Think A 'Bit'Coin

Think A 'Bit'Coin

Apoorv Sharma Mayank Mishra | Feb 22, 2021

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Rick Falkvinge, IT entrepreneur and founder of the Swedish Pirate Party fearlessly quoted,

Bitcoin will do to banks what email did to the postal industry.

The world is moving towards providing absolute convenience in almost every mainstream work. The new technology of cryptocurrency is empowering short-term investments and easy money exchange. Hence, it becomes essential to explore this field before jumping on the bandwagon of investing.

To understand the cryptocurrency system, it is necessary to combine elements from the three disciplines of economics, cryptography, and computer science. Cryptocurrency is a cryptographically secured digital asset that can be used as a mode of payment. It contrasts with the traditional monetary medium of exchange by disallowing any central authority for supervision of transaction records, controlling the creation of additional assets, and verifying the transfer of asset ownership.

After failing badly in 2017-18 and receiving hate-speeches from eminent investors, Bitcoin availed the unfortunate 2020 to retract itself to heights achieved never before. Bitcoin is at its all-time high of $52,947 till the time of writing this article. With companies like Tesla investing substantially, digital money has become the talk of the town

It is henceforth speculated that the time has come for it to leave the laps of tech-geeks and economists and reach out to common people. Read the complete article to unfold the secrets of this wonderful enigma of digitalization.

Diving In

It all started in 1983 when the American cryptographer David Chaum put forth an anonymous cryptographic electronic money called e-cash. Later, in 1998, computer scientist Wei Dai published a description of "b-money", characterized as an anonymous, distributed electronic cash system.

Bitcoin, as the first decentralized cryptocurrency, was created in Jan 2009 by an anonymous cryptographer/a group of several cryptographers named Satoshi Nakamoto. In its proof of work, it used the SHA-256 cryptographic hash function. Bitcoin was created with the vision of simplifying money exchange without the interference of any external authority, secured by complex cryptography. It is a virtual monetary unit, having no physical representation. Bitcoin is described in units (analogous to our coins and notes), which is divisible and can be divided into 100 million "Satoshis," the smallest fraction of it.

However, changing the modern way of banking through digital currency isn’t a cakewalk. This utterly decentralized system of exchanges comes with few loopholes. While making payments, we trust banks to rectify the discrepancies occurring within, whereas cryptocurrencies are monitored directly by the users with a constitution of guidelines. This can give rise to issues. Let us see some simple problems, which can occur during digitalized payments and how are they cured by Bitcoin's developers. 

Understanding the complete picture of the cryptocurrency framework requires a substantial amount of time and energy. The article tries to put forward the basics through simple analogies.

No Bank! How are payments managed?

Imagine a group of people using digital money as a mode of payment. Without the supervision of authority, the monetary system will fall prey to the double-spending problem, which is stated as follows,

Electronic data can be copied any number of times at a negligible cost. This feature is highly undesirable for money. If cash data files can be copied and the duplicates used as currency, payment infrastructure would collapse.

To solve any issues like this, Satoshi ingeniously invented blockchains. Consider a group of three friends, who do not exchange cash within themselves, instead, do this: Whenever A has to pay B some amount, B writes in the diary, “B owes A ‘X’ INR”. This account is common for all three and newly added sentences are visible to everyone. This is a minute version of the blockchain.

The Bitcoin Blockchain is a data file that carries the records of all past Bitcoin transactions, a ledger, including the creation of new Bitcoin units. Each block includes the cryptographic hash function of the prior block in the blockchain, linking the two. If by some means, several blocks are created at the same time, the algorithm traces the history and provides scores, of which the maximum is added to the chain. At the time of writing this article, 670,917 blocks had been added to the Bitcoin blockchain, with an average adding time of 10 minutes!

This ledger is publicly owned,i.e. each member can have his own copy of the blockchain. Whenever any transaction is done between Owner A and Owner B, the ledger list is augmented. Not only the two of them are aware of this, but the whole community can see the change in possessions. It is very normal to think what, if any member augments to the ledger without the prior knowledge of the spending party. Just like, “B owes A 10000 INR”. Another version of the same question is, why would everyone believe that the transaction added to the chain is valid.

For a humongous number of users, this consensus mechanism built by Bitcoin is another worth-knowing process.

Who validates the transactions?

Validating the transactions is the work of miners. For our analogy of the trio, let's say after ten days, A starts checking the diary (ledger). While doing it, he would personally visit every “spending” party to ask if the existing line in the diary is valid or not. Another method to carry out the procedure would be to assign specific signatures to everyone which they can use to legalize any newly augmented line in the list. The task done by is close to the one that miners perform. 

A miner collects pending Bitcoin transactions and verifies their legitimacy. This is a rewarding, independent field of work. A random person with a goal to collect newly credited Bitcoin units, willing to spend handsome money on the required apparatus and electricity (owing to which there are only a few large groups of miners), is a miner. Once he identifies some legitimate transaction through the means of sophisticated digital signatures, he needs to convince all other network participants to add his or her block candidate (person involved in the respective transaction) to their individual copies of the Bitcoin Blockchain. To convince the general audience, the miner should verify the respective block candidate through that digital signature! Not that easy as it sounds. Since digital signatures can be copied nonchalantly, cryptocurrencies use hash codes for the same using hash functions like dSHA 256.

For example, we will look at the hash value for the text, "Federal Reserve Bank of Saint Louis." The fingerprint of this text, which was calculated using the hash function dSHA256, is 72641707ba7c9be334f111ef5238f4a0b355481796fdddfdaac4c5f2320eea68

Now notice the small change in the original text to "Federal Reserve Bank of Saint Louis." It will cause an unpredictable change of the fingerprint, which can be seen from the corresponding new hash value:


Mining Machine

The exhaustive work makes mining terribly difficult. Hence, it is done in groups of like-minded people. Some miners pool resources, sharing their processing power over a network to split the reward equally, according to the amount of work they contributed to the probability of finding a block. A "share" is awarded to members of the mining pool who present a valid partial proof-of-work. The Bitcoin network is calibrated in such a way that, on average, a block candidate with a valid hash value is found every 10 minutes. The winner of the mining contest receives a predefined number of newly created Bitcoin units.

One full course is available at Coursera for diving into the core fundamentals of cryptocurrency, which is beyond the scope of the article. Having said this, let us analyze the contemporary situation of Bitcoin in the market.

Current scenario

Transaction fees for bitcoin payments are significantly lower than those made for credit and debit card purchases. This feature is an advantage for small and medium-sized enterprises (SMEs)  as they have a limited budget. There is no fee to receive bitcoins, and many wallets let the user control how large a fee to pay when spending. Higher fees can encourage faster confirmation of a transaction. Bitcoin poses an ideal scenario for payment exchange with SMEs.

However, the hackers have exploited Bitcoins' anonymity aspect, which was evident in the recent incident in 2018, where the victims of ransomware had to pay in Bitcoins. Similarly, in November 2019, Uber released documents mentioning that the company had to pay USD 100 million in Bitcoins to hackers.

Source: Quora.

Analyzing the country-wise legalization, we find that developed countries like Japan, the United States, Canada have legalized cryptocurrencies. In contrast, India is at a nascent stage of implementation with sufficient restrictions. Try owning your own ICO (initial coin offering) and be the flagbearer of this technology in the country!

The ban of cryptocurrencies across developing countries is because,

Bitcoin is highly volatile, hence suitable for people having a vast number of resources. By the way, no one is stopping you to invest if interested. However, risks revolving around these investments should be considered before-hand.

The Main Risks Of Investing In Bitcoin

Virtual currencies are rapidly gaining popularity. ATMs for different transactions in virtual currencies are appearing in Western and European countries. Virtual money can be bought and sold on the Internet, and many financial analytics companies have started tracking digital currency and investment forecasts. Like other means of payment methods, Bitcoin is integrated into the pre-existing economy even without being a secured digital currency. So far, the future of digital currency seems very promising. However, unexpected drops in the rate make even the most seasoned investors wary.

Bitcoin cost fluctuations are almost unpredictable, which adds to the riskiness of this asset. Financial analysts accurately predict the value of real currencies based on data from the outside world. However, to predict how much Bitcoin will cost tomorrow is almost impossible. To invest in blockchain technology, you should meet with blockchain companies to hire blockchain developers. Bitcoin mining has caused a huge burden on the climate. According to the Technical University of Munich, in 2018, bitcoin emitted over 22 megatonnes of carbon dioxide annually, comparable to the total emissions of cities such as Las Vegas and Vienna.

One may think about the reason behind this fluctuation in pricing of the Bitcoin.

What determines its price? 

Bitcoin pricing is influenced by factors such as the supply of bitcoin and market demand for it, the number of competing cryptocurrencies, and the exchanges it trades on. It is a volatile currency; confronting leaps and plummeting is a matter of days! One should not forget that Bitcoin is at a very nascent stage of its development, for only eleven years have passed since its establishment. During this time, it has faced numerous hacker attacks, illegal uses, tirades by economists, and banishment in several countries. Fluctuation, in its price, henceforth owes to the above-mentioned reasons.

This fluctuation is often chastised by veteran investors including Warren Buffet. Let us see how economists react to the emerging era of cryptocurrencies.

What economists think about cryptocurrencies?

Only 21% of 48 economists polled by the Center for Economic Policy and Research believe cryptocurrencies, like bitcoin and etherium, could jeopardize the economy and cause a crisis. Source-Quartz

Some economists think bitcoin will only be widely adopted if conventional currencies fail. Jürgen von Hagen of the Universität Bonn speculated

Cryptocurrencies would become attractive if central bank-issued currencies became very unstable,Their widespread use in the financial system would be a result, not a cause, of instability.

 The other pool of thinks that solving safe payment problems in cryptocurrencies creates others. One is scalability; the process of picking random validators takes time, is expensive, and consumes a lot of electricity. In fact, miners usually do their work in countries with cheap electricity supply.

The issue with almost everyone is the volatility in the value of cryptocurrencies which makes them less useful as currencies. This volatility is an inherent feature by design. Since there is no central bank that adjusts the supply of bitcoin to accommodate changes in demand, bitcoin's value can swing sharply with demand. However, before jumping to any conclusions one should understand that this innovation is novel and the field is not completely researched.

Even Artificial Intelligence has completed more than six decades of research for being at the place it is. Cryptocurrency should also be given some time since a lot of research is being done in the background that strives to bring about a gradual increase in user amicability and a decrease in price volatility. For the questions regarding its sustenance in the market, only time has all the answers.

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