Bitcoin

Bitcoin

Bitcoin has been described as a “techno tour de force” by Microsoft founder Bill Gates, and as a “remarkable cryptographic achievement … that has enormous value” by Google CEO, Eric Schmidt.

Bitcoin is both a cryptocurrency and an electronic payment system invented by an unidentified programmer, or group of programmers, under the name of Satoshi Nakamoto. It allows people to send or receive money across the internet, even to someone they don’t know or don’t trust. Money can be exchanged without being linked to a real identity.

First, we must understand the difference between Bitcoin (with a capital “B”) and bitcoin (with a lower case “b”). The first, as a proper noun, is the name of the network and system as a whole. Bitcoin in this context is the name of a technology. Lower case “b”, bitcoin, is the name of the actual units of currency. As an example, an investor can own bitcoin but not Bitcoin.

One of the differences between using bitcoin and using regular money online is that bitcoin can be used without having to link any sort of real-world identity to it. Unless someone chooses to link their name to a bitcoin address, it is hard to tell who owns the address. Bitcoin does not keep track of users; it keeps track of addresses where the money is. Each address has two important pieces of cryptographic information, or keys: a public one and a private one. The public key, which is what the “bitcoin address” is created from, is similar to an email address; anyone can look it up and send bitcoins to it. The private address, or private key, is similar to an email password; only with it can the owner send bitcoins from it. Because of this, it is very important that this private key is kept secret. To send bitcoins from an address, you prove to the network that you own the private key that corresponds to the address, without revealing the private key. This is done with a branch of mathematics known as public key cryptography.

Although the technology behind Bitcoin is exciting, the entire reason it was created was to decentralize control of currency and allow for a stable economy. For thousands of years, gold, silver and other precious metals were used as currency. This was ideal for many reasons, but one important reason is that no single entity could take control over it.

Right now, no government is using the gold standard which means that each countries currency is backed only by the peoples’ trust in their governments and banks. This has failed over and over again. This fiat money system allows governments to stimulate the economy artificially and temporarily, but ultimately fails in the long run because it is dependent upon the goodwill and competetence of politicians.

Zimbabwe is a great example of how the fiat money system is destroyed by incompetency in leadership. In the 1980’s Zimbabwe gained its independence from Britain, and it’s dollar was even more valuable that the American dollar. Their economy was thriving and growing. After a failed economic plan designed by the IMF and World Bank, Zimbabwe began to struggle. There were many factors that led to economic decline, but their government ensured failure by printing money as a solution to problems they couldn’t otherwise figure out. At one point, they printed a $21 trillion bill to pay off debts owed to the IMF. The currency that was once competitive with the US Dollar had seen inflation rates of up to 80 billion percent.

Most countries do not experience this extreme inflation and rapid destruction of their economy. Less corrupt governments generally take longer to see the effects of their monetary policy. Even the United States has resorted many times to printing money in an effort to stimulate the economy. During Obama’s presidency the Federal Reserve has effectively tripled the monetary base in the United States. During that same time period most people have not experienced a proportional increase in income or economic growth. Yet we have seen prices increase significantly for most goods and services.

The value of decentralizing a currency is that it takes power over the economy away from an elite group of bankers and politicians. The belief is that even a government on its best behavior cannot properly manage an economy.

Just like gold, there is a limited number of bitcoins in existence. Hardwired into the Bitcoin protocol is a limit of 21 million bitcoins. As I write, there are just over 16 million in circulation and the rest have yet to be mined. Also akin to gold is the benefit that bitcoin can be split up into any denomination. So even though it is perfectly scarce, it can be infinately divided.

This ensures that when you trade something for bitcoin there won’t be a massive influx of new bitcoins entering the market the next day thus devaluing your previous purchase. Also you can send or receive any denomination of bitcoin.

One of the most controversial aspects of Bitcoin is that it allows for perfect anonymity. All transactions are recorded publically on the blockchain, but there is nothing that connects you with any public address. It’s very easy to conceal your identity and make perfectly anonymous transactions. This is a valuable tool for maintaining privacy and security.

Even though transactions are anonymous, all address balances and transaction details are publically available on the blockchain. That means if you know someone’s address you can look up the assocaited balance. One thing to consider is that if you continually reuse the same public address, and you give it to someone who knows you, they could look up the address balance on the blockchain. For this reason, its wise to generate a new public address for each transaction and many wallets manage this for you.