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Bitcoin and the rise of cryptocurrencies

cryptocurrency

by Andrei Bogza

In the beginning

Bitcoin is a form of currency created and stored electronically. Unlike traditional currencies such as dollars or euros, bitcoins are issued and managed without any central authority whatsoever: there is no government, company, or bank in charge of Bitcoin. They are produced by ordinary people around the world using computers to solve the equivalent of a mathematical puzzle using the SHA-256 crypto algorithm.

The Bitcoin digital currency was theorized in a paper published in 2008 on the Cryptography Mailing List by Satoshin Nakamoto. In 2009, the Bitcoin software was made public as open source and the network was launched making available the first units of the currency that were called bitcoins. To this moment, little is known about the identity of the inventor of Bitcoin, whether “Statoshi Nakamoto” is his or her real name or there is an entire group behind it.

After its launch, the Bitcoin community began to grow slowly and although there was no particular use for it, more and more people got involved in producing the currency in a process called mining. Mining is a record-keeping service that keeps the block chain (the public ledger where all transactions on the Bitcoin network are stored) consistent, complete and unalterable. This is done by repeatedly verifying and incorporating new transactions into a new group of transactions called a block that chains to the previous block (hence the name block chain). With each block, the miner or group of miners working on it is rewarded with an amount of bitcoins. It started from 50, now is 25 and as the number of blocks in the block chain increases the number will further diminish.

As there were no businesses accepting Bitcoin, the first transactions were made from person to person mostly for services or digital goods. There is also a famous (true) story about a Florida programmer who paid 10000 bitcoins for someone to buy and send him two 25$ pizza. Looking at today’s exchange rate for Bitcoin, that amount is $2 million, making it the most expensive pizza in history. Ouch!

Attack of the clones

As Bitcoin awareness spread, the demand started to grow leading to the creation of exchange services. These exchanges made it possible for ordinary people who had no knowledge of the mining process (or the powerful hardware needed) to have access to the currency. This led to an increase in value that further led to mainstream media attention, praises from financial experts, but also criticism. Businesses accepting Bitcoin as payment also started to appear, taking the number of transactions per day to the tens of thousands.

The apparent success of Bitcoin and the open source nature of its code led to an explosion of alternate cryptocurencies, some almost exact copies of Bitcoin, while others with different cryptographic algorithms or innovative methods to verify the proof of work. The first alternative cryptocurrency was Litecoin, a version of the Bitcoin protocol with shorter time needed to verify a transaction and a different hashing algorithm that was intended for everyone to be able to mine it without the need for specialized hardware (at that time, Bitcoin was moving from mining with a computer to high performance graphic cards and specialized purpose hardware that would solve SHA-256 hashes). Another popular cryptocurrency is Dogecoin, a coin very similar to Litecoin, that has its roots in the internet culture from pictures with a dog called Doge. Dogecoin gained a lot of media attention after raising the equivalent of $30000 in dogecoins of the $80000 needed for the Jamaican bobsled team to participate in the Sochi Olympics.

As earlier mentioned some of the Bitcoin clones brought innovation to the table and took the idea of cryptocurrency and the computing power behind it to a whole new level. For example, Primecoin searches for chains of prime numbers (further advancing the field of cryptography and encryption). Another example is Gridcoin, a currency which contributes its computational power for research that may lead to advances in medicine, biology, mathematics, science, climatology, astro- and particle physics, thus providing real benefits to humanity.

At the moment, there are 530 cryptocurrencies available for trade in online markets and more than 740 in total. 10 of them have market capitalization over $10 million.

The Good

As previously said, cryptocurrencies are intended to be decentralized currencies based on peer to peer transfers without any regulation by a central group, government or party. This also means that they are not under monetary policies which could lead to economic disaster.

At the heart of the digital currency is the idea of rebellion against fees. This is achieved by removing the need for a third party to process and verify transactions as it is done by the network of miners. The result is that cryptocurrencies allow for goods to be sold at lower prices, as prices don’t need to account for third party fees incurred in the process.

Cryptocurrency affords its users complete anonymity. Purchases at ATMs or by credit card link your personal information to each and every transaction. This allows for businesses, banks and governments to access this data, to track you and take note of your purchases. In contrast, cryptocurrency transactions carry no personal information but the address where the coins originated.

Another big advantage for Bitcoin and even bigger in the case of other digital currencies is speed. The coins can be sent and received in a matter of minutes while sometime transfers using traditional banks take days.

The Bad

Although mentioned as an advantage earlier, anonymity is a double edged sword. As there is no personal information linked to the sender or receiver of the currency, this makes it attractive for tax evasion, drug trade and terrorism. In the past years, several online black markets took shape in the deep web. Although most of them were closed by the US Government, some still thrive as its layers of anonymity protect the perpetrators. The most well know example is Silk Road, a deep web online market where customers had access to illegal substances, weapons and even murder for hire services.

Due to its decentralized nature, any digital currency can increase but also drop in value without any warning. As it was the case with bitcoin, the currency went from $50 to $1000 in a few weeks, later to drop again. Although the price has been stable for the past year, within the $200-300 range, the history could repeat itself or even make it worthless.This is also clearly written in the Bitcoin FAQ on bitcoin.org: “Although previous currency failures were typically due to hyperinflation of a kind that Bitcoin makes impossible, there is always potential for technical failures, competing currencies, political issues and so on. As a basic rule of thumb, no currency should be considered absolutely safe from failures or hard times. Bitcoin has proven reliable for years since its inception and there is a lot of potential for Bitcoin to continue to grow. However, no one is in a position to predict what the future will be for Bitcoin.”

And the future

While at the current time there are tens of thousands of businesses accepting Bitcoin and other cryptocurrencies as payments and as many start-ups and investors, the ideas of global acceptance and replacing standard currencies are still far away. Some countries like Iceland, Bolivia, Ecuador, Kyrgyzstan and Vietnam completely banned cryptocurrencies. Others like China banned banks from offering services to businesses involved in the trading of cryptocurrency.

Even if Ecuador is mentioned among the countries which banned cryptocurrencies, a decision was taken on the 23rd of July 2014 by the Ecuadorian National Assembly to pave the way for its own government backed centralized cryptocurrency, backed by the assets of the Central Bank.

Although the future regarding cryptocurrency is unknown, one thing is certain for now: the technology behind Bitcoin, both the block chain and its distribution nature, will have a deep impact in our society and industry.

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