Bitcoin has been in the news recently for good and bad reasons. You are probably also seeing the word Blockchain, and may be curious what that is. It is important for people wary of government intervention in their lives to understand what Bitcoin is, and if it is an avenue that can be used to safeguard wealth or act as an investment.
Five years ago, Bitcoin was the only major online currency. This is still the case, but there is competition from all sides. There have been many similar competing currencies released in the last few years, and these are universally referred to as Altcoins or Crypto Currency. Many of these new coins never took off, and others, after initially succeeding, have tumbled in value and are now worthless. Some, like Ethereum and Monero, have managed to have some success and have gained enough in value to be truly valuable in their own right.
These Altcoins work as currencies, and are accepted by many merchants online. They are also a form of investment, and a way to transfer wealth without using the banking system. With the recent increase in economic challenges in China, it is widely thought the Chinese are using Bitcoin to move their money out of China and into different currencies. Each time there is an economic policy change in China, the price of Bitcoin seems to react.
The most important Bitcoin related event for us, the general public, has been the recent emergence of exchanges where we can purchase Bitcoin and other Altcoins with dollars. These exchanges, such as Coinbase, are still in their infancy. Most only offer Bitcoin and perhaps one or two other Altcoins for sale, but that is quickly changing. There is very little regulation in the cryptocurrency exchange industry currently, though as you will read further down, that regulation is coming.
Before you read the next paragraph, it is important to understand it is possible to safeguard Bitcoin when you buy it by storing it in a Bitcoin Wallet outside of the exchange you bought it from. Similar to a brick and mortar bank, you have the option of pulling the Bitcoin out and sticking it someplace where hackers (and the government) cannot get to it. You can even put your Bitcoins into a ‘paper wallet,’ which is a wallet with a private key existing nowhere except where you write or print it.
Here is the bad news. On August 2nd, 2016, an exchange called Bitfinex was hacked and over $70 Million in Bitcoin belonging to people using Bitfinex was stolen by the hacker. This was all Bitcoin stored with Bitfinex as savings, just as I might store money in a bank. Had it been removed by its owners and put into a Bitcoin Wallet as explained above, no hacker would have had access to it. There is no FDIC insurance to cover the loss, and there is no simple way to find and recover the Bitcoin from the thief. Keep in mind this was a hack into the Bitfinex exchange, similar to a bank robbery. The Bitcoins stolen still exist, and no in hacking was done to the currency itself. They just transferred ownership.
Here is an example: Bitfinex Hack Shows How Bitcoin Blockchain Can Be a Liability
With a Cyprus-like bail-in, Bitfinex is spreading the pain to all of their customers. They are repaying the people who lost their Bitcoins by taking 36% from the unaffected accounts on their system, and giving it to the people with losses. That means everyone loses, including Bitcoin holders everywhere who have seen the price drop by ten percent since the theft. Prior to the theft Bitfinex lured in customers with claims of being the most secure exchange. As of the time of this article, Bitfinex still has not announced how the theft occurred. It is widely assumed they do not know what happened. Remember, above I mentioned there is little regulation and no insurance in the exchange industry.
Before the exchanges started to appear in 2014, the only way to acquire Bitcoin was to mine it. Bitcoin mining still is being done today, but is no longer practical for the average person. Companies have built huge banks of incredibly fast processors to mine with, giving them an advantage over even the best personal computers we can purchase from a retailer. In order to understand Mining, you need to understand how the Bitcoin Blockchain works.
Here is an explanation of the Blockchain that makes the most sense to me. To start with, think about the system we are familiar with today… the banks you deal with in the real world. Are you able to see all of your bank’s transactions behind the scenes? Not a chance. Can you imagine a system where anyone can see your paycheck deposited into your account, and then see where you send your money? Of course not. For privacy reasons, no bank would ever make this information public, or let anyone know exactly what it is doing with the money it takes in.
In contrast, what if you could make a new anonymous account with the push of a button, and instantly make an anonymous transaction from that account? Below is a Bitcoin account address I just created. As you can see, it is random and 34 characters long. I may or may not ever use it to buy something. I could send it to someone buying something from me, and they could send me Bitcoin from their account using the address: 1H6cQ8NL5Zi7VPeM493rMVT3KFT2ZL2WdC
It does not matter if everyone can see an amount traveling from this anonymous account to someone else’s anonymous account, especially if this was just one of millions of anonymous transactions bundled together into one file where everyone in the world could see them. This system means all creative auditing, fraud, data manipulation, currency creation from thin air, and other financial mischief goes out the window. Once a transaction happens, it cannot be altered by anyone because all computers worldwide have access to the information and would know immediately if something changed. This is what happens every 10 minutes on the Blockchain. A new ‘Block’ is added to the end of the chain with all of the anonymous transactions publicly available from the previous 10 minutes. All computers on the network have access to the new block of information and agree the block is correct. This chain of 10 minute blocks goes all the way back to the beginning of Bitcoin, and continues to grow.
CIO Explainer: What is Blockchain?
Now that you understand the Blockchain, you might be wondering how the anonymous transactions all get combined into the 10 minute blocks. This is where ‘Mining’ comes is. Mining is a term used for the process of assembling the new Blocks, and rewarding the computers putting them together the quickest with new Bitcoin. Every computer mining on the network is frantically putting together all of the transactions from the last 10 minutes into a correctly formatted file. All of these computers are running at incredible speeds, but only one is going to finish first and add the new block to the end of the Blockchain. The winning computer is currently rewarded with 12.5 Bitcoins (approximately $7,250 USD at the time I am writing this) for winning the 10 minute race. This is called Mining. Other Altcoins use the same method for processing their transactions.
Bitcoin is only valuable because the people holding it give it value, just like the fiat dollars we use today. There is nothing behind Bitcoin that is inherently valuable, just like there is no gold behind fiat currency. One difference is there is an inflexible finite amount of Bitcoin that will ever exist of approximately 21 Million. Our governments are creating Trillions of additional fiat currency from nowhere, which dilutes the money already in the system. That will not happen with Bitcoin. Approximately 79% of all the Bitcoin that will ever exist is already created. The other 21% is still being distributed via the Mining rewards. It is predicted the last Bitcoin will be distributed in 2024, and that a minuscule fee at that time will be collected from each transaction to incentivize the miners to continue creating blocks.
More people every day are realizing the diversity and value Bitcoin offers. In 2016 alone, the price has more than doubled, making it an outstanding investment. Price swings like this also makes it a very risky asset. The price of Bitcoin in 2013 briefly topped $1,000, and then fell all the way below $250, before starting its recent climb.
This chart provides a useful illustration: Bitcoin Price Chart
I am speculating this climb is due to the strained economic environment we now find ourselves in. When the stock market is doing well, people have their money in the market. Much like physical gold, people are looking at Bitcoin for an alternative place to keep their wealth away from the Wall Street, the government, and the banks, while also hoping for a positive return on their investment.
As Bitcoin has become more widely used, accepted, and valuable, the government has a stronger and stronger incentive to get their share. For this reason you are starting to see attempts at regulating Bitcoin sales and profits. This will lead to exchanges in the United States and other developed countries eventually being forced to hand over personal information on transactions and financial gains if they wish to maintain their business and not be hit with expensive lawsuits and fines by governments. While the transactions are currently anonymous, they are in reality only as nonymous as the exchanges allow them to be. Once the government knows which Bitcoin wallet addresses are tied to your account on Coinbase, for example, it is a short leap for them to use those addresses to figure out what happened with the Bitcoin associated with the account. Programmers and entrepreneurs are working on new ways to hide Bitcoin user’s identities to combat this regulatory intrusion.
Here is some interesting news: North Carolina Governor Signs Bitcoin Bill Into Law
And take a look at this: How to Use Bitcoin Anonymously
The governments have started saying they are going to regulate Bitcoin to fight terrorism, but this is an effort to paint Bitcoin as a source of money laundering to the general public in order to get their approval for regulation (read: taxation). Anything the government wants to control, such as guns and Bitcoin, they tie to terrorism or drug dealers to gain public acceptance for their invasion into our privacy. In the meantime, they send Millions of dollars in cash to Iran which will be used to truly fund terrorism.
Here is some interesting news: Europe to End Anonymous Bitcoin Exchanges to Fight Terrorism
I wanted to provide a definition and information on the current state of Bitcoin to educate everyone, but not necessarily to make a recommendation whether Bitcoin is right for you. Just like when you purchase stocks, gold, or any other investment, you need to weigh your risk tolerance versus the potential rewards Bitcoin has to offer. What rewards? The value of Bitcoin nearly tripled in a few months earlier this year, and I would not be surprised if a year from now Bitcoin has exploded to be more valuable than we could have imagined. Be careful though, the risk associated with Altcoins right now is akin to gambling. I don’t fully trust the exchanges to keep my Bitcoin safe from hackers and government regulation. I am personally investing in a small amount of Bitcoin and Ethereum as a hedge against the future, but only with money I am not afraid to lose.