171030 The Inevitability of Bitcoin

distributed networkBitcoin is a cryptocurrency.  If the term is new to you, a cryptocurrency is a digital currency; virtual money.  It was the byproduct of another invention, blockchain.  Blockchain was invented by Satochi Nakamoto, an unknown inventor.  In 2009 he made the following announcement:

Announcing the first release of Bitcoin, a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority.  

Double-spending was the biggest problem for any electronic cash system.  If someone pays you online, how do you and your bank know that the payee didn’t already use all his money somewhere else?  You rely on your bank and the payee’s bank to ensure that the money hasn’t been double-spent.  It involves a lot of secrecy, electronic handshaking, passcodes, keys, locks, and accounting.  In the end, those systems aren’t very good.  There are often long delays, there is often theft, there is fraud and misdirected funds.  Blockchain is the technology that creates a decentralized network.  There is no central clearinghouse for the exchange of Bitcoin.  Bitcoin is the currency that is being exchanged.  We can go on and describe how it Bitcoin works in greater detail but suffice it to say over the past eight years Bitcoin has gained a huge following and spawned many other cryptocurrencies.

Before getting into all that, it’s important to ask “why?”  Why Bitcoin? Why now?

Bitcoin is inevitable.  At the beginning of the United States of America, when we had to create our own currency, we based our currency on gold. It was possible to trade paper and coin for gold.  Gold became impractical to use as everyday currency.  It was not easy to carry, divide or weigh.  For the next 250 years, paper and coin was the currency of choice.  Today most of our financial transactions are done with debit or credit cards.  Checks are quickly falling out of favor.  In fact, only 11% of people prefer cash as a method of payment.

Furthermore, more and more of our transactions are done online.  For those, we must use a digital form of payment.  In the very near future, a new payment requirement will become necessary — computer to computer payments.  Your computer will interact with the computer of a good or service without your direct involvement.  Those payments might be very, very small and/or very, very fast.  For example, you will go to a website where you pay to read what is there by the word.  A word might cost $0.0001324.  Your Lyft, Uber or Apple driverless car service gets directions and the payment from your smartphone.  You pay for groceries simply by bagging them and carrying them out of the store.  There are no cashiers.  Much of this will be micropayments and they will happen quickly, too quickly for us to be actively involved.  Nor would we want to be.  For this type of transaction, it will be necessary to have a cryptocurrency, one that can be divided into 1/100,000,000th of a coin if necessary.  Also, the cryptocurrency will have to be decentralized.  There is no time to send a message back to a central clearinghouse, wait for a response, and then send messages off to a couple of exchanges and two or more banks in order to keep up with the necessary bookkeeping.

Bitcoin does all of this with ease.  Until you have actually received or spent a bitcoin it is hard to imagine just how easy bitcoin is to use.  To keep bitcoin you use a bitcoin wallet.  Bitcoin is placed in the wallet by means of a public and private key.  To receive bitcoin, you would give the payee your bitcoin wallet public address.  Your address is part of the bitcoin blockchain.  Every single owner of bitcoin has a complete record of every bitcoin transaction, kept in the blockchain.  New transactions are not permitted until all of the modes in the bitcoin network surrounding the new transaction agree that it is a legitimate new transaction.  For a more detailed description of the blockchain technology and why it works, other entries cover that in great detail.

One of the first questions about bitcoin is “Isn’t bitcoin used by drug dealers and money launderers?”  Yes, it is.  That’s because it is totally anonymous, secure and fast.  But that is also why it is used by families sending money home to Venezuela and the Philippines.  That is why people suggested to the independence-seeking Catalonians who are now looking for a new currency to use Bitcoin.  The best part about Bitcoin — there are no fees.  There is no central government or governing body.  There is no clearinghouse or regulations, at least for now.  It would be very surprising if a country allowed bitcoin without imposing some sort of regulations or governance.  In fact, China has already barred some forms of cryptocurrency and announced they will be issuing regulations on Bitcoin soon.  Russia has already outlawed Bitcoin but then restated their intent to regulate it.  Russia will, however, be issuing CryptoRubles, a state-owned cryptocurrency.

There are 16,600,000 bitcoins in existence.  Some more will be issued as time goes on but the total will never exceed 21,00,000 bitcoins.  That makes them exceedingly rare when they have to be shared by the world’s 7.5 billion people.  On January 1, 2017, bitcoin was valued at a little over $600.  At the moment, bitcoin is $6150.  Estimates range from $6000 to $25,000 for the value of bitcoin by the end of 2018.  Estimates range from $0 to $1,000,000 for the value of bitcoin at some point in the future.

Technology requires that there be a cryptocurrency.  Paper and coin, which replaced gold nuggets, isn’t flexible enough to work with computerized systems.  When we use debit or credit cards over the internet we are practically using a digital currency.  The only difference is that the banks, the exchanges, and the clearinghouses that handle the digital transactions are all involved.  The only role the cards are playing is acting like the account numbers for the banks to keep in their ledgers.  Each of those players must keep the information secret, and take responsibility for its being genuine.  There are long delays; often days are set aside while transactions are proven, settled and cleared.  Technology in the near future will require fast, reliable, secure, anonymous transactions.  Blockchain technology promises to deliver all of that.  In fact, blockchain is so well liked and reliable that most of the Fortune 500 companies are already using blockchain to secure all sorts of networks from financial to legal to real estate.  Why not currencies, too?

If you want to get a sense of how popular bitcoin is already, check out bitlisten.com. There the programmer has made a bubble for each bitcoin transaction with the size of the bubble equal to the amount of bitcoin.  The tone played gets lower with the size of the transaction as well.  You’ll be surprised.  There are hundreds of transactions per minute. Bitcoin is inevitable and it’s here to stay.

171023 Blockchain

Key to Bitcoin’s success is the underlying blockchain technology, an example of a distributed network. Blockchain is a brilliant solution to the problem of trust. Trust makes the world go ’round.  Put simply, without trust online payments would never work.  Sure, you could send virtual currency to someone over the internet but how would they know if it were real or not.  How do they know if you haven’t sent the same virtual currency to someone else?  In a traditional money/currency scheme, a central clearinghouse or ledger is kept to note all transactions.  Those are examples of centralized networks where all nodes can be traced back to a central point.  That’s the system in place today for the entire banking system throughout the world.  The problems with that kind of system are many.

With a centralized banking system, secrecy is key.  There are fees necessary for someone to do the accounting and it all takes time.  With all of the safeguards that have been put in place, there is still fraud.  I’ve been told it was as much as seven percent on the credit card network at one time.  For example, a wire transfer takes an enormous amount of information, filled out on a form at the bank.  Addresses, balances, and permissions have to be verified.  Even so, wire transfers take hours and have enormous sending and receiving fees associated with them.  Blockchain does away with all of that.  Openness is key and transactions are completed in a matter of seconds, with no fees at all.  There is a very small processing fee for any transaction.

The enigmatic inventor of blockchain, Satochi Nakamoto, created a brilliantly simple yet elegant solution to the problem.  Transactions would be distributed throughout the network.  A block would be created with each new set of transactions.  Usually, blocks have about 1000 bytes (1K).  The new block is chained to several existing blocks through a simple but elegant process.  The new block is not considered bonafide until several existing blocks authenticate its existence.  When it is authenticated, it is added to the chain.  The chain grows ad infinitum.  Multiple existing blocks authenticating new blocks is key to the issue of trust.  Bitcoin has used blockchain since 2009.  There have been many millions of transactions thus far.  Blockchain works!