The volatility of the currency has earned it a lot of skeptics, but its crazy good value has earned it even more buyers. Everybody is talking about investing into bitcoin like a hot shot wealth manager and it’s very difficult to get the facts right. But, it’s important to get them right, especially when so much money is at stake. But, for someone who is new to the rodeo, what is all the fuss about?
What is this new fad?
Let’s start from the basics and work up from there.
Bitcoins is a digital currency. A user can store them in e-wallets. Obviously, they are not tangible. Any transactions using bitcoins are made using the e-wallets in which they are stored. Bitcoin transactions do not need a third party like a currency exchange or a bank.
Transferring BitCoin from one person to another is done directly. In effect, the fee for executing these transactions is much lower because no intermediaries are involved. Using bitcoins, you can send money from one part of the globe to another.
The software on which the bitcoin platform is built and runs is open-source. So, all the code is available to everyone for review. This is an incredible amount of freedom, which is unheard of, especially within the financial services industry. That is a big reason why bitcoin became so popular so quickly.
As there is no centralized system, your accounts can never be frozen. Moreover, there is no need to create a governing entity.
Sounds amazing, doesn’t it? It’s the absence of a controlling entity that makes it unregulated and hence, so volatile as well. Obviously, the absence of such an authority has its side-effects too.
How Does The Bitcoin Economy Work?
This question is at the heart of understanding what bitcoin truly is. The bitcoin economy is powered by the blockchain technology. This is the battery that is powering it all. Anyone using bitcoins should understand at least the basics of the blockchain technology.
When people message or talk to each other today, they do not have to dial in an exchange. Thanks to the modern technology, they can see, talk, and text each other directly. However, while exchange of media has become direct, financial transactions still need to use a third party. Banks, currency exchanges, or clearing houses are all external agents that need to be involved to handle our traditional money transactions, because of their trustworthiness. However, with this new blockchain technology, all of that might change.
Blockchain technology uses shared network and cryptography to maintain the security of the network. This creates a transparent, decentralized database of all the transactions that carry value. This can be used for keeping a record of anything from bitcoins to property to votes. Here is how it works.
Blockchain technology uses separate blocks of information that are connected to each other in a network. The technology was initially used for timestamping documents as early as 1991. However, the technology did not make much noise until it was sort of rediscovered by Satoshi Nakamoto in 2009.
By the way, he is the creator of Bitcoins. The property inherent to blockchains is that once a data has been entered into a blockchain, it is not easy to change.
Any kind of data can be stored inside the blocks in a blockchain. In the case of bitcoins, it is the bitcoin transaction data, which includes the information about the sender, receiver, and the amount of bitcoins transacted. A block also has a digital fingerprint that is unique to the block and its contents. Anytime any information changes inside the block, a new digital code is created to identify it.
A new code means that it’s a new block. The last piece of information inside a block is the digital code from its predecessor block. This is what creates a chain. Ergo, the blockchain. The digital fingerprint makes it very difficult to tamper with the content of the block. There are many other ways through which the blockchain network is secured. One of these ways is by using a peer to peer network.
The bitcoin blockchain allows anyone to join the network. Every new member of the network gets a complete copy of the ledger of transactions. These members make an entry into their ledgers every time a transaction takes place. These members make sure that the blockchain is working well by comparing each of their records. They all have to be identical. This is how any kind of fraudulent activity can be detected in the network.
So, in order to do any kind of fraud, a hacker will not only have to make a fraudulent entry, but change the entry on each of the computers on the network. This is an almost impossible task.
People have realized that the blockchain technology has a lot of applications other than in the cryptocurrency market. These include storage of medical records, collection of taxes, international transactions, and more.
How to Mine Bitcoins?
Bitcoins can be generated in any part of the world, thanks to the internet. All that users need to do is download a free application. This application is called the bitcoin miner. Users need to put in a certain amount of work to mine bitcoins. But, there is only a fixed number of bitcoins. So, the blockchain keeps adjusting the amount of work that is need to mine one bitcoin. This makes sure that new coins are mined across the network, but at a predictable rate.
How to Trade in Bitcoins?
All new bitcoins that are mined are automatically added to the bitcoin wallet. A bitcoin wallet is essentially an online account from where you can use your bitcoins to make transactions. This is identical to internet banking. A username, a password, & the user are a part of the bitcoin network.
Now, when a user transfers a bitcoin, a digital signature is created. This is a unique ID which records the transaction. Once the request to transfer a bitcoin has been created, it has to be validated by a bitcoin miner, which is then stored in the network. This transaction is 100% anonymous and also completely secure.
This way, people can transfer bitcoins from one person to another. Many businesses have also started taking bitcoins as a form of payment. So, people can purchase anything from coffee to a server using a bitcoin. Moreover, there are bitcoin ATMs that have opened up too.
There are a multitude of currency exchanges where bitcoins can be converted into any one of the fiat currencies like dollars, yen, pounds, euros, and more. But, no matter how bitcoins are transferred, the same process of validation and record keeping is observed.
How Does the Future of Bitcoin Look Like?
Bitcoin is on a roll, to say the least. The prices are soaring. A bitcoin is trading for almost $20,000 now. The problem is that there are many strong skeptics and staunch supporters. It really depends on the risk appetite of an individual to decide which one they want to believe. While some say that it is only going to rise more, many experts are shouting off the rooftops that bitcoin is a bubble that is all set to burst.
Bitcoin is definitely overrated because without an underlying asset, its value only depends on speculation. Many people are buying the cryptocurrency because they think it is the currency of the future. This is a very lopsided view. As soon as the bullish sentiment fades, so will its value. That does not mean that it is not worth anything. Bitcoin has opened a whole new market.
Cryptocurrencies are definitely here to stay, as is the blockchain technology. Of course, the world governments are still looking at how they can create new laws governing these cryptocurrencies. Until then, then will remain too volatile to be considered as a serious component of any sane investment portfolio. Moreover, with many economists calling out for tagging bitcoins as illegal is not going to help in the integration of the currency into the mainstream financial system.
For the risk takers, bitcoin can offer quite a wild ride. What started in 2009 as a currency worth pennies is today trading at thousands of dollars and is predicted to touch hundreds of thousands of dollars. It is a wild horse. It has the potential to make billionaires in an instant, and can make people go bankrupt the next. So, in short, irrespective the kind of investor anyone is, they should tread carefully.