The news of Bitcoin’s recent and successful market performance is spreading like wildfire. In the eleven years since its inception, it has surpassed the market value of companies such as Visa, Mastercard, and Walmart (CNN Business). As of the date of this publication, one Bitcoin is being traded for $34,306.17. This incredible feat has made Bitcoin quite popular for investors and people interested in financial markets. However, some critics have raised concerns about Bitcoin and cryptocurrency in general. Defining Bitcoin, explaining its functions, and addressing the advantages and disadvantages to cryptocurrency will be the subject of this week’s blog post.
Although the algorithms for the modern-day cryptocurrency have existed since the 1980s, the emergence of Bitcoin has changed the future of financial transactions. Bitcoin’s founding in 2009 is shrouded in mystery. The housing market crash of the same year was the catalyst for its emergence. By whom is the enigma. The founder of Bitcoin is known by the pseudonym Satoshi Nakamoto. The true identity of the person or persons is still unknown.
Bitcoin is a form of decentralized cryptocurrency. Because its design is public, all transactions are managed by “peer-to-peer” technology instead of banks. Cryptocurrencies are often compared to an online version of dollar bills and can be used to buy and sell services and products. To obtain Bitcoins, people can buy it using “real” money, have people pay for a product using Bitcoin, or “computer-mining,” like searching for gold. Because Bitcoin is essentially a computer file, consumers can store them on a digital wallet, accessed by any smartphone or computer, and even send them to other people. Now that Bitcoin has been defined, it is important to know how it works.
When a beginner uses Bitcoin, it generates a Bitcoin address. You can create more than one address and share the addresses with friends and family so transactions can ensue. These addresses can only be used once. Bitcoin has three main functions (Bitcoin):
- Function 1: Blockchain – a shared public ledger which all consumers within the Bitcoin network depend on. It includes and verifies all transactions and spendable balances to ensure both are owned by the spender.
- Function 2: Transaction – an exchange of value between Bitcoin wallets. Although transactions are included in the blockchain, Bitcoin wallets keep a “private key.” Private keys prove the owners of the transaction. Bitcoin also uses “signatures” to ensure the lack of alterations to the transactions.
- Function 3: Mining – a process which confirms and places the transactions in the blockchain in chronological order. It also bears the responsibility of protecting the neutrality of the Bitcoin network. Transactions are only confirmed when they are compiled in a “block” which includes rigid cryptographic rules approved by the Bitcoin network so previous blocks are not modified. Mining also prohibits individuals from controlling, replacing, or adding blocks and parts of the block chain. In other words, it prohibits theft.
After defining and explaining Bitcoin’s functions, and as the number of people investing in Bitcoin increases, addressing the benefits and drawbacks of this cryptocurrency are crucial.
There are plenty of advantages and disadvantages to investing in Bitcoin (Money Crashers). Let’s first discuss its benefits. As previously mentioned, Bitcoin is not controlled by any political or financial institution. These parties can only confiscate or suspend cryptocurrency either for retribution for political acts or for a criminal investigation.
Bitcoin also has greater liquidity compared to its competitors like Ethereum, IOTA, and Dogecoin. This permits users to keep much of its value when switching to fiat currencies like the U.S. dollar bill. Essentially, out of all the cryptocurrencies, Bitcoin is most like a fiat currency.
Bitcoin has become widely recognized as a payment method, partially because of their built-in privacy protections. It allows users to distance the account itself from the public persona. Unlike using cash or PayPal transactions where protections are scarce, Bitcoin tracks transactions between users but it is difficult to discover who the users are. Individuals or groups who want to mitigate the use of fiat currency should invest in cryptocurrency, since a plethora of sellers accept Bitcoin payments (Microsoft, Overstock, Etsy, AT&T, Shopify). Even though Bitcoin has inexpensive transaction fees, it also eases the process of international transactions because, like credit card payments and ATM cash withdrawals, it does not require international transaction fees.
Finally, Bitcoin’s built-in scarcity component inculcates the currency with inherent value like gold and other metals. This supports its lasting value against fiat currencies and non-scarce cryptocurrencies.
A major inconvenience to using Bitcoin is the lack of policy regarding refunds and chargebacks. Because of its decentralized design, it is extremely difficult for users to dispute transactions. Even though miners are responsible for recording the transactions, it cannot prove the legitimacy of those transactions.
Bitcoin’s reputation as the world’s most popular cryptocurrency precedes itself, so much so that it becomes vulnerable to fraud cases. Examples include the small-scale Ponzi scheme with Bitcoin Savings & Trust to grand-scale hacks such as the infiltrations of Sheep Marketplace and Mt. Gox, which were bilked of hundreds of thousands of Bitcoins. To add, Bitcoin attracts groups and individuals involved with the black market due to its inherent anonymity protections. Ultimately, Bitcoin’s competitors do not acquire nearly the number of users to engender maliciously profitable activity for criminals. If fiat currency were used, such crimes would be prosecuted by law enforcement (see Member Dr. Stephen Castell’s recent article on the subject).
There is the exception of people who are converting to newer cryptocurrencies. Depending on the type of cryptocurrency, these services either eliminate third-party involvement in transactions or use “smart contracts.” These contracts hold the cryptocurrency providers liable for their offerings. If the number of people leaving Bitcoin for another service increases, then its value would certainly decrease.
As previously mentioned, an advantage to Bitcoin is its liquidity and ability to be easily exchanged. However, it becomes susceptible to unpredictable price swings within small time intervals. For instance, after the FBI announced the legitimacy of Bitcoin as a financial service, its value skyrocketed in late 2017 and yet halved at the start of 2018 due to the Mt. Gox hack. These decimated billions of dollars of the market value instantly.
Lastly, Bitcoin mining weakens the environment because it exhausts large quantities of electricity. The source of power for Bitcoin stems from coal plants. When mining occurs, the amount of electricity used directly correlates to the vast amounts of air pollutants released into the atmosphere, creating difficulty for surrounding citizens to breathe.
As the world transitions into a virtual age, and the value of fiat currency remains in flux, people face the crucial decision to either invest in cryptocurrency or continue with their current monetary choices. For those looking to invest in Bitcoin or cryptocurrency, hopefully this blog post provides general insight and clarity for future financial endeavors.
Sources:
https://bitcoin.org/en/how-it-works
https://www.moneycrashers.com/bitcoin-history-how-it-works-pros-cons/