In 2009, a group of programmers under the alias of Satoshi Nakamoto created the first type of decentralized cryptocurrency – Bitcoin. Unlike traditional currencies, the value of Bitcoin is neither backed by any government nor does it have a physical representation, such as physical bills and coins. Its value depends upon how much faith people have in its ability to be accepted as a form of payment. Bitcoin uses peer-to-peer networking to enable a decentralized system, which means that no financial entity can review your assets or reverse transactions. This leads to greater anonymity since transactions aren’t pinpointed to real-world identities.
Due to its ability to hide the identities of its users, Bitcoin has also been associated with financial crimes and purchasing illegal materials. Last month, hackers infected over 200,000 computers in 150 countries with a ransomware demanding $300 worth of bitcoins to decrypt users’ files. The Silk Road, a market that sells over one billion dollars of illegal drugs, revolved around the Bitcoin ecosystem.
Since 2015, Bitcoin has been accepted by over 100,000 merchants, including PayPal, Microsoft, and the Mozilla Foundation. Many financial institutions are cautious about Bitcoin and banks are hesitant to exchange Bitcoin for government-backed currencies partially due to its association with criminal activities. A couple months ago, the SEC rejected a Bitcoin-based ETF to be listed on stock exchanges in part due to its lack of regulations and the risks it presented to investors.
When Bitcoin first came out, it was worth about the same as penny stocks but since then, its value has increased astronomically. By mid-2013, one Bitcoin was worth around $100 USD. At the start of this year, it was valued at almost $1000 and in June, its price jumped to $3000. Will it continue to rise, or is it already overpriced? Nobody knows. Without being backed by anything, its price is set by people’s speculations. However, its high volatility and lack of oversight have led some investors to question the feasibility of justifying an investment in Bitcoins. On the other hand, who’s to say that Bitcoin now isn’t like Amazon stocks in 1997, whose price has increased by 50x (not adjusting for stock splits).
So how do Bitcoin transactions work? Here’s a simplified summary:
When Alice transfers some Bitcoins to Bob, Alice also pays a transaction fee and broadcasts the digital signature of the transaction to all the other nodes in the network. Specific nodes, called Bitcoin miners, read this transaction (along with other transactions that are broadcasted) and group them into a “block”. The Bitcoin miner also includes a transaction for itself as incentive for doing the mining as well as adds a “proof of work” token in order to receive the transaction fee set by Alice and other senders. This block is then appended to the original block that contained all previous transactions to form a “block chain”, which is then broadcast to all other nodes. Once the other nodes verified the block chain, they use it as the original block and would append their blocks to it.
Because Bitcoin is the first decentralized currency, there’s no precedent data to predict whether it would become successful or not. Perhaps one day it would be adopted by the general public or perhaps governments would find a way to introduce regulations to its market. The future remains to be seen but in the present, it seems like Bitcoin is gaining traction as the first currency of its kind.