions. But we don’t have any commodity linked to our currencies, and whether or not banks are trusted third parties is questionable, given the behaviour of most banks in recent times.
A commodity based currency will generally be the replacement for a fiat currency, whether that be coffee beans, seashells or perhaps something that wouldn’t be recognised before the digital boom of the last few decades. Enter cryptocurrency.
Cryptocurrencies are digital based currencies linked to a digital commodity. There are quite a few cryptocurrencies available, but the most popular and easily traded is Bitcoin.
What is Bitcoin?
Redditor americanpegasus wrote a 100 word explanation of what Bitcoin is, which won a WeMedia award. There probably isn’t a better way to describe it:
“The engine changed transportation, and the Internet transformed communication. Now Bitcoin is redefining the very concept of money.
A network that cannot be shut down or owned holds a limited number of ‘coins’. Users verify the history of every coin constantly and create new ones by solving math problems. Coins don’t belong to people, but instead to anonymous addresses. By broadcasting their intentions to move coins to a new address, people ‘spend’ their bitcoins.
A combination of a precious commodity (like gold), a spendable currency (like dollars), and a speculative investment (like stocks), Bitcoins are the future of money.”
The engine of Bitcoin is the blockchain technology that it’s built on. It’s a decentralised, peer-to-peer, open ledger. This removes the need for a trusted third party, or a bank, because every transaction can be verified by the blockchain.
Mining for Bitcoin
There are only a limited number of bitcoins too, and only a set number can be mined and are released at regular intervals, so new coins can’t be created from nothing. This again is verified and regulated by the blockchain.
To help the currency retain its commodity based value there are two things to remember about mining. Firstly, Bitcoins are only released every ten minutes, and after every four years the number of coins available is halved. By 2140 no new Bitcoins will be available to be mined, so, like many commodities, there is a limited amount of it.
Secondly, the mathematical algorithms a computer has to solve gets more and more difficult, meaning the computers needed have to be up to the task. When Bitcoin first came around in 2009, miners could have used a standard PC or laptop. Miners now are engaged in an arms race to see who can get the best machinery to mine new coins.
This presents new problems. The currency was supposed to be decentralised, however the technology needed is so expensive to buy and run, in terms of energy and cooling, that the technology is lying with a select few people.
Many of the biggest Bitcoin miners are in the southern states of the USA, but it’s likely the technology will have to move to cooler climates, simply because it’s easier to keep the hardware cooler the closer to the poles you get. This is the scale of the technology needed to mine Bitcoin, and environmental concerns have been raised around the vast sums of energy the currency needs.
Bitcoin miners are needed to verify transactions too. This may seem to strike at the heart of the decentralisation of currency, which Bitcoin prides itself on, but it simply means they use their computer’s processing power to verify transactions. Again, this is done on the blockchain, the open ledger that holds a record of all bitcoin transactions.
Can Bitcoin bring some financial balance to the world?
Bitcoin was originally set up as a replacement as an alternative to the current economic system. The first block in the blockchain, the “genesis block” reads: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”.
But Bitcoin has to overcome a lot of roadblocks before it could rival another currency.
Bitcoin is being used predominantly for money transfers and as an investment. Bitcoins can be sent anywhere across the world without the same fees charged by international money transfer services.
The currency is incredibly volatile for investors. Bitcoin shot up in value late in 2013, peaking in on 4th December 2013 at $1147.25. At the time it was more valuable than gold.
Since then it has gradually declined in value, hitting its lowest value since it’s spectacular rise on 4th January 2015 at $263.63, a long way off what it had been just over a year ago.
Despite its volatility, it has attracted the eye of those working for the country’s financial sector, yes, that’s the government.
In August, Chancellor George Osborne spoke fairly ambiguously about Bitcoin, he even got his obligatory press photo with a Bitcoin ATM.
At this time the Treasury launched a public consultation on Bitcoin. Bitcoin featured in a debate on the creation of money in the House of Commons, and even the Bank of England issued a document on Bitcoin, where they seem to love the blockchain technology, but the currency less so.
It’s understandable why the Bank of England would be wary of Bitcoin, if the bank can’t control it, then it loses its power as currency issuer and trusted middle man.
The involvement of governments into finance is usually worrying enough, but that’s not its only problem.
If you can’t mine Bitcoin, which most people now can’t, then you have to buy Bitcoin. Bitcoin can be bought at a Bitcoin ATM. There are 8 of these ATMs in the UK and Ireland.
Some shops also buy goods in Bitcoin. CEX will buy your old electrical goods for Bitcoin. If you have no DVDs going spare, or if the ATM is out of Bitcoins, then the other option is a Bitcoin exchange.
Bitcoin exchanges can be daunting if you don’t know what you’re doing. It’s a place where Bitcoins can be bought and sold via these exchanges for fiat currency. Transfers are generally made either by PayPal or by direct bank transfer, and then onto the user’s Bitcoin wallet.
In February 2014 Bitcoin’s biggest exchange, Mt. Gox based in Tokyo, started to wobble, suspending all trading and closing its website. By April 2014 it was had gone into liquidation.
Approximately 850,000 Bitcoins were lost totalling $480 million. Japanese Police investigating the incident estimate that all but around 7,000 coins were fraudulently stolen.
This isn’t the only case of a Bitcoin exchange facing problem, on 4th January 2015, around 19,000 BTC valuing an estimated $5 million were stolen from European exchange Bitstamp.
That sort of fraudulent activity is a fairly small problem compared to what will be Bitcoin’s biggest problem if it were to ever contend with the dollar or the pound, and that is the size of each block in the blockchain.
Each block is capped at 1MB, this is to prevent miners centralising too much of the power, however as the amount of transactions increases, the block size will have to increase to keep up. Without increasing the cap, the Bitcoin network is only capable of completing 7 transactions per second, which isn’t at all practical, especially when compared with the millions of fiat transactions that happen every day.
It’s all about the blockchain
But all this brings us to the technology, where the real excitement lies. In an interview for Wired, tech entrepreneur Brock Pierce said: “The internet we use today is the internet of information, the blockchain is the internet of value.”
The blockchain is the open ledger upon which Bitcoin has been built, but this technology does not have to remain exclusive to Bitcoin. It is the open ledger that anyone can look at. It’s fast, decentralised, and difficult to corrupt.
The technology is so new, it is impossible to tell how it could be used, but some suggestions already range from giving people the ability to vote online, to buying a house without having to pay expensive agency fees.
And this isn’t just some conceptualised nonsense. Start-up accelerator firm Latitude are advertising for places at their blockchain summit in the Cayman Islands. The firm is advertising for blockchain entrepreneurs to spend three months there developing ideas to then pitch to investors. The Cayman Islands has been chosen because of its regulatory and tax environment, which Latitude believes favours start ups. It’s also really sunny and has beautiful beaches. It’s alright for some.
What’s the future for Bitcoin?
It’s impossible to say. Bitcoin fanatics will tell you it’s the only logical way out of our current economic problems. The reality is that Bitcoin is nowhere close to achieving that. The technology isn’t mature enough yet for that.
There are also the current power structures that are in place that Bitcoin needs to contend with. As we know already, those with power are reluctant to give it up or share it.
Bitcoin will either explode spectacularly onto the financial scene, or it will continue to fizzle out until it finally dies when something similar replaces it.
One thing is guaranteed though, the blockchain is here to stay, for better or for worse.