By Elizabeth Frasier-Nelson – elizabethfnelson@internationalbanker.com
Move over fiat money, here comes Bitcoin, or so the current hype would have us think.
Over the past couple of months, Bitcoin’s sharp price fluctuations have created a lot of buzz about the crypto-currency and its feasibility as a bona fide digital currency. Since Bitcoin is independent from government regulation, some people believe that the whole financial landscape may be about to permanently change.
But, should you worry or rejoice over Bitcoin? Here’s what everyone needs to know!
For starters, Bitcoin can be a bit confusing, even for a seasoned financier. It is a digital currency (or crypto-currency) that you can use to purchase goods and services online.
However, unlike the normal currency you’re used to, the Bitcoin system is decentralized. It is powered and managed by its users, rather than a centralized national or international entity, such as a bank.
Defined from a user point of view, Bitcoin is ‘Internet cash’ – a form of digital currency you use online. It is used nearly the same way you use offline cash denominations.
The Bitcoin network operates on the crypto-currency concept. It is based on the idea of creating a new form of currency that is geared and managed through cryptography, rather than through a central bank.
Satoshi Nakamoto published the first proof of concept and specification for crypto-currency in 2009. Although he left the Bitcoin project prematurely, more developers have since joined. The project has grown exponentially in scope and stakeholders over the last few years.
Bitcoin’s open-source nature has led to many concerns, most of which are unjustified. For example, although the core software and protocols are openly available to developers for modification, the system is deemed secure. There have been several high profile news stories where millions of dollars worth of Bitcoins have been stolen, however these thefts have been from platforms that take payment in or operate as an exchange for Bitcoin, such as the Silk Road II and MT Gox. The thefts have not been from the Bitcoin network itself.
The creators of Bitcoin intended it to enable instant and secure online transactions or fund transfers without the bureaucracy, constraints, and charges that typify the normal transfer processes found in banking institutions.
In the past year, the use of Bitcoin in online transactions has increased steadily. You can now find hundreds of online merchants that accept Bitcoin as a payment option. It is especially popular with users who want to ensure online anonymity.
Currently, the Bitcoin network is not under any singular ownership, much like no single person or company owns email. Although there are numerous developers improving the core software, they cannot implement any changes in the Bitcoin protocol because users freely choose the software version they want to use.
Bitcoin is an app that provides a digital wallet containing Bitcoins that can be used for online transactions.
Behind the scenes, the Bitcoin network runs on a public ledger, known as the block chain. This ledger is comprised of all the transactions that have gone through the Bitcoin network. Consequently, a user’s computer can verify whether a transaction is valid by querying this ledger. Digital signatures are also used to authenticate each transaction.
To acquire Bitcoins, you can purchase them at a Bitcoin exchange using normal currency or you may simply exchange with someone. You can also acquire Bitcoins through Bitcoin mining.
Bitcoin’s value is not static. It varies with people’s demand. As a result, it can fluctuate when people wish to make online transactions.
Initially, Bitcoins were only used for the purchase of goods online and for the transfer of funds. As their popularity and value rapidly increased, people started incorporating Bitcoin as an asset in their investment portfolio; albeit, a high risk asset because of its volatility.
With time, more and more people started using the digital currency for investment and savings. Eventually, Bitcoins were traded on standard platforms, spiking the digital currency’s price to $200, and then again to $300. As expected, the bubble quickly burst, although few had anticipated that it would burst so soon.
At that time, many dismissed Bitcoin and labelled it no real threat to fiat currency. Moreover, since people wrongly percived the digital currency’s supply as infinite and there was no centralised issuer and controller, many in the financial world quickly dismissed Bitcoin entirely.
By the end of 2013, Bitcoin’s price exploded once again, reaching an all-time high of $1200. Although price swings continue, Bitcoin has caught the attention of big investors, financiers and bankers. As of yet, no high-profile investor has nailed their flag to the digital currency mast.
Currently, Bitcoin has no major financial function. As a result, it does not appear to be a serious threat to fiat currencies. Paper currencies have value by government fiat. Since we live in a government controlled world, it’s hard to see how Bitcoin will eliminate paper currencies as we know them. That is not to say that Bitcoin has no value; it has, of course, demand value.
Bitcoin’s first major advantage is user control. There are no banks, no limits, and no borders. You can send and receive funds at any time you wish; anywhere in the world.
Also, there are minimal fees attached to payments, typically to facilitate priority transaction processing. In some cases, there are no fees at all.
The transparency and neutrality of the system allows for trust among users. In addition, the Bitcoin core is cryptographically protected, so no one can modify or manipulate the network.
Finally, Bitcoin can be used anonymously online. So, if you want to increase your privacy, you may use Bitcoins wherever they are accepted.
On the downside, Bitcoin can be used to purchase illegal items online, such as drugs. All a person needs do is buy Bitcoins using cash. This is a legal action. Then, the person can use the Bitcoins to purchase whatever he or she wants anonymously online. The seller of the goods can complete the transaction anonymously, as well. Lastly, the Bitcoins are converted back to normal currency.
Another downside is that Bitcoin is not readily accepted by many online businesses. Moreover, many people are not aware of the existence of Bitcoin, let alone know how it works.
All in all, it remains to be seen whether Bitcoin will grow into a viable, alternate currency. Currently, it has little effect on traditional payment and investment mediums. How long will be the big question?