Bitcoin: Revolutionary currency or a disappearing act?

In the space of 6 months, Bitcoin has gone from a poorly understood, somewhat secretive concept associated with the darker side of the Internet, to a currency that in many eyes has been ratified by the US Senate.

Bitcoin is an open source peer-to-peer electronic money and payment network introduced in 2009. They are increasingly used as payment for legitimate products and services, and merchants have an incentive to accept the currency because transaction fees are lower than the 2 to 3% typically imposed by credit card processors. Notable vendors include OkCupid, Reddit, WordPress, and Chinese Internet giant Baidu.

Only last week, the price passed $1000 per bitcoin and this Google trends chart illustrates the meteoric interest surrounding it.

In the great scheme of traded currencies, bitcoin is still a tiny minority, and whilst more vendors are accepting it and traded volumes are increasing, its durability remains to be seen. Some early adopters have been made fabulously wealthy but is it worth investing in? Indeed, how would you even go about acquiring the currency? Having some great clients from the fields of finance, we here at JPC like to dive into the world of currencies and economics. In this first of a series of articles on bitcoin, we’ll start to answer these questions.

Genesis Block

The bitcoin currency was invented by Satoshi Nakamoto- (a pseudonym) after he published a research paper on the Cryptography Mailing List in 2008. (http://www.metzdowd.com/mailman/listinfo/cryptography).

The principle is deceptively simple: people compete to generate bitcoin blocks by using computers to solve mathematical problems.  Once a problem is solved, the winner gets a prize (currently 25 bitcoins,): this is called Mining and it is the only way to generate new coins.

You might ask what is stopping someone buying 50 computers and set them all up to mine bitcoins? Well, integral to the bitcoin network is a system that increases the complexity of the problems as more bitcoins are generated.

So as more bitcoins are are mined, the harder the math in generating them gets. This brings the generation rate back down. Today, a bitcoin block is generated every ten minutes.  Bitcoin’s popularity means that specialist equipment capable of performing huge numbers of calculations every second is now required for mining within sensible timeframes.

Whilst no doubt frustrating for those wanting to get rich quick, this elegant system gives bitcoin one of its greatest assets: stability. In the world of regular currencies, governments, with their monopoly on the printing presses, where money can be printed on demand, this can drive up inflation and make goods more expensive (more money = more demand for goods= higher prices).

 

This cannot happen with bitcoin. You cannot simply create more bitcoins on demand (above the normal rate of production), and the currency cannot be “inflated” away by opponents or governments.

Lets get back to Satoshi: In January 2009, bitcoin’s creator started mining and generating the first blocks of the currency, known as the “Genesis Block”. Within a year, over 1.5 million bitcoins had been created. At today’s value, this equates to over $1.1billion, a good portion of which Satoshi still owns. Mysteriously, Satoshi then vanished. He ceased all communication with the developers he was working with and has not been heard of since.  There is one, grainy image of him and even the accuracy of this is questionable:

How does the currency survive its creator, how is it ran and who decides the rules?

All will be answered in the upcoming 2 articles

 

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