Blog #19 - What Is Bitcoin? - Part - I

 
 

What is Cryptocurrency?

Can you imagine a thing – the value of which was zero around ten years back and today, it's value has touched almost 28 lakhs! I'm talking about Bitcoin, that has recently touched it’s all time high price point due to which it is being talked about in the market and the media again So, I thought this would be the right time to write an educational article on it and explain to you what Bitcoin actually is, what is its history? Merely 12 years ago, on 31st October, 2008, a person named Satoshi Nakamoto published a paper on the Internet. Satoshi's main motive was clearly evident from the first line of the paper. “A version of electronic cash that would allow payments tobe sent directly from one party toanother party without going through a financial institution.”

 

What is Bitcoin?

 

Cryptocurrency is a digital asset over which central banks or financial institutions have no control or regulation. For instance, the US dollar is controlled by the central bank of US. The Indian Rupee is controlled by the RBI. But there is no central bank or any main financial institution that controls the bitcoins/cryptocurrencies. Back then, cryptocurrency was merely an idea in the mind of that person. But now, there is trading worth lakhs and crores on its crypto exchange just like shares are traded on the normal stock markets. In order to understand the paper of Satoshi and the context of crypto currency, we will have to understand some concepts of our economic history. Our financial systems are based on trust. The currency notes and coins have value in our society because they are guaranteed by the government and the central bank takes a look at any note in your wallet. For example, a 200 hundred rupee notes. It reads - "I promise to pay the bearer a sum of 200 hundred rupees”. This is a promise made by the Governor of the Central Bank, that is, the Reserve Bank. There is his signature right below. This note holds no value without this promise/guarantee. This note will be reduced to an ordinary paper if it does not carry this signature. 

 

 

Bitcoin : Illustration

 

 

There is a small, but interesting story in this context. After the Second World War, America became the most powerful country in the world and the rest of the countries had to align their currency with the US dollar and what was the US dollar aligned with/guaranteed by – a reserve  of gold. The actual value is that of gold or silver. But it is not practical to carry gold or silver around in your pocket. The currency notes were printed for convenience. But US did away with this gold standard rule back in 1971. After that, the central banks of the rest of the countries could print their notes as per their wishes. But what do cryptocurrencies and Bitcoin have to do with this?

 

It helps you to guess how powerful the government and the banks – especially, the central banks of the country are as far as monetary policy is concerned. The fact of the matter is that when you deposit your money in the banks, you give the banks permission to play with that money, in one sense. By making use of these deposits, the banks give loans to companies and individuals This is what fetches returns, that is, interest on the money that you have deposited. Very recently, we have seen that some banks use these savings and deposits in a very irresponsible manner. It happens quite often that banks give loans to big industrialists without performing adequate checks and then these loans become bad debts/NPAs. And who becomes the victim in such cases? Depositors like us. In the last 15 months, three deposit taking institutions have failed - Yes Bank, PMC bank and Laxmi Vilas bank. But even the decisions of the government can put the common man in danger Do you remember November, 2016? Demonetization! The government laid to waste the 500 and 1000 rupees notes in one single strike. 86% of Indian currency became unusable.

 

Why Bitcoin was launched?

 

Those in favour of the Bitcoins and cryptocurrencies are so because they do not want the government or the central banks to exercise so much control over their money or currency. Do you now understand the original idea/vision of Satoshi? Satoshi imagined Bitcoin as an alternate financial system which would be based on software technology and would be outside the control of third parties. You might be able to recall the Global Economic Meltdown of 2008 Mega investment bankers like Lehman brothers had become bankrupt. Cryptocurrencies were born right after this scenario. Bitcoin was the first to arrive. And then many other crypto currencies surfaced- Ethereum, Litecoin and Ripple. In fact, in the beginning of the year, more than 2000 cryptocurrencies were available on the internet.

 

How Cryptocurrencies Works?

 

Let us move on to the main point now – how does crypto- technology work? If truth be told, in order to understand this, one needs to have knowledge of advanced mathematics and computer science - which I don't have. But if you want to start investment or trading, then basic knowledge would suffice. Let us take the example of Bitcoins. There is one public account in digital form, of all the bitcoin transactions - this is called a 'ledger'. A copy of this ledger exists on all the systems that are a part of the Bitcoin network. Groups/persons that run this system are called 'Miners'. The job of the miners is to verify transactions. Say, A has to transfer 2 Bitcoins to B's account then Miners will have to confirm whether A actually does have 2 Bitcoins in his account or not. To complete the transaction, miners will have to solve a complicated mathematical equation. You might have studied about variables back in school. Every Bitcoin transaction has a unique variable. The job of the miners is to calculate it. It's not that they sit with a pen or paper to solve the equations. All these calculations are carried out on the computers automatically because they are extremely complicated and their combinations run in crores which is why these miners require computers with very complex and high processing power. Once the equation is solved, the other computers within the network confirm it and this transaction is added to the chain. A block of transactions gets created. And hence, the technology is called 'block chain' And what do miners get in exchange for this? They get the most valuable thing- Bitcoins! This system is called 'Proof of work'. The miners have to prove the computation work they do in order to get awarded the Bitcoins in return. If all this explanation went straight above your head like a bouncer, then do not worry! Because understanding the philosophy, vision and future of crypto technology is far more important than understanding the working of crypto technology.

 

The Future of transaction : Bitcoin

 

 

How to use Cryptocurrencies?

 

Now the question comes – how to use crypto currency and Bitcoins? It is extremely important to understand that as well. Because on one hand, some people use Bitcoins as an investment while on the other hand, some people use cryptocurrency as an alternate currency. A lot of people want to replace it with currency and use Bitcoins in place of rupees and dollars. But the main use of crypto currency at present is like an investment. We invest money in cryptocurrency hoping for a higher return in the future and hence get more money in return. This, then becomes a "store of value", just like Gold. Just like we don't use gold in our daily transactions but instead buy it and store it in the bank lockers like a guarantee to get more returns in the future because the price of gold keeps rising gradually. People do the same with Bitcoins and this is why Bitcoins are also called "Digital Gold" But just like any other investment, this too, entails risks. And those who criticize this as a form of investment say that Bitcoin is a digital currency. It has no inherent value of its own. For example, you can physically touch the gold in your hands. If you buy a house as an investment, it will be physically available to you. Bitcoins, on the other hand, are not physical. Everything is happening on the computer. It could still be referred to as a "niche product" that does not have a widespread acceptance in the society. Cryptocurrency is not yet a medium of exchange, that is, you cannot go to the nearby shops and buy bread and eggs with Bitcoins. But this trend might change in the future because there are several restaurants and hotels in the Western countries that have begun to accept Bitcoins as an alternative form of payment. 

 

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