Bitcoin is one type of a cryptocurrency which is the currency of the future.

It was designed in 2008 by Satoshi Nakamoto  to help cope with the financial crash and try to prevent it from reoccurring. Satoshi vanished in 2011 telling a Bitcoin colleague he had: “Moved on to other things.”

To understand what it is and why it’s booming, we have to understand why it was created and how it works.

 

The 2007-2008 economic crash also known as the global financial crises occurred, I won’t get into the specific details of why it crashed but it was because banks and hedge funds had too much power, were excessive with their risk taking and knew they would get bailed out with tax payer’s money. If you want to know more there are hundreds of articles on it or watch The Big Short.

 

After the crash Satoshi understood that the world needed a decentralised banking option. He created block-chain technology, read his paper here. Essentially it’s a peer to peer version of electronic cash which allows people to send money without it ever having to go via a financial institution.

By not having any financial institution or corporate owner, bitcoin isn’t corrupted or influenced by outside factors which allows money to be transferred more anonymously and with no transaction fees. It’s controlled by honest nodes, people have tried to find vulnerabilities before but no funds were seized or lost.

Bitcoin has a system to avoid double spending and attackers by using blockchain technology which is  a decentralised peer to peer system with timestamps on transactions. E-commerce needed a considerable amount of information and trust, bitcoin has proof the currency is authentic, therefore trustworthy.

The way blockchain technology is set up is incredibly sophisticated, even if an attacker has more computer power than all of the honest nodes (which is highly unlikely) then it would be more profitable for him to play by the rules and be rewarded with generating new coins than it would be to defraud people by stealing his payments back.

With the anonymity that coincides with bitcoin, many have started using it on the “dark-net” a.k.a the “deep web.” Just because a minority are using the currency for illegal uses doesn’t mean you can generalise bitcoin as dangerous or even concerning. Every time technology has evolved there has been and will be a minority that leverage it in a negative way to society.

Bitcoin is undergoing a meteoric rise, in both the spotlight and its value. As a result many naive investors are jumping on the Bitcoin train because of the growing hype. However, they don’t understand what Bitcoin is, or the risks surrounding it.

Recently I was having a conversation with someone and they were talking about how they were interested in buying Bitcoin. Except their main concern was that they didn’t have a safe to store it. They didn’t feel comfortable having something of that much value just in their bedside draw… I refrained from laughing and explained the following;

Bitcoin is a cryptocurrency and therefore has no physical form. It is created, held and transferred electronically.

The solution that Bitcoin offers is decentralization; no one controls it. This means that the banks do not have the powerful influence that they do over the current banking systems and Wall Street itself. In addition, only a set amount can ever be created, unlike current currencies where it can be printed in volume at will, this helps to control the effects of economic factors such as inflation to the currencies value. The graph below shows how the inflation rate decreases as the amount of Bitcoin left to be mined decrease.

But how are they created?

I used the term mined, as mentioned Bitcoin is a digital currency, and therefore has no physical form. However, it is created through a process known as mining, ironic right. Mining in simple terms is the solving of a digital puzzle known as algorithms. 

 Miners compete to solve the puzzles, on completion the miner is rewarded with a block, which contains a set amount of Bitcoin. Each time a puzzle is completed the puzzles get more complex and the Bitcoin in the block decrease, alternatively an attacker could beat the honest nodes and be rewarded with a certain amount of bitcoin.

What does it provide?

Bitcoin provides users with a no-fee payment system for fast transactions across the globe. At this point in time Bitcoin has not been accepted by any government or central bank although can be exchanged for traditional currencies and this is the opportunity that investors and traders see.

It is to be remembered that bitcoin is essentially a program and therefore developers are able to build on top of the existing platform. However, bitcoin is very limited in the freedom that developers have when trying to expand.

Since the beginning of bitcoin its transaction times have been getting increasingly slower in line with its increased popularity and transaction rate. This could suggest that the platform is not designed for the high level of transactions that it has experienced. Additionally, due to the limitations of what can be further build on top of the existing platform improvements to speed up the transaction time are limited.

Risks

Bitcoin has been red flagged by many authorities and institutes and for good reason. There is a large amount of inherent risk surrounding it.

Bitcoin offers a rival to government currency and therefore they lack control. Therefore, will try to regulate, restrict or ban the use of Bitcoin. Arguments being that it can be used for black market transactions, money laundering, illegal activities or tax evasion.

Bitcoin’s value lies within the population seeing value in it, Currently the main driver of Bitcoin’s value and demand is its current exchange for money.  

Stories have captured the headlines of Bitcoin ransoms around the globe. The apparent lack of identity surrounding the transfer of the crypto currency makes it apparently untraceable. However, many argue that this is not the case.

Increasing amount of newly developed cryptocurrencies on the market also pose a risk to Bitcoin’s growth. Like any new venture if something better comes along the public is going to side with it. Currently Bitcoin is leading the market cap for cryptocurrencies, however, up and coming currencies and add ons are rivaling the market leader.

However, the increase risk comes with a potential for an increased return. Bitcoin does take the power away from major institutions and organisations that control the current monetary system.