Bitcoin means different things to different people. For some, it is a future of freely moving currency untied to any central bank. To others, it is a purely digital entity of questionable value and dubious origin. But what is Bitcoin, in the most basic sense?
In most casual conversations, you can get away with knowing that bitcoin is, basically, a digital currency. But of course, it’s much more complicated than that. In fact, it is two much more complicated things.
Bitcoin is a cryptocurrency, or a digital currency, that uses rules of cryptography for regulation and generation of units of currency. Bitcoin falls under the scope of cryptocurrency and was the first and most valuable among them. It is commonly called a decentralised digital currency.
A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets. Cryptocurrencies are classified as a subset of digital currencies and are also classified as a subset of alternative currencies and virtual currencies.
Table of contents:
- 1 What is Cryptocurrency?
- 2 What Is Bitcoin?
- 3 How Bitcoins Work?
- 4 What is Blockchain Technology?
- 5 How can I buy a Bitcoin?
- 6 Bitcoin’s Strengths
- 7 Bitcoin Weaknesses
- 8 Is Bitcoin Legal
- 9 Bitcoin Cash Fork and Other Cryptocurrencies
What is Cryptocurrency?
Cryptocurrencies are lines of computer code that hold monetary value. Those lines of code are created by electricity and high-performance computers. Cryptocurrency is also known as digital currency. Either way, it is a form of digital money that is created by painstaking mathematical computations and policed by millions of computer users called miners. Physically, there is nothing to hold, although you can exchange crypto for cash.
Crypto comes from the word cryptography, which is the security process used to protect transactions that send the lines of code for purchases. Cryptography also controls the creation of new coins, the term used to describe specific amounts of code. Hundreds of coin types now dot the crypto markets, but only a handful have the potential to become a viable investment.
Governments have no control over the creation of cryptocurrencies, which is what initially made them so popular. Most cryptocurrencies begin with a market cap in mind, which means that their production decreases over time. Ideally, any particular coin becomes more valuable in the future.
- Cryptographic: Cryptocurrency uses a system of cryptography (AKA encryption) to control the creation of coins and to verify transactions.
- Decentralized: Most currencies in circulation are controlled by a centralized government so their creation can be regulated by a third party. Cryptocurrency’s creation and transactions are open source, controlled by code, and rely on “peer-to-peer” networks. There is no single entity that can affect the currency.
- Digital: Traditional forms of currency are defined by a physical object (USD existing as paper money and in its early years being backed by gold for example), but cryptocurrency is all digital. Digital coins are stored in digital wallets and transferred digitally to other peoples’ digital wallets. No physical object ever exists.
- Open Source: Cryptocurrencies are typically open source. That means that developers can create APIs without paying a fee and anyone can use or join the network.
- Proof-of-work: Most cryptocurrencies use a proof-of-work system. A proof-of-work scheme uses a hard-to-compute but easy-to-verify computational puzzle to limit exploitation of cryptocurrency mining. Essentially, it’s similar to a difficult to solve “captcha” that requires lots of computing power. NOTE: Other systems like proof-of-work (such as proof-of-stake) are also used.
- Pseudonymity: Owners of cryptocurrency keep their digital coins in an encrypted digital wallet. A coin-holder’s identification is stored in an encrypted address that they have control over – it is not attached to a person’s identity. The connection between you and your coins is pseudonymous rather than anonymous as ledgers are open to the public (and thus, the ledgers could be used to glean information about groups of individuals in the network).
- Value: For something to be an effective currency, it has to have value. The US dollar used to represent actual gold. The gold was scarce and required work to mine and refine, so the scarcity and work gave the gold value. This, in turn, gave the US dollar value.
Cryptocurrency works similarly regarding value. In cryptocurrency, “coins” (which are nothing more than publicly agreed on records of ownership) are generated or produced by “miners.” These miners are people who run programs on specialized hardware made specifically to solve proof-of-work puzzles. The work behind mining coins gives them value, while the scarcity of coins and demand for them causes their value to fluctuate. The idea of work giving value to currency is called a “proof-of-work” system. The other method for validating coins is called proof-of-stake. Value is also created when transactions are added to public ledgers as creating a verified “transaction block” takes work as well. Further, value comes from factors such as utility and supply and demand.
What Is Bitcoin?
Is Bitcoin a currency? An investment? An asset? A stock? Well, yeah. It can be all of them. One individual Bitcoin is a piece of digital currency, otherwise known as BTC. As a general concept, Bitcoin is a system for securely buying, storing, and using money digitally. Bitcoins are found by Bitcoin miners and added onto the public blockchain network – but we’ll get to that later.
Thanks to rapid advances in public interest in the cryptocurrency, you can buy Bitcoins online or on your phone with popular apps like Coinbase – though many still choose to mine Bitcoins. Once you have Bitcoins, stored in a Bitcoin wallet, you’re welcome to use them as currency or you can hold onto them as an asset to invest in (much like gold). Bitcoin, which is mined with expensive hardware designed to solve intricate mathematical problems, is that there is a finite amount of it – 21 million Bitcoins, to be exact.
The idea behind Bitcoin is for there to not only be a digital currency, but a decentralized network behind it in contrast to the highly centralized system banks use for fiat currency. Bitcoin transactions are irreversible, and the pseudonymous public ledger the transactions are made on give it a level of transparency other financial systems don’t offer.
A single bitcoin varies in value daily. Check places like Coindesk to see current par rates. There are more than $2 billion worth of bitcoins in existence. Bitcoins will stop being created when the total number reaches 21 billion coins, which is estimated to be sometime around the year 2040. As of 2017, more than half of those bitcoins had been created.
Bitcoin currency is completely unregulated and completely decentralized. The currency itself is self-contained and uncollateralized, meaning that there is no precious metal behind the bitcoins. The value of each bitcoin resides within the bitcoin itself.
Bitcoins are stewarded by miners, the massive network of people who contribute their personal computers to the bitcoin network. Miners act like a swarm of ledger keepers and auditors for bitcoin transactions. Miners are paid for their accounting work by earning new bitcoins for each week they contribute to the network.
12 key things to know about Bitcoin
As a total novice, I spent days researching the ins and outs of Bitcoin, its benefits and risks. Here’s my distilled list of the key points.
- Trust – Fills the ‘trust gap’ between two parties (currently the role of banks)
- Secure – Transactions encrypted within a Blockchain which is impossible to hack
- Decentralised – With no one body in control, it can’t be taken down, hacked or manipulated
- Unregulated – There’s no guarantee of protection if a payment is made in error
- Transparent – Both code and all transactions (imagine knowing where every tax penny went)
- Low cost – Removes institutions and friction, especially for international payments
- Speed – Complete digital network (and no more loose change!)
- Limited supply – Capped at 21 million Bitcoins
- Truly global – Doesn’t geographically exclude people
- Privacy – Institutions don’t hold your data
- Virtual – Despite its name, Bitcoin has no physical coins. All 1s and 0s
- Volatile – Bitcoin value fluctuates wildly as it’s still relatively new.
Ultimately Bitcoin promises to democratise money, whilst removing almost all of the friction and cost in making a secure payment.
You don’t need to understand everything.
Under the bonnet Bitcoin is an incredibly complex technology, which makes it so secure. Most people don’t really know how card machines or even the internet works but still use them everyday.
We’ll dig deeper into the background and implications of Bitcoin later if you’re keen to learn more.
How Bitcoins Work?
Bitcoins are completely virtual coins designed to be self-contained for their value, with no need for banks to move and store the money. Once you own bitcoins, they behave like physical gold coins. They possess value and trade just as if they are nuggets of gold in your pocket. You can use your bitcoins to purchase goods and services online, or you can tuck them away and hope that their value increases over the years.
Bitcoins are traded from one personal wallet to another. A wallet is a small personal database that you store on your computer drive smartphone, tablet or somewhere in the cloud.
Bitcoins are forgery-resistant. It is so computationally intensive to create a bitcoin, that it isn’t financially worth it for counterfeiters to manipulate the system.
What is Bitcoin Mining?
The process of Bitcoin mining is an elaborate one, and a deeply controversial one as well. This is the process wherein solving the aforementioned mathematical problems comes into play. In Bitcoin mining, the computer solving this problem is part of what’s known as the “proof-of-work system.” In this system, the computer attempts to determine a number. The computer that successfully finds the number uses it to hash a block to the previous block in the blockchain network, announces it to the network which validates it, and is then rewarded with BTC.
This process has become controversial because the amount of energy it takes to mine a single block is astonishing; computers make billions of guesses per block, and system is designed to keep the pace of a block getting mined every 10 minutes. That’s billions upon billions of guesses a day for just a single computer, and the constantly-growing group of miners means a lot of people using this method that is not at all energy-efficient.
It also has made it far less likely of a single person mining a Bitcoin. Bitcoin miners are a dime a dozen today, and an individual will need to spend a lot of money on their computer and an expensive ASIC miner that gives them the best chance of mining BTC. As a result, mining pools, where Bitcoin miners pool their resources together and split the BTC reward among the entire pool, have become more common.
How many bitcoins are there in the world?
Bitcoins are generated following a strict mechanism. One can count the number of coins in existence at any point in time by multiplying the number of blocks times the coin value of a block. The coin value of a block follows a well-defined rule. Every 210,000 blocks, the value is halved (approx. every 4 years). The first block was of 50 BTC, the 210,001st was valued 25 BTC, and so on.
As of now, the total number of coins in circulation is over 17.4 million BTC. The network is designed to add the supply of 21 million bitcoins. Current supply growth is 12.5 bitcoins per block (approximately every ten minutes) until mid-2020. Afterwards, it will be 6.25 bitcoins per block for 4 years until next halving. This halving continues until 2110–2140 when 21 million bitcoins will have been issued.
Who is Satoshi Nakamoto?
Bitcoin was introduced in 2008 by an unknown creator going by the name of Satoshi Nakamoto, who communicated only by email and social messaging. While several people have been identified as likely candidates to be Satoshi, as the creator is known in the world of Bitcoin, no one has been confirmed as the real Satoshi, and the search has gone on.
Satoshi created the original rules of the Bitcoin network and then released the software to the world in 2009. Satoshi largely disappeared from view two years later. Anyone can download and use the software, and Satoshi now has no more control over the network than anyone else using the software.
The History of Bitcoin
The Bitcoin system was created and put into place by “Satoshi Nakamoto.” That’s in quotes because nobody knows who that is, whether it’s one man or woman or a group of people. What is known is that early in 2009, Nakamoto mined the first 50 Bitcoins, and an industry was created.
The next enormous step in Bitcoin’s progression came nearly a year and a half later, when a man named Laszlo Hanyecz paid 10,000 Bitcoins for two pizzas, the first confirmed purchase in the cryptocurrency’s history. At the time, the Bitcoin rate was mere fractions of a penny for 1 BTC. Today, that same number of Bitcoins is worth over $70 million. Let’s hope it was at least pretty good pizza.
By 2011, Bitcoin began increasing rapidly in value, from penny fractions to being worth over one dollar. Over the next couple of years, controversies drive the price up (via seemingly random periods of investors getting involved) and down (after a security breach of Mt. Gox, then the top Bitcoin exchange), an absurd level of volatility that has become the norm for cryptocurrencies. After 2013, though, it stagnated for several years. It’s rise goes from speedy to slow and steady.
But 2017 brought back the crazy up and down Bitcoin we know and love, as Wall Street began to see Bitcoin as more viable than ever. The end of the year sees a massive BTC price peak, coming close to $20,000 in Bitcoin value. A more detailed timeline can be found at New York Magazine.
The idea Nakamoto had for Bitcoin was outlined in a 2008 white paper. Nakamoto believed that the use of third parties (like banks) in financial transactions made them too susceptible to fraud, saying that people needed “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.” Nakamoto was able to attain this decentralized network with blockchain technology.
How Do Transactions Happen?
Now, let us see how these concepts work together. To record transactions, we need to put them in a database (like an Excel sheet).This would normally be stored in one place in a centralized network. But because Bitcoin uses a decentralized network, the Bitcoin database is shared. This shared database is known as a distributed ledger and it is accessed using the blockchain.
To send Bitcoin to someone, you need to digitally sign a message thaƒt says, “I am sending 50 Bitcoins to Peter”. The message would be then broadcasted to all the computers in the network. They store your message on the database/ledger.
What is Blockchain Technology?
The blockchain network is essentially a transparent ledger, and is sometimes referred to as distributed ledger technology (DLT). The “block” is a collection of transactions, and the “chain” is the hash that connects the blocks, creating a network. Before it can be added to the block, the transaction must be validated by the other computers within the network, known as nodes. These are the nodes also doing the mining. They go to work trying to determine the hash for a block that will reward them, they validate the new block and continue to validate all existing blocks.
Bitcoin owners have two different keys: a public one and a private one. The public key is what everyone else in the network can see; if you make a transaction, it appears in the blockchain with your public key, and the recipient’s public key is used to send Bitcoins their way. The private key helps to verify the sender; essentially, B’s public key is used as an output for where to send them, and A’s private key is used to sign off on the transaction.
Once this happens, the other nodes get to work validating the transaction. This is where the mining begins. Added to the other transactions set to be in the next block, miners get to work trying to validate the block with a proof-of-work. These are the mathematical calculations the computers attempt to solve. Once the proof-of-work is solved, the block is validated and confirmed.
Blocks are bound together by a hash, a unique string of characters. The information within a block generates these hashes, and they are contained not just in that block but the block after that. This way there is a running record of the information that is always making sure it’s consistent. If there is an attempt to change the information in a block, it will change the hash – but not in the next block.
Blockchain technology is said to have other uses and potential in other industries, but as a concept it has become inextricably linked to Bitcoin.
Here is a slightly more technical description of how mining works. The network of miners, who are scattered across the globe and not bound to each other by personal or professional ties, receives the latest batch of transaction data. They run the data through a cryptographic algorithm that generates a “hash,” a string of numbers and letters that serves to verify the information’s validity, but does not reveal the information itself. (In reality this ideal vision of decentralized mining is no longer accurate, with industrial-scale mining farms and powerful mining pools forming an oligopoly – more on that below.)
Given the hash 000000000000000000c2c4d562265f272bd55d64f1a7c22ffeb66e15e826ca30, you cannot know what transactions the relevant block (#480504) contains. You can, however, take a bunch of data purporting to be block #480504 and make sure that it has not been tampered with. If one number were out of place, no matter how insignificant, the data would generate a totally different hash. If you run the declaration of independence through a hash calculator, you get 839f561caa4b466c84e2b4809afe116c76a465ce5da68c3370f5c36bd3f67350. Delete the period after “submitted to a candid world,” and you get 800790e4fd445ca4c5e3092f9884cdcd4cf536f735ca958b93f60f82f23f97c4. Which is more than a little different.
This technology allows the bitcoin network to instantly check the validity of a block. It would be incredibly time consuming to comb through the entire ledger to make sure that the person mining the most recent batch of transactions hasn’t tried anything funny. Instead the previous block’s hash appears within the new block. If the minutest detail had been altered in the previous block, that hash would change. Even if the alteration was 20,000 blocks back in the chain, that block’s hash would set off a cascade of new hashes and tip off the network.
Generating a hash is not really work, though. The process is so quick and easy that bad actors could still spam the network and perhaps, given enough computing power, pass off fraudulent transactions a few blocks back in the chain. So the bitcoin protocol requires proof of work. (See also, How Does Bitcoin Mining Work?)
It does so by throwing miners a curve ball – their hash must be below a certain target. That’s why block #480504’s hash starts with a long string of zeroes – it’s tiny. Since every string of data will generate one and only one hash, the quest for a sufficiently small one involves adding nonces (“numbers used once”) to the end of the data. So a miner will run [thedata]. The hash is too big, try again. [thedata]1. Too big. [thedata]2. Finally, [thedata]93452 yields a hash beginning with the requisite number of zeroes. The mined block will be broadcast to the network to receive confirmations, which take another hour or so – though occasionally much longer – to process. (Again, this description is simplified. Blocks are not hashed in their entirety, but broken up into more efficient structures called Merkle trees.)
Depending on the kind of traffic the network is receiving, bitcoin’s protocol will require a longer or shorter string of zeroes, adjusting the difficulty to hit a rate of one new block every 10 minutes. Current difficulty is around 2.603 trillion, up from 1 in 2009.
Mining is intensive, requiring big, expensive rigs and a lot of electricity to power them. And it’s competitive – there’s no telling what nonce will work, so the goal is to plow through them as quickly as possible. Miners have begun to form pools, divvying the rewards up among themselves. And the rewards are juicy. Every time a new block is mined, the successful miner receives a bunch of newly created bitcoin – at first it was 50, then it halved to 25, now it is 12.5 ($107,500 at the time of writing). The reward will continue to halve every 210,000 blocks – around four years – until it hits zero, at which point all 21 million bitcoin will have been mined, and miners will depend solely on fees to maintain the network.
That miners have begun to organize themselves into pools worries some. If a pool exceeds 50% of the network’s mining power, its members could potentially spend coins, reverse the transactions, and spend them again. They could also block others’ transactions. That could spell the end of bitcoin, but even a so-called 51% attack would probably not enable the bad actors to reverse old transactions, because the proof of work requirement makes that process so labor intensive. To go back and alter the blockchain at leisure (a time-consuming process under any circumstances), a pool would need to control such a large majority of the network that it would probably be pointless. When you control the whole currency, who is there to trade with?
A 51% attack is a financially suicidal proposition, from miners’ perspective. When Ghash.io, a mining pool, reached half of the network’s computing power in 2014, it voluntarily broke itself up in order to maintain confidence in bitcoin’s value. Other actors, such as governments, might find such an attack interesting, though.
Another source of concern related to miners is the practical tendency to concentrate in parts of the world where electricity is cheap, such as China – or increasingly, following a Chinese crackdown in early 2018, Quebec.
Keys and Wallets
Bitcoin ownership boils down to two numbers, a public key and a private key. A rough analogy is a username (public key) and a password (private key). A hash of the public key, called an address, is the one displayed on the blockchain (using the hash provides an extra layer of security).
For you to receive bitcoin, it’s enough for the sender to know your address. The public key is derived from the private key, which you need to send bitcoin to another address. IThe system makes it easy for you to receive money, but requires you to verify your identity to send it.
To access bitcoin, you use a wallet, which is a set of keys. These can take different forms, from third-party web applications offering insurance and debit cards, to QR codes printed on pieces of paper. The most important distinction is between “hot” wallets, which are connected to the internet and therefore vulnerable to hacking, and “cold” wallets, which are not connected to the internet.
Many users opt to use exchanges such as Coinbase, putting the exchange in control of the private keys.
How can I buy a Bitcoin?
There are companies in most countries that will sell you Bitcoins in exchange for the local currency. In the United States, a company called Coinbase will link to your bank account or credit card and then sell you the coins for dollars. Opening an account with Coinbase is similar to opening a traditional bank or stock brokerage account, with lots of identity verification to satisfy the authorities.
For people who do not want to reveal their identities, services like LocalBitcoins will connect people who want to meet in person to buy and sell Bitcoins for cash, generally without any verification of identity required.
What is the price of bitcoin today
How can I store my bitcoins?
To see how the system works, imagine someone called Alice who’s trying out Bitcoins. She’d sign up for a cryptocurrency wallet to put her bitcoins in.
The Bitcoin Wallets
There are three different applications that Alice could use.
- Full client – This is like a standalone email server that handles all aspects of the process without relying on third-party servers. Alice would control her whole transaction from beginning to end by herself. Understandably, this is not for beginners.
- Lightweight client – This is a standalone email client that connects to a mail server for access to a mailbox. It would store Alice’s bitcoins, but it needs a third-party-owned server to access the network and make the transaction.
- Web client – This is the opposite of “full client” and resembles webmail in that it totally relies on a third-party server. The third party replaces Alice and operates her entire transaction.
You’ll find wallets that come in five main types: Desktop, mobile, web, paper and hardware. Each of these has its advantages and disadvantages.
What do I need to know to protect my Bitcoins?
Here are four pieces of advice that will help your bitcoins go further.
As you’d do with a regular wallet, only store small amounts of bitcoins on your computer, mobile, or server for everyday uses, and keep the remaining part of your funds in a safer environment.
- Backup your wallet on a regular basis and encrypt your wallet or smartphone with a strong password to protect it from thieves (although, unfortunately, not against keylogging hardware or software).
- Store some of your bitcoins in an offline wallet disconnected from your network for added security. Think of this as a bank, while you, generally, keep only some of your money in your wallet.
- Update your software. For added protection, use Bitcoins’ multi-signature feature that allows a transaction to require multiple independent approvals to be spent.
Spending some time on these steps can save your money.
We recommend the Nano Ledger S and Trezor – Hardware Wallets.
The Advantages of Bitcoin:
- International payments are a lot faster than banks
- Fees are low
- Blockchain — near impossible to hack
- Decentralized — cannot be shut down at a single point<
- Transparent — you don’t have to trust anyone
- Anonymous — you don’t need to use your name
- Powered by the community — the fees are shared instead of going to a single point (i.e. a bank or PayPal)
- No verification for new users — anyone can use it
That doesn’t mean Bitcoin won’t have its place in the future, however. Let’s talk about some advantages and disadvantages to Bitcoin over traditional currency.
Anonymity and Privacy
Bitcoin purchases between individual users are entirely private: it’s possible for two people to exchange Bitcoins or fractions of coins between wallets simply by exchanging hashes, with no names, email addresses, or any other information. And because the peer-to-peer network uses a new hash for each transaction, it’s more or less impossible to link concurrent purchases to a single user. The nature of the peer-to-peer encrypted network makes it secure from the outside, as well: no one else can see your personal purchases or receipts without first getting access to your wallet.
No Required Transaction Fees (For Now)
Conventional non-cash purchases include transaction fees: pay with a Visa credit card, and Visa will charge the merchant a few cents to verify the transaction. And of course, the cost of that charge is passed on to you in the form of higher prices for goods and services.
At the moment, there are no mandatory transaction fees for Bitcoin. Individual users and merchants can submit their purchases to the peer-to-peer network and simply wait for it to be verified on the next block. However, this process can take time (and it takes more time the more the network is used). So to speed up transactions, many merchants and users add a transaction fee to increase the priority of the transaction in the block, rewarding users on the peer-to-peer network for completing the verification process faster.
As the global supply of Bitcoins reaches its 21 million coin limit, transaction fees will become the primary method for miners to earn Bitcoins. At this point, presumably most transactions will include a small fee simply as a function of completing the purchase quickly.
No Central Governing Authority or Taxes
Because Bitcoin isn’t recognized as an official currency by any country, buying and selling Bitcoins themselves and using them to purchase goods and services isn’t regulated. So anything you buy with Bitcoins is not subject to a standard sales tax, or any other tax that’s normally applied to that item or service. This can be huge economic boon if you’re wealthy enough and interested enough to do a lot of business exclusively in Bitcoin.
Without being subject to most monetary laws, Bitcoin is effectively a barter system. Imagine your current supply of Bitcoins as a gigantic stack of potatoes: if you trade ten thousand potatoes for a new TV, the government won’t ask for a sales tax in the form of eight hundred potatoes. It simply isn’t equipped to handle any transactions not performed in its own currency.
However, you should be aware that any conventional earnings you receive from dealing in Bitcoin will be treated in the usual way. So if you transfer $10,000 worth of Bitcoins to your bank account via a Bitcoin market, you will need to report it as income on your taxes. Dealing in Bitcoin doesn’t nullify other standard requirements for taxation, either: even if you purchase a new car via Bitcoin from a private seller, you’ll still have to register that car with the government and pay taxes based on its market value.
The Disadvantages of Bitcoin:
- Mining uses lots of electricity
- Not as fast as other cryptocurrencies
- Fees change a lot
- Anonymous — used for crime
- Difficult to use — private keys, public keys etc.
So if Bitcoin is so great, why isn’t everyone using it? Well, obviously, it has some drawbacks too, especially at the current time.
Possible Government Interference
Any time something new comes around and challenges the status quo, the government is going to get involved to make sure that things remain the way they are supposed to be. The fact is that the US government, and other governments, are looking into Bitcoin for a variety of reasons. Just in the last few days, the US government has started seizing some accounts from the biggest Bitcoin exchange. More is likely to come in the future.
No Monetary Sovereignty
Perhaps the biggest weakness of bitcoin is that it is not a “recognized” sovereign currency—that is, it is not backed by the full faith of any governing body. While this could be seen as strength, the fact that Bitcoin is a fiat currency which is accepted only on the perceived value of other bitcoin users makes it highly vulnerable to destabilization. Simply put, if one day a large number of merchants who accept bitcoin as a form of payment stop doing so, then the value of bitcoin would fall drastically.
The current high value of Bitcoin is a function of both the relative scarcity of Bitcoins themselves and its popularity as a means of investment and wealth generation. If confidence in the Bitcoin market is suddenly and drastically reduced—for example, if a major government declared Bitcoin use illegal, or one of the largest Bitcoin exchanges was hacked and lost all of its stored value—the value of the currency will crash and investors will lose huge amounts of money.
The United States Treasury does not recognize bitcoin as a conventional currency, but does recognize its status as a commodity, like stocks and bonds. Similarly, the US Internal Revenue Service considers bitcoins property and taxes them as such if they are declared. No other country has declared bitcoin to be a recognized currency, but engagement with bitcoin and other cryptocurrencies varies from place to place. Some countries are investigating bitcoin as a growing commodity market, some take the same stance as the US declaring them assets, and some have explicitly banned their use for transfer of goods or services (though the means of enforcing those bans are limited).
Lack of Protections
The Bitcoin network has no built-in protection mechanisms when it comes to accidental loss or theft. For instance, if you lose the hard drive where your Bitcoin wallet file is stored (think corruption or drive failure with no backup), the Bitcoins held in that wallet are lost forever to the entire economy. Interestingly, this is an aspect which further exacerbates the limited supply of Bitcoins.
Additionally, if your wallet file is stolen or compromised and the Bitcoins contained within it are spent by the thief before the rightful owner, the double spending protection mechanism built into the network means the rightful owner has no recourse. Unlike if, for example, your credit card is stolen, you can call the bank and cancel the card, bitcoin has no such authority. The Bitcoin network only knows that the bitcoins in the compromised wallet file are valid and processes them accordingly. In fact, there is already malware out there which is designed specifically to steal Bitcoins.
Bitcoin markets are vulnerable to attack or fraud. Major exchanges like GBH and Cryptsy have been shut down with all the Bitcoin entrusted to their care presumably stolen by the operators. Japan-based Mt. Gox, formerly the handler of over half the Bitcoin transactions on the planet, was shuttered after a theft of hundreds of thousands of Bitcoins. The 2014 incident caused a huge (but temporary) drop in the value of Bitcoin worldwide.
Black Market Appeal
A central principle to the design of the Bitcoin system is that there is no single transactional processing authority. As a result, no single user can be locked out of the system. Combine this with the inherent anonymity of transactions, and you have an ideal medium of exchange for nefarious purposes.
Bitcoin has become an ideal means for commerce in illicit goods and services. The quintessential case is the Silk Road, a dark web site that allowed users to anonymously trade items like drugs and fake identification, all bought with Bitcoin thanks to its untraceable nature. The story of Silk Road’s illegal trade didn’t even stop after the US Drug Enforcement Agency and Department of Justice shut down the site and seized its digital holdings in 2013. A Secret Service agent was charged with stealing over $800,000 of bitcoin from the investigators, who had held the seized digital currency to be auctioned off for the benefit of the law enforcement agencies.
While this is not exactly a weakness in Bitcoin (after all, drug dealers using cash doesn’t undermine the value of the currency itself), the unintended consequence of its usage for dubious purposes could be considered one. In fact, the US Treasury Department recently applied money laundering rules to bitcoin exchanges.
Is Bitcoin Legal
The legal status of bitcoin varies substantially from country to country and is still undefined or changing in many of them. Whilst the majority of countries do not make the usage of bitcoin itself illegal, its status as money (or a commodity) varies, with differing regulatory implications. While some countries have explicitly allowed its use and trade, others have banned or restricted it. Likewise, various government agencies, departments, and courts have classified bitcoins differently.
But for the most part it remains relatively safe to use as long as it is not tied to illicit purchases or activities. Many countries have issued statements indicating that bitcoin and other digital currencies are not regulated and do not exist as officially sanctioned currencies: a status that could put users at risk but would not have them violating any laws. Bitcoin is outright illegal in some countries, such as Iceland.
Depending on where and how you utilize bitcoin, it is important to remain up-to-date on the latest regulations concerning the digital currency. As laws change across borders, governing bodies and, increasingly, as the platform gains popularity, questions about bitcoin’s legality will continue to be raised.
Bitcoin Cash Fork and Other Cryptocurrencies
A fork occurs when one blockchain splits into two, creating two separate records of data. It is up to the network of bitcoin miners to agree which one of these to continue using, and which should be discarded.
Forks are the result of a misalignment of the community’s mining programs, and enable the blockchain to undergo essential software updates. The two main types are soft forks and hard forks.
- Soft forks: the upgraded blockchain is now responsible for validating all transactions (blocks), but the existing blockchain will still recognise and record these transactions. Keep in mind that this only works one way: the upgraded blockchain will not recognise any blocks mined via programs using the existing blockchain.
- Hard forks: the upgraded blockchain is now responsible for validating all transactions, but the existing blockchain no longer recognises these blocks as valid, nor records them. This means all users of outdated programs must update to access the upgraded blockchain.
Generally, forking is resolved with little to no disruption. But differences of opinion in how a cryptocurrency should scale or function have proven insurmountable in the past. The most high-profile example of this is bitcoin cash, which came about when bitcoin hard forked and divided bitcoin miners along with it. This ultimately resulted in two distinct cryptocurrencies, bitcoin and bitcoin cash, albeit ones with the same transactional history up until July 2017.
On August 1st, 2017, long debates between bitcoin proponents and disagreements on how to solve its problems resulted in a currency split. The Bitcoin standard was broken in two, with the original system unaffected and the new Bitcoin Cash standard added. This was less like a stock market split and more like a software fork. Every person or organization who owned Bitcoin in any amount immediately owned an equal amount of Bitcoin Cash, with sales and transfers of both currencies occurring normally after the split. Like the original Bitcoin, Bitcoin Cash is entirely digital and has no real-world physical component (despite the name).
The split is a hard fork in software terms. The separate Bitcoin Cash peer-to-peer system allows for eight times more transactions per block, making it a better (but not necessarily equal) competitor to credit and debit cards for constant online and in-person sales. The operators of Bitcoin Cash hope that it will become a more widely-accepted currency for standard purchases, like coffee shops or supermarkets.
Because of the newer system, Bitcoin Cash has not benefited from the explosive growth of value that the original Bitcoin Cash has experienced. At the time of writing, Bitcoin Cash (BCH) is trading at approximately $325 per unit, less than 10% of the value of the original Bitcoin. That’s not necessarily a bad thing for the new standard: a currency with a smaller range of market fluctuation and a slower, more steady growth rate may be appealing to businesses. But at the moment, Bitcoin Cash transactions aren’t supported by any notable merchants, aside from existing cryptocurrency exchanges and wallets.
Without major support from large online or physical retailers, Bitcoin Cash seems unlikely to become as successful as the original Bitcoin. It’s more likely that the forked standard will join the ever-expanding list of competing cryptocurrencies without any notable application beyond the cryptocurrency market itself. These competing currencies use peer-to-peer systems similar to the original Bitcoin, but with significant changes in cryptographic methods and terms. Examples include Litecoin, Ethereum, and Zcash.
None of the competitors to Bitcoin has reached any notable fraction of its current value, and support from retailers outside of the growing and somewhat speculative niche of cryptocurrency exchanges is minimal.
Bitcoin and cryptocurrency are fascinating developments, a mark of the desire for participants in the information age to lessen their dependency on the economic and legal systems that prop up institutions from before the 21st century. It’s certainly made plenty of fortunes in its brief existence…and lost more than a few as well. The long-term viability of Bitcoin as a medium for wealth has yet to be determined.
If you’d like to get involved in Bitcoin or any of its competitors, make sure to do your research and use caution. Bitcoin can be a lucrative hobby and an exciting investment, but as with any other kind of investing, it’s always best to diversify for safety. If you’d like to read more about Bitcoin, we recommend checking out Bitcoin.org and the Bitcoin Wikipedia page.
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