Learning Cryptocurrency

Introduction

The year was 2008, and while the world was busy celebrating Halloween carving pumpkins, Satoshi⁽¹⁾ was working on a whitepaper to publish his idea on Bitcoins that would soon revolutionize the way money and transactions are perceived. Money has always been an integral part of human life. From barter system to coins, to bills, then virtual money and smart contracts, our money too has changed forms and been through some interesting transitions over the course of time. Through plain English explanations, relatable situations and unprejudiced views, I’d attempt to explain cryptocurrency right from the basics with a hope to pique your curiosity and sustain your interest.

What is money?

A recent survey said that seventy percent of youth don’t understand the concept of money let alone cryptocurrency (don’t believe this, I just made it up). However, I won’t be surprised even if it’s true. So let’s try to change and understand this today bit by bit. Life was simple when barter system existed and people exchanged one item for another. But soon society realized that this method isn’t competent and they need an efficient way to trade which is fair and centralized. The central authority (or government) decided to build and circulate currency that would be controlled and validated by them. It had national acceptance and worked as a means of conducting trade. So a simple piece of paper would be valued at say one dollar because the government has assured its people that they can buy goods worth a dollar using that piece of paper. Such currency printed and authorized by the government is called Fiat currency. This system worked just fine and people were content and businesses functioned flawlessly. So what triggered the need and advent of cryptocurrency?

Irregularities in traditional currency

Well, a series of incidents in recent past highlighted the ruthless level of control and authority governments over the globe have on their currencies. The 2008 Lehman brothers controversy wherein banks sanctioned unmoderated loans sunk the US economy resulting in recession and crashing stock market. Demonetization exercised by governments in some countries eliminated few denomination currencies in a moment. Paper bills have been counterfeited for conducting unlawful acts and have always been vulnerable to security breaches. Moreover, governments can print excess currency causing hyperinflation leading to surge in prices of basic commodities. During the corona virus pandemic, the US government printed around six trillion dollars to support its people (yeah, remember how happy stimulus pay check made you?). And since US dollar is the world’s reserve currency used for various international trade, an increase in dollar cash flow resulted in inflation in many countries. Next, in order to transfer funds abroad, your transaction has to go through multiple layers of approvals, charging you a convenience fee and some waiting period. Well, you get the point now – the central government literally owns the country’s money and has the authority to drive it. Thus, people had reasons to doubt the fiat currency’s ability to drive economies smoothly through such centralization.

Cryptocurrency

Before the advent of automation, people used to do a lot of tasks manually. Such tasks provided employment to people but carried the risk of human error and inconvenience. Similarly, cryptocurrency is the new automation in the world of fiat currency. What automation did to labors, cryptocurrency can do to banks and governments. It simply removes the power governments possess over public money. In short, it decentralizes. The federal authorities cannot exercise control over the cryptocurrency policies, and it’s based on algorithms. Now before diving a little more deep into the cryptocurrency fundamentals, make sure you have followed so far as it will help put things into context. If not skim above once before proceeding. Also, if you are active reader and would like to read varied content then please subscribe to this blog for getting notifications.

Technicalities in Bitcoin

Alright, let’s dive a little deep to understand how bitcoins are made. Quick answer is by solving mathematical puzzles using sophisticated computers having high computational power. For more clarity let’s start from the point where you think of buying a bitcoin. To buy bitcoin, you create an account on some exchange and chip in your money. Your exchange company then takes your transaction and ques it up in the bitcoin network and waits for it to get added on to a block. A block is basically a collection of multiple transactions that is created by some people by solving a complex puzzle called the proof-of-work. These people are called miners and have advanced computers for solving puzzles. As soon as the puzzle is solved, a block gets created and your transaction waiting in the queue (called as mempool) gets a home. There are multiple miners competing at the same time to solve that mathematical puzzle and the first one to solve gets some bitcoins as reward. The newly created block gets attached to the other existing blocks and the competition continues for mining the next block. On an average, a new block is created every ten minutes and has 1MB of capacity to hold transactions.

All the blocks are connected to each other on a single thread called the Blockchain. This Blockchain is at the heart of Bitcoins decentralization model. In a sense that no government or political party can control it or decides policies, it just follows algorithms. The math puzzle (called proof-of-work) is based on a concept called the hashing technique. It is how this puzzle is solved. Hashes are digital fingerprints. Every block has its own hash starting with few zeros. The proof-of-work math puzzle is basically to find a hash (i.e. string of 64 characters) lower than certain number called target. The miner who is able to get that lowest hash string first is the winner of the next block. Advanced computers with sophisticated chips generate multiple such hashes at a speed of 130 exahashes / second (130 followed by 18 zeros).

The first block was mined in 2009 and the reward for solving the proof-of-work puzzle was 50 bitcoins at that time. This reward gets cut into half every four years. For example – in the year 2012, reward for solving the puzzle became 25 bitcoins and today, after 12 years, it is 6.25 bitcoins ⁽²⁾. Now here comes the twist. Unlike the traditional currency bills which have no limit on its printing capacity, bitcoins are capped. The total supply of bitcoins would only be 21 million bitcoins. Fun fact – around 18.6 million bitcoins have already been mined by 2020 and are in circulation. Pop quiz – what happens to price when the supply is less and demand more?

Bitcoin thrives on its ability to provide absolute security and privacy to its users. In order to maintain this anonymity, bitcoin assigns a pair of private key and public key to every user generated by algorithms. You can transfer your bitcoin from the exchange account onto a hard wallet like an USB protected by these keys. People on the crypto network can see all transactions on your account but they cannot find out who you are or where you live. Now comes the scarier part – if you lose your private or public key, there is now way to recreate it and all bitcoins in your account would remain locked for entirety.

Irregularities in Cryptocurrency

It would be naïve to say that cryptocurrency is immune to malfunctions or cyber-attacks. Although the robust algorithmic structure has given it enormous security, it can still be subject to fraudulent acts. One such act is called the 51% attack wherein the fraudulent party, using exorbitantly high speed computers, starts creating new blocks rapidly and takes control over the Blockchain. This is a rare form of attack as it requires exceptional computational power and resources. However, the most famous bitcoin fraud happened in Feb 2014 at the world’s premier Bitcoin exchange in Tokyo. Bitcoins worth $8 billion today were stolen without a trace by hacking into the exchange’s internal server and stealing their customer’s private keys ⁽³⁾. Next irregularity in bitcoin is its average waiting period of ten minutes to register a transaction. Bitcoin can only handle 4.6 transactions per second which is far less compared to credit cards that record over 5000 transaction per second ⁽⁴⁾. Just imagine buying a coffee and then waiting in line for ten minutes for your transaction to get processed. Many countries around the world did ban Bitcoin initially as it made tax evasion easy, tracing payments harder encouraging money laundering, drug trafficking etc. Bitcoin has its share of sinister reputation.

Features of Cryptocurrency

Bitcoin is known for its highly volatile price fluctuations. Once in Dec 2017, Bitcoin’s price went from $15K in the morning to around $19K by lunchtime and down to $16K by evening. Now the important point to be noted here is the factors that make an investment good are different from those that make a currency good ⁽⁵⁾. People think of investments as something that would increase in value and give them returns, while they expect currency to be extremely stable for conducting everyday trade. When Satoshi announced his Bitcoin idea, he emphasized on its usage for all large and small transactions as removing middle man was at the heart of Bitcoin’s invention. However, slow transaction time and highly volatile nature keeps Bitcoin far from being an everyday transaction tool.

Mining bitcoins is also a burden on environment. According to a study by University of Cambridge, bitcoin consumes more energy annually than most countries and US states leaving significant carbon footprint and e-waste ⁽⁶⁾. Many organizations have set up giant mining farms having tens or hundreds of ASIC-powered systems. Iceland and Quebec due to its cold weather are preferred spots for miners. However, China due to cheap coal energy, smooth internet, and low-cost manufacturing of the ASIC chips have become the hot favorite spots for miners. Today China mines around 80% of all bitcoins and has control over majority of its hash power ⁽⁷⁾. Is the decentralization feature that Bitcoin pride itself on getting sacrificed over a country’s mining capability? The future will tell.

Conclusion

Bitcoin is not a physical coin. It’s virtual money – an idea with no physical shape or form. Today, cryptocurrencies are gaining a lot of attention and traction. And there are many other cryptocurrencies like Ethereum, Ripple and stable coins. I don’t know if you should invest or not – it depends on you and your risk appetite but what matters is your level of curiosity and awareness. And it’s fine to make some bad business decisions but never let lack of knowledge and inquisitiveness stifle your abilities to think and make educated decisions. A well-read mind and an experienced soul are a great combination in a world filled with unpredictability. Cheers!

 

^References

1. Satoshi Nakamoto, pseudonymous person who published the Bitcoin whitepaper

2. (n.d.). Retrieved from https://learn.robinhood.com/articles/bitcoins-mining-reward-is-about-to-be-cut-in-half-what-investors-should-know-about-the-halvening/

2. (n.d.). Retrieved from https://www.bloomberg.com/news/articles/2021-01-31/-trillion-dollar-mt-gox-demise-as-told-by-a-bitcoin-insider

3. (n.d.). Retrieved from https://towardsdatascience.com/the-blockchain-scalability-problem-the-race-for-visa-like-transaction-speed-5cce48f9d44

4. (n.d.). Bubble or Revolution. Paravane Ventures.

5. (n.d.). Retrieved from https://cbeci.org/faq

5. (n.d.). Retrieved from https://cbeci.org/faq

6. (n.d.). Retrieved from https://www.theguardian.com/technology/2021/apr/07/china-bitcoin-mining-climate-targets-nature-study