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Inside the Bitcoin Mania

Boom and bust

You can use it to buy a pizza, rent a hotel room, or pay for a bounty of illegal drugs. It’s public but anonymous, volatile but limited in supply, wildly popular but hardly well understood. If you had bought $1,000 worth in 2010 and held on to it until today, you would be a multi-millionaire (1).

This is bitcoin, the digital currency that has electrified the public in recent months. Bitcoin’s worth hovered around $1,000 at the beginning of 2017, before skyrocketing to more than $19,000 in December (1,5). Bitcoin’s value has increased 15 times faster than Amazon’s stock and 10 times faster than the Dow Jones, but on Dec. 22, the price of bitcoin plunged 30 percent, validating critics’ claims regarding its inherent volatility (9, 5). Overall, bitcoin has been five times more volatile than the S&P 500, an American stock market index (1). And yet, despite warnings from prominent investors and financial tycoons, the bitcoin mania continues, leaving many wondering: what draws so many people to this unconventional currency?

Bitcoin’s meteoric rise

How it works

Bitcoin is completely digital; the photos of golden coins are just a way for the media to depict something that has no physical properties. Built on a decentralized network, bitcoin is designed to sidestep the central banks and intermediary institutions that issue traditional currencies. In the words of the anonymous founder of bitcoin, the currency is based on “cryptographic proof instead of trust, allowing any willing two parties to transact directly with each other without the need for a trusted third party” (4).

Here’s how it works: let’s say you’ve read the headlines about bitcoin’s astronomical growth, and you want to join the frenzy. You choose to buy a certain amount of bitcoins from Coinbase.com, one of the many websites that facilitate such transactions. You’ll first need to provide personal information and verification, just as you would for setting up a credit card account.

Once you buy the bitcoins, the transaction is recorded in an anonymous, public ledger called the “blockchain,” which keeps your identity anonymous by using number labels instead of names (6). Similar to Wikipedia, anyone with the computing power can review the blockchain and check for discrepancies, but, unlike the online encyclopedia, the bitcoin system has no centralized database. Instead, a decentralized community of bitcoin “miners” uses high-powered computers to ensure accuracy in the blockchain, and the miners are then rewarded for their work with a set amount of bitcoins (8). Theoretically, anyone could become a bitcoin miner, but only those with access to cheap electricity and enough computing power can gain a profit. After buying your bitcoins, you can then transfer them digitally to other people, convert them into other currencies, or wait until the price rises and then sell them for a profit. The genius of blockchain technology is that all of this occurs without recourse to a centralized third-party.

Who is he really?

Since its inception, bitcoin has been shrouded in mystery. Its founder, who goes by a pseudonym of Satoshi Nakamoto, created the currency in 2009, but he disappeared two years later and remains hidden.

The true Nakamoto is most likely a British academic who became disillusioned with established financial institutions. In the two years before his disappearance, Nakamoto published research papers containing approximately 80,000 words of British English. In addition, he inserted a cryptic message in the computer code of the first 50 bitcoins: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” This referred to a 2009 article from the London Times that described how the British government was planning to rescue the “too-big-to-fail” banks, reflecting Nakamoto’s frustration with the 2008 financial crisis and the ensuing bailouts (3).

Bitcoin’s founder would also have to be profoundly intelligent. Internet-security researcher Dan Kaminsky tried to discover bitcoin’s weaknesses, but he came up empty again and again; the system, he realized, was nearly flawless. “He’s a world-class programmer, with a deep understanding of the C++ programming language,” Kaminsky said. “Either there’s a team of people who worked on this, or this guy is a genius” (3).

The search for bitcoin’s mysterious founder continues

The search for bitcoin’s founder carries immense importance, for Nakamoto is believed to hold one-fifth of the total supply of bitcoins. If he ever sold this supply at one time, he would potentially flood the market, triggering a catastrophic decline in bitcoin’s value. A brilliant visionary or a profit-seeking mastermind? Only time will tell (1).

Bitcoin’s future

What does the future hold for bitcoin? It appears too volatile to be used as a medium of exchange, and many investors are still reluctant to embrace the cryptocurrency (2). In practice, the anonymous nature of bitcoin transactions has attracted criminals as well as rogue regimes. For instance, the cryptocurrency first gained popularity on a black market site called Silk Road, and it has since been used by hackers as a way to extract ransom payments (6). Foreign governments such as Venezuela are also experimenting with bitcoin technology in order to evade U.S. sanctions (10).

Will bitcoin be the thing of the future?

The real revolution, however, may occur through blockchain technology rather than through bitcoins themselves. As American entrepreneur Marc Andreessen states, blockchains allow “one Internet user to transfer a unique piece of digital property to another internet use, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer” (8).

Blockchain technology could be used as a public ledger for other transactions, working as a notary, for instance, or a record of land titles. Ironically, many large financial institutions such as the Bank of England are beginning to explore the possibility of utilizing blockchain technology to reduce the time and cost of transactions (7).

Ultimately, in the words of the Economist, blockchain is “a way of making and preserving truths,” a decentralized method of verifying information (7). In a world like ours, where trustworthy transactions are increasingly hard to come by, the consequences of such technology are enormous.

 


Image sources:

  1. Featured image: https://www.nytimes.com/2017/12/22/business/bitcoin-plunges-more-than-25-percent-in-24-hours.html?rref=collection%2Ftimestopic%2FBitcoin&_r=0
  2. https://www.economist.com/blogs/buttonwood/2017/11/greater-fool-theory-0
  3. https://www.newyorker.com/magazine/2011/10/10/the-crypto-currency
  4. https://www.nytimes.com/2017/10/01/technology/what-is-bitcoin-price.html

Sources:

  1. https://www.cnbc.com/2017/11/01/bitcoin-price-hits-6500-to-new-record-high-after-cme-futures-plan.html
  2. https://www.economist.com/news/leaders/21732526-there-investment-case-cryptocurrency-bitcoin-speculative-asset-not-yet
  3. https://www.newyorker.com/magazine/2011/10/10/the-crypto-currency
  4. https://bitcoin.org/bitcoin.pdf
  5. https://www.nytimes.com/2017/12/22/business/bitcoin-plunges-more-than-25-percent-in-24-hours.html?rref=collection%2Ftimestopic%2FBitcoin&_r=0
  6. https://www.nytimes.com/2017/10/01/technology/what-is-bitcoin-price.html
  7. https://www.economist.com/news/briefing/21677228-technology-behind-bitcoin-lets-people-who-do-not-know-or-trust-each-other-build-dependable
  8. https://www.coindesk.com/information/what-is-blockchain-technology/
  9. https://www.nytimes.com/2017/11/27/technology/bitcoin-price-10000.html
  10. https://www.nytimes.com/2018/01/03/technology/russia-venezuela-virtual-currencies.html?_r=0

5 Comments

  1. Thanks for this in-depth look at bitcoin, Chris! I found it fascinating.

  2. Reading the beginning of this article makes me wish I had bought $1000 of bitcoin in 2010!

  3. What a well-researched article about Bitcoin Chris! Great Job!

  4. This was really well done
    Bravo