What I Learned about Cryptocurrency (Bitcoin)
We have probably all heard of Bitcoin and know someone who knows someone who is into trading and buying cryptocurrency. But what is it exactly? How does it work? These are questions I wanted to explore and try to answer in order to understand it better. Hopefully, this information will give a clearer picture of what cryptocurrency is all about.
I do not claim to be an expert on this subject, nor do I intend for any of the following to be used as advice to buy or an endorsement of cryptocurrency.
So, What is Bitcoin?
Bitcoin is one of over 1,000 cryptocurrencies and the most popular and widely used of them all. It was launched officially in 2009 following the Wall Street Banking fiasco by Satoshi Nakamoto. It is unclear as to who Satoshi Nakamoto is or whether this name refers to one person or a group of people. The Bitcoin grew out of the frustration people had with the financial system: the mishandling of borrower’s money, exorbitant banking fees, distrust of the banking system and the sentiment of deception.
The idea was to create ” a new electronic cash system” that was “completely decentralized with no server or control of the authority.”
So, cryptocurrency is a decentralized currency (independent from the financial system) which the owners are in control of entirely. It is essentially an exchange of digital information that allows owners to transact (buy and sell) without the intermediary of a financial institution. The information flows from person to person in a network (through a file-sharing system). It does not follow the traditional rules and regulations of financial transactions. There is no collection of names, IDs or other personal information.
The first Bitcoin pioneers wanted to:
- eliminate the “middleman”
- eliminate interest fees
- make transactions transparent
- halt financial corruption
- cut back on fees
More Details Please
- Cryptocurrency transactions are anonymous and irreversible. Once the transaction goes through, it can not be changed. No one knows the identity of either the buyer or the seller.
- There is no physical location. Bitcoins are received through digital addresses and there is no connection to the buyer or the seller.
- Transactions are fast and global. They happen within minutes anywhere in the world since it is a global network.
- All transactions are secure, They are locked into a cryptography system and owners have one or more encryption keys to access their account to send or buy currency. It is virtually impossible to break into the code.
- The system is independent. Anyone can download the software and install it. Once the account is set up, you are set to go and can begin buying and trading.
- The supply of Bitcoin is highly controlled and limited. Only a small number of bitcoins come out every hour and there is a cap of 21 million Bitcoins. Presently, there are around 16 million in circulation.
Are they accepted as currency?
Currently, there are over 100,000 merchants and businesses that accept payment with cryptocurrency including big names such as Expedia, Microsoft, Dell and Overstock.com and the list is growing. People pay for things like pizza, flowers, and gift cards with Bitcoins.
Ok, So how does it work?
Bitcoin and other cryptocurrencies are mined by miners. The mining process is a highly complex combination of algorithmic problem solving and record keeping. Volunteer users verify transactions within the network on computers. Each transaction is recorded in a ledger which is grouped with other transactions to form a block. These blocks (or groups of transactions) are then put into a blockchain, which is essentially a massive publicly accessible and permanent record of all transactions worldwide.
The existence and continuity of the blockchain is dependant on the miners to keep up their work of recording transactions, which will continue to grow indefinitely. Blockchains are created roughly every ten minutes. They are the only record and arbiter of all transactions and proof of ownership. The blockchain also serves as a payment processing system which is also facilitated by the miners.
In return for their dedication and work, the miners are rewarded with Bitcoins and they also receive transaction fees paid by buyers. Sellers who charge transaction fees typically get paid first over those who do not.
Each owner has a private (digital) key which confirms his digital identity and allows him to buy or sell Bitcoins. The key is called an encryption key. The keys must be kept very safely; if they are lost, it is impossible to access your account and if it is permanently lost, so is your Bitcoin currency – into virtual space.
Bitcoin exchanges (such as Coinbase, CEX, Coinmama or Kraken) allow owners to exchange (trade) Bitcoin units (Bitcoin can be broken down into subunits) for world currencies such as the dollar or the euro and for other cryptocurrencies. There are transaction fees for the exchange.
Where do you keep the Bitcoins?
Bitcoins are stored in digital wallets, either private or public wallets (in a public exchange or storage center). Generally, the wallets are secure cloud storage locations with special owner ID information confirming ownership.
Where do you buy Bitcoins?
There are different ways you can acquire Bitcoin. One way is to set up an account with an exchange (such as the ones mentioned above) and then depositing fiat currency (dollar, euro) into your new virtual wallet. It is free and simple to set up an account – just like setting up a Paypal account. Then you are ready to begin buying and trading in cryptocurrencies. Another way to earn Bitcoins is to accept them as payment for goods or services. Owners cand lend out Bitcoins and earn interest on them. You can also earn bitcoins through trading.
What about the risks?
Since Bitcoin is a digital currency, there is always the risk of theft through hacking. The public exchanges (and wallets) are particularly vulnerable to theft through hacking. So, the possibility is there.
Bitcoin transactions are virtually untraceable, which means they are very secure, but at the same time they are also obscure. You can never know who you are buying your currency from, nor who is buying from you. If you have bought from scammers, there is very little recourse for you to recover your funds.
Being a relatively new and decentralized currency system, the rules and regulations governing cryptocurrency are a bit murky. It is a “legal grey area”. Some things to be wary of are:
- stealing of private keys
- wallet theft and vulnerability
- Illegitimate or fraudulent exchanges
- Vulnerability of exchanges
What is the takeaway?
Bitcoin and other cryptocurrencies are still in their infancy. There is a lot we know, but also a lot we do not know. There are obvious benefits. There are also risks. It could be argued that there are risks with traditional currency as well and money has been lost through mishandling and deception there too. The jury is still out on where it is going and the governing rules are still murky at best.
One thing I have gotten out of this is that common sense should always rule. For obvious reasons, you probably wouldn’t want to put the money you can’t afford to lose into any financial endeavor without first getting all the facts, if at all.
Disclaimer: This post is purely for educational purposes. It is not to endorse or facilitate any financial decisions. Before engaging in any financial transaction, you should always consult a professional advisor. I am not a financial advisor, nor a legal advisor. I do not offer financial or legal advice.
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- February 24, 2020