Tuesday 11 December 2018

Another Angle: A refresher's guide to Bitcoin: what, when, why and how much

A cryptocurrency ‘mining rig’, right, sits on a desk in the office of Open Computing in Singapore
A cryptocurrency ‘mining rig’, right, sits on a desk in the office of Open Computing in Singapore

Olga Kharif

The initial price of Bitcoin, set in 2010, was less than 1 cent. It crossed $19,000 (€15,270) last month. Since then, events have reminded the world that its wild ride involves downs as well as ups, as it fell to about $11,400 (€9,160).

The ups have been driven by investors anxious to get in on the best-established cryptocurrency as new trading opportunities nudge it toward the mainstream. South Korea's plan to ban cryptocurrencies contributed to the recent slump.

News of a heist of $500m worth of a different digital currency called NEM in Japan isn't likely to help. This may also prompt regulators around the globe to rethink their rules.

1 What exactly is Bitcoin? It's a form of money that's remarkable for what it's not: It's not currency you can hold in your hand. It's not recognised by most traditional stores. It's not issued or backed by a national government.

At their core, Bitcoin and its imitators are sets of software protocols for generating digital tokens and for tracking transactions in a way that makes it hard to counterfeit or re-use tokens. A Bitcoin has value only to the extent that its users agree that it does.

2Where did the Bitcoin system come from? The original software was laid out in a white paper in 2008 by a person or group of people using the pseudonym Satoshi Nakamoto, whose identity remains unknown, despite several efforts to assign or claim credit.

Online fantasy games had long used virtual currencies. The key idea behind Bitcoin was the blockchain - a publicly visible, largely anonymous online ledger that records Bitcoin transactions.

3 How does that work? Think about what happens if you make an online transfer using a bank. It verifies that you have the funds, subtracts that amount from one spot in a giant database it maintains of accounts and balances, and credits it in another.

You can see the result if you log on to your account but the transaction is under the bank's control. You're trusting the bank to remove the right amount of money, and the bank is also making sure you can't spend that money again. The blockchain is a database that performs those tracking functions - but without the bank or any other central authority.

4 Who performs the bank function for Bitcoin? It's done by consensus on a decentralised network. Bitcoin transactions can be made through sites offering electronic 'wallets' that upload the data to the network. New transactions are bundled together into a batch and broadcast to the network for verification by so-called Bitcoin miners.

5 Who gets to be a miner? Anybody, so long as you have really fast computers, a lot of electricity and a desire to solve puzzles. The transaction data in each batch is encrypted by a formula that can be unlocked only through trial-and-error guessing on a massive scale. The miners put large-scale computing power to work as they compete to be the first to solve it. If a miner's answer is verified by others, the data is added to a linked chain of blocks of data and the miner is rewarded with newly issued Bitcoin.

6 How does the system prevent cheating? Because every block contains data linking to earlier blocks, an attempt to spend the same Bitcoin twice would mean revising many links in the chain. Plus, as miners compete, they verify each other's work each step of the way.

7 What is blockchain's appeal? Enthusiasts see it as a new way of doing all sorts of business.

Costs could be lower without a central middleman doing the work of keeping track of transactions, and charging for it. Banks and stock exchanges have invested heavily in developing blockchain technology, while retailers like Wal-Mart are experimenting with using blockchain for ensuring food safety.

Central banks are even speculating about issuing blockchain-based official currencies and other forms of blockchain emerged, often using their own cryptocurrencies to facilitate transactions. The most prominent is the ethereum blockchain, sometimes described as a platform for so-called smart contracts.

8 Why hasn't the competition hurt Bitcoin? As the number of cryptocurrencies and tokens multiply - they now reach into the thousands - Bitcoin remains the best-known, time-tested and valuable. That's led to it being viewed by some as the most predictable venue for people wanting to bet on blockchain's exponential growth.

9 What explains the surge in Bitcoin's price? The spurt last year was mostly fuelled by the news that futures trading was in the offing. Cboe Global Markets began trading futures contracts tied to Bitcoin on December 10, and CME Group followed suit on the 17th, while Nasdaq plans to start this year.

The ability to trade on Bitcoin's price without owning it - and to bet that its price will fall - is seen as expanding Bitcoin's appeal to investors. The fact that Bitcoin's software guarantees that there will be a finite supply has added to the fear of missing out for some investors.

Coinbase, a Bitcoin exchange, was overwhelmed by two to three times its normal traffic on November 29, when Bitcoin's price soared past $11,000, making its service temporarily unavailable to some users.

New crypto-focused hedge funds are opening up weekly, and already surpass 100. Most of them invest at least part of their funds in Bitcoin. (Bloomberg)

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