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Let’s Talk Bitcoin

What is Bitcoin?

Bitcoin is a digital currency, represented as ‘BTC’. The currency units are called bitcoins, represented as ‘btc’.

How did it come into existence?

Remember, remember, the thirty first of October 2008, the day the world received news from Satoshi Nakamoto, stating simply, “I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party”. Coming at the depths of the 2008 financial crisis, the timing was perfect for a change. That was a time when banks were unwilling to lend to one another because of suspicion that their counterparts would go bankrupt. Trust was the one thing completely absent from the system. Ships were stalled because they didn’t know if the bank’s Letter of Credit was any good. Trade had ground to a halt. In the midst of this, Satoshi Nakamoto published a white paper outlining a peer-to-peer electronic cash system, dubbed bitcoin.

Bitcoins come into existence through ‘mining’, the same case as with gold. Gold mining adds about 2% a year to the global gold stock. Bitcoin mining, by its very nature, can add only a total of 21 million bitcoins into circulation. Unlike fiat money which can be printed at will by central bankers, generating bitcoins require the miners to solve a difficult math problem and publish a proof-of-work, which has to be accepted by all the other participants to actually come into existence. Each accepted proof-of-work starts a ‘block’, and all further transactions are accounted in that block. A new block is started when a miner submits another proof-of-work, and so on. The transactions in the block are timestamped, forming a ‘block chain’ that contains all the bitcoin transactions right from the very first bitcoin.

To summarise, every block starts with newly generated bitcoins and contains records of bitcoin transactions recognized until the next block is generated. The blockchain is thus a public ledger system showing both the inflow of newly generated bitcoins as well as transactions of all the previous bitcoins.

On 12 January 2009, the first bitcoin transaction took place. The first published exchange rate for bitcoin vs. a universally accepted currency, the US dollar, was $1 for 1,392.33 btc. Had an early adopter held onto those coins, a dollar exchanged for bitcoin would now be worth $580,000+!

Why does bitcoin have value?

To fully answer this question, we need to first understand why any form of currency has value. Ludwig von Mises theorized that every form of money started out as just another good with value in use. In the early days of barter, some goods, by their nature, were more in demand or more easily exchangeable for other goods. Thus, these goods acquired an exchange value in addition to a use value. People were willing to exchange for these goods, knowing that they could then further exchange them for the goods they actually desired. Hence, some goods became a medium of exchange. As the system evolved, these media of exchange eventually started to act as a store of value. People exchanged their goods and services for these media of exchange and held onto them for periods of time, knowing they would be able to buy other stuff with it far into the future. The media of exchange which was also regarded as a store of value came to be called money. Since ancient history, gold and silver served this function. But they did not start their life as money; it just happened somewhere along the way. All the things we call money today, the fiat currencies of the world, derived that characteristic from gold or silver.

Holders of bitcoin currently regard it as a digital currency. Its value lies in its being accepted as a medium of exchange in transactions. It is also considered a store of value by a part of the community which is distrustful of central bank money printing. As bitcoin gains wider adoption and bitcoin transactions grow, the community which regards it as a currency will expand, thus creating powerful positive network effects and further enhancing the attractiveness of bitcoin. At some point, it will be the digital equivalent of gold and silver.

Can bitcoin be hacked?

No. All those articles you read saying bitcoin has been hacked are written by people who are completely clueless about what bitcoin is. Let’s say a pickpocket steals cash from your wallet. Would you report it saying the rupee has been hacked? Absurd! But that’s precisely what journalists are doing when it comes to bitcoin. A bitcoin wallet gets hacked and a news item comes out saying bitcoins have been hacked. With bitcoin, the community can actually take a stand and disallow the hacker from spending his ill-gotten bitcoins. It is theoretically possible, although it hasn’t been attempted yet.

Is it possible to spoof new bitcoins into existence?

No. To generate bitcoins, you need to submit a proof-of-work which involves solving a math problem. Once you solve the problem and publish the solution, it is possible for others to check and ensure you have actually solved the problem. Only then will you receive credit for the new bitcoins mined. Also, newly mined coins can only be spent after 120 more blocks have been created.

Bottom line: bitcoins can neither be hacked nor spoofed. The transactions in the blockchain are a genuine representation of all that has happened in the bitcoin market since the very first mined bitcoin.

Investment implication

To me, bitcoins are currently a fun speculation. Being a gamer at heart and having played an MMORPG since December 2004, the concept of a virtual currency is not new to me. The conversion of virtual game currency to fiat money is an age-old industry which has thrived even as gaming companies have valiantly attempted to shut it down. The same goes for government attempts to shut down bitcoin. There is no one central server to target, no one physical location to bomb, and no one individual to imprison to stop the bitcoin blockchain. The only possible way of shutting down bitcoin would be to shut down the internet. Even then, the bitcoins would continue to exist and can be spent once internet access is restored. The bitcoin public ledger system is as resilient as a cockroach, and being a part of the community, being a person who even understands a bit about bitcoin, is motivation enough for me to be a holder of bitcoin. I get to participate in what to me is the start of a new era, and whatever the price of bitcoin, I’ll have made a profit just by being a part of it.

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