Bitcoin: all you need to know about it in 2016

12:35 PM


Many different voices have been heard on this self-proclaimed revolutionary new cryptocurrency. 
Let’s throw some light on the subject so that the next time you get involved in a conversation about it you’re not a mere listener!

Bitcoin


Bitcoin is a peer-to-peer digital currency. Units of this currency are digitally created, without a physical counterpart. The set of rules for the whole system was defined in the seminal paper published in October 2008, by a blogger with the pseudonym of Satoshi Nakamoto. In order to provide transparency and avoid double-spending, a decentralized support networkwas set-up to audit the transactions, and publish them in a public ledger called“the blockchain”.  Every Bitcoin transaction is published in this log, using encryption in order to keep users identities anonymous.  
Thus, Bitcoin is a currency without a physical expression.
Now, let’s enumerate the essential elements that compose and define Bitcoin, as originally thought in Satoshi´s seminal paper.

Bitcoin essentials

  • Bitcoin was conceived to function as peer-to-peer digital currency with minimal intervention from 3rd party agents. This means that Bitcoin transactions (online by definition) can be sent directly from one party to another without going through an intermediary such as traditional financial institution.
  • Bitcoin money supply tends to be fixed, that is to say finite, due to the asymptotic function that rules its creation. This means that in the long term, prices expressed in Bitcoins tend to follow a deflation path.
  • The Bitcoin ecosystem was envisaged and built to keep the anonymity of the parties involved in each transaction. Two users could exchange bitcoins without revealing personal information, like their names or bank account numbers. However, some information is indeed revealed, which is why Bitcoin is called pseudo or quasi anonymous scheme. Nevertheless, even if it is not 100% anonymous, it is quite difficult to trace the identity of each user.
  • A decentralized support network was set as an audit and control layer to avoid double-spending (issuing the same digital units twice, and thus, committing fraud). This support network provides CPU to run the validations, and to timestamp the transactions in the public log, “the blockchain”. As an incentive to be part of this network, the participants -called miners- are credited with units of the digital currency (following the asymptotic function).
Let´s explore in-depth some of the implications of the way Bitcoin was conceived. 

Peer-to-peer currency

The Bitcoin scheme is set as a peer-to-peer currency in order to generate minimal intervention from 3rd parties. The intention is to avoid the intermediation of centralized entities and corporations as we have today in the traditional financial system (banks, credit cards, central banks). 
The only 3rd party involved in a Bitcoin transaction is a decentralized node (“a miner”) from the supporting network, that provides processing muscle for auditing & control, and who will be rewarded with mining credits. In opposition to the tradicional financial environment, in the Bitcoin environment there are not centralized entities that can control transaction fees. 
This fact is easily understandable in the following charts.
Let's see a typical credit card transaction.
 Now, let's check a Bitcoin transaction.
Hum, pretty impressive, right?

Money supply

There is no centralized entity in charge of issuing the units of Bitcoin.The money supply is not controlled by a Central Bank (therefore a Government), but it is already defined as asymptotic and issued by the miners that contribute with CPU to the supporting network. 
As a result of this design decision, the money supply tends to be fixed for Bitcoins, unlike fiat currencies where the money supply can be expanded permanently (via monetarists policies). Fiat currencies are issued by governments all around the world, that can expand the money supply primary printing more notes, and secondly allowing fractional reserve banking schemes (banks create money via credits, having in their vaults only a fraction of the customer deposits). If we look at the money supply of US Dolar from 1960 to 2014, we will see that the curve follows an exponencial increment, and it has theoretically no limit. This means that there's a risk of inflation if the money supply is not fully aligned with the economic growth.

On the other hand, Bitcoin supply was defined as asymptotic.
This means that the total amount of Bitcoin units will be fixed around 2040 (although technically the Bitcoin creation increases in an opposite rate as an incremental exponencial function, for the purpose of our analysis will consider it as a fixed money supply).
The implications of the differences in the money supply are that in the long run, in opposition to fiat currencies from the traditional financial system which tend to generate inflation, Bitcoin prices tend to deflation. 

 

Price is not (that) important

The importance of Bitcoin in 2016 is not the price, but adoption. As per a basic rule in economy given a fixed supply and an increased demand, prices increases. We are used to dealing with governmental currencies that depreciate from time to time. But in the case of the Bitcoin, as the supply will be fixed once it reaches its originally defined limit, the currency will appreciate as adoption grows, which means that the purchasing power of the money would be increased in the long term. 

Regulation

At this stage of the irruption of Bitcoin, there are no regulations applicable to the Bitcoin scheme. So far the Bitcoin ecosystem startups are regulated in their interaction with the traditional financial system. But as adoption grows, governments will eventually try to do it, which promises to be a passionate debate due to the originality of the Bitcoin conception.

Pros and Cons

So far we’ve seen the essential elements, but let’s focus on the advantages and disadvantages of this new currency.

Advantages

  • Decentralized. It is a decentralized currency without any central bank, government or centralized institution being involved in the money supply.
  • Online Payments. It is a digitally native currency, which makes it ideal for online payments. There are no minimal amounts required, and no 3rd parties that need to be the man-in-the-middle to validate the trust in the transaction. This can be an excellent payment method for a digital subscription model. A magazine for example can charge a fraction of bits for the articles read, or a cinema streaming portal can charge for the actual amount of time watched.
  • Speed and price. You can transfer money anywhere in the world within minutes with insignificant fees. No powerful centralized intermediaries are needed to complete a payment, no matter where in the world is located each participant.

Disadvantages

  • Volatility. The Bitcoin price expressed in USD has behaved in a wild manner since its creation. This extreme volatility can be a setback for certain types of transactions or investment plans.
  • Reliance on technology. Although along the 8 years of existence highly qualified digital security specialists have reassured that the system is a highly trustful, as it is not backed by any institution that can provide guarantees, some analysts remain skeptics that there might be structural problems or even a Satoshi Backdoor in the system.
  • Obsolescence. Bitcoin is the most popular cryptocurrency but not the only one. There are many others. Litecoin for example has more frequent blocks and this should result in merchants receiving faster confirmations for their online sales. Corporations from the traditional finance world are experimenting with its proprietary cryptocurrencies, like Citi Corp. Although it has run a long ride, we are just in the dawn of digital currencies.

Bitcoin in 2016.


Bitcoin, as we have just seen is quite a revolutionary concept as originally defined. The practice however is subjected to lots of controversies.
Some detractors emphasize its criminal potential due to being conceived having anonymity as a central value of the ecosystem. The Silk Road affaire (the Amazon-like alternative for drugs & illegal stuff) and the Ft. Gox bankruptcy scandal were among the most negative incidents that gained the biggest attention of the mass media. Yes, anonymity can be used for committing fraud with Bitcoins, but we have to keep in mind that physical cash (here you can pick the currency that you like) is the most important element used by the organized crime today (crime, drugs, wars). The controls for criminal activities and money laundry have to be reinforced no matter which currency is being dealt with.
In addition, we have recently seen the visceral resignation from a former Bitcoin Core developer (the team that manages the operational rules of the decentralized support network), due to being in strong disagreement with other members of the team. A technical issue, the size of the blocks to be stamped in the blockchain (as adoption grows, the system needs to be adapted), revealed a strong conflict of points of view. No matter how technically complex the issue is, in order to be fixed, the bottom line problem is the impossibility of reaching an agreement between all the members of the core development team. Whether we are talking about cryptocurrencies or a product design feature, human coordination is still a fundamental feature to succeed in every project. Hopefully in the case of Bitcoin, differences can be openly debated and a technical solution can be reached in order to cope with the growing demands of an increased adoption.
But not everything is controversial in the bitcoin world. We can also identify truly original concepts that can be used in other fields.
One of the most creative elements is the blockchain. Every Bitcoin transaction is registered via encryption in a public ledger via a block that contains all the details of the transaction (bitcoin payer address, amount, date, time, receiver address). Due to the encryption method, which generates cryptographic hashes (that transform a collection of data into an alphanumeric string), each block stamped in the blockchain can’t be modified or changed. This means that this is a digital equivalent of a notary.
Can you imagine then how many activities in our modern life can be transformed if we can apply this “highly secure digital notary system”?
Some start-ups are showing the way ahead. Everledger for example has a permanent ledger for diamond certification and related transaction history, and provides verification services for insurance companies and owners.
Basically the blockchain feature can eventually be used for any asset that carries a unique identifier which is difficult to destroy or duplicate. It can also be used to solve copyright claims, if the patents office starts using it.
At an early stage, Bitcoin was considered a truly experimental exercise, with no real possibilities in reaching the mainstream of the finance world.
Nowadays, there are some signs that show that this may not be the case anymore. Traditional financial institutions are following closely all the increase in its adoption, as well as the technical developments.
As a clear indicator of this trend, we can highlight the recent addition to Paypal’s Board of Wences Casares, CEO of Xapo (one of the most important actors in the Bitcoin environment). This announcement can be interpreted as movement from established actors in the traditional financial environment in order to be updated with a first-hand protagonist from the fintech knowledge frontier. 
Following this path, some big names in finance and banking (Visa, Nasdaq, Citi, Orange) have invested in the bitcoin start-up Chain. They have built blockchains that can issue assets of many different kinds.
If Bitcoin and the blockchain are the future of finance, everybody will jump on the bandwagon.

 

Final words.


In my opinion, 2016 will be a fascinating year for Bitcoin.
The fundamentals are all set, and the storms of the past couldn’t undermine the present, nor the future.
The growing challenges of Bitcoin adoption provide both threats and opportunities. From start-ups to big corporations, everyone is watching the performance of Bitcoin.
Bitcoin seems to be still in the innovators phase of the Rogers adoption curve, with the first early adopters stepping in. As per January 2016, we can’t estimate when bitcoin adoption will cross the chasm and reach the mainstream of the early majority.
Hopefully, Bitcoin developers’ criticism can be assimilated, egos aside, so that the growth can be escalated smoothly without impacting the ecosystem as a whole. Once the technical path to growth is paved with the necessary adjustments, the adoption chasm might be crossed.
To conclude, we can suggest the key accelerators needed for a successful journey to the generally accepted finance arena. Firstly, the Bitcoin ecosystem would have to develop more and easy-to-use integration tools for the masses, including education efforts. Secondly, more predictability in the core network will rest some volatility to the price, which will allow a participation of more traditional players. Finally a fully democratic approach from the network core will need to be guaranteed to keep Bitcoin close to its original essence.

Esteban Etcheverry
Technology specialist, avid book reader and devoted art lover.
twitter: @eetcheverry1
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Sources.

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2 comments

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