News, articles and opinions about Bitcoin have been cropping up often on technical forums lately. The basic concept of an internet payment system that does not follow the “normal” money standards whets appetites. Despite evoking opinions of all types, Bitcoin is beginning to catch on. The system has been up and running for over 5 years at the moment of writing (March 2014) and there are now over 12 million bitcoins in circulation with a unit value of over 600 dollars. Nobody yet knows if Bitcoin is here to stay but it doesn’t seem likely to disappear in the near future.
How Bitcoin works?
The concept is based on system users having a “digital wallet” with a pair of cryptographic keys (public and private), allowing them to make a signed “worldwide” declaration that they have passed a certain amount of bitcoins from their own digital wallet to another’s. The receiver of this sum then has to confirm that this transaction is correct, giving something in exchange for these bitcoins (e.g, Premium website access rights).
The trick lies in this confirmation being made simultaneously by a large number of computers connected up to the Bitcoin network. Each computer will try to set up a transaction validating “block”. Creation of this block will be of such mathematical difficulty (to be defined by the Bitcoin protocol) that it will call for a great CPU effort. Each new block is added to a chain shared by all users. This block chain records all linked transactions throughout the whole network, so each user can work backwards through the chain to trace the complete path of each bitcoin.
Instead of traditional “currency issuance”, the system is designed to work by way of the gradual minting of new coins (inflation), serving precisely to reward users who take on the generation of these blocks. Thus, the first user who manages to carry out the mathematical task of creating a block adds a certain amount of bitcoins (established by the system) and takes them into his or her possession (the other users recognize these coins as belonging to this first user). This concept is called “mining”. This model aims to make it more profitable for users “to do good” and dedicate their IT resources to verifying transactions rather than trying to deceive other users and create false transactions.
Pros and cons
The most groundbreaking feature of this system is that it sets up peer-to-peer transactions without middlemen, without having to change currencies, without borders of any type and without having to pay any third-party commissions. There is no need for banks or money changers, no wait for the money to come and no transaction taxes. Bitcoin depends on no government so its stability is not conditioned by any political or social factors, etc. There is no possibility of external intervention. Users know the money-minting system (mining) and do not have to fear any uncontrolled minting of new money.
System anonymity is not clearly a pro or a con. On the one hand all transactions are publically recorded and cannot therefore be hidden. Each unit in the chain can be traced right back to its origin. Secondly, each user may have many different accounts and, in principle, there is nothing in his or her wallet number that might identify the individual or institution lying behind the transaction. Anonymity is currently the governing principle although there are all types of opinions for and against, and the possibility of future regulation cannot be completely ruled out.
As for the drawbacks, the system does have some intrinsic design limitations, notably lack of wallet security. If anyone “mugs” you and manages to find out your key, your money will be robbed without any chance of recovery or pursuing the thief. You might also lose wallet money if you lose the data and have no backup copy to hand.
The design limits transaction speed. The minimum confirmation time is 10 minutes and may be longer if your transaction is not validated in the first block.
Other doubts are thrown up by system scalability. As things stand today the ceiling is 7 transactions a second. Some mechanisms have been mooted to increase this number but there are doubts about whether they will be effective.
But the biggest bug of all is confidence. How many people are going to trust this system enough to pay over “real” money for this type of mathematical contrivance? How many companies will really be ready to sell services in return for such a nebulous concept of money? Unless the number of persons / companies builds up to a critical mass the whole system might be undermined and brought crashing down by rampant mistrust.
The value of each bitcoin unit in relation to other currencies is not free from market speculation. The soaring value of bitcoins in the last year is eyebrow-raising; it might well be the result of a speculative bubble rather than real appreciation. Bursting of the bubble and a nosedive in value might well be on the cards now.
Another factor is that the growth of this technology might pose serious threats to very powerful monetary stakeholders (governments, banks…). It would not be at all surprising if, at some moment, a powerful stakeholder seeing its vested interests threated might be tempted to spike the whole system. A well-run smear campaign could well produce a panic effect and a massive exodus.
What is the future of Bitcoin?
This seems to be the question the whole world is asking and there are also plenty of answers but based rather on intuition than any informed knowledge. The risks are undoubtedly there, and it is not yet clear if average users en masse will be able to understand and trust in this new technology.
Much of the criticism is based on current bitcoin use. Most of today’s bitcoin transactions concern the black market and speculation. But this is the dark side that usually appears in the use of any new technology; it doesn’t mean the technology per se is malicious.
My own opinion is that the advantages are so vast that technology of this type is bound to win out sooner or later. Bitcoin has some loopholes and has suffered some setbacks that are more than likely to hinder massive takeup. I believe it now needs to be developed or a new alternative brought out along similar lines. Maybe we need to wait for a new generation of users completely at home in the new digital world.
In any case the most important thing for any technology firm is to pay attention to these technologies, keep track of their development, find out about them and seek a niche. It is highly likely that the “global village” will sooner or later have a “global” transaction system suited to its needs and without all the disadvantages and inefficiency involved in “classic” currencies. If this happens, we mustn’t miss the bandwagon.
- The original document describing the basic rules: https://bitcoin.org/bitcoin.pdf
- A pretty good explanation of the concepts: https://es.bitcoin.it/wiki/Introducción
- Doubts about growth: http://www.washingtonpost.com/blogs/the-switch/wp/2013/11/12/bitcoin-needs-to-scale-by-a-factor-of-1000-to-compete-with-visa-heres-how-to-do-it/
- Bitcoin price index: http://www.coindesk.com/price/
Author: Crescencio Lucas Herrera
Las opiniones vertidas por el autor son enteramente suyas y no siempre representan la opinión de GMV
The author’s views are entirely his own and may not reflect the views of GMV