Crack open a financial paper, listen to the radio or check the market listings and you’ll probably hear news of something called ‘Bitcoin’. This is a currency that’s been around for a while now, but only really became a massive talking point in 2017, when it saw a meteoric rise in its monetary worth, shooting from a value of $800 to $18 000 per Bitcoin in the space of a year. Now investors are interested in it.
Banks and other financial institutions are investigating it. Governments are looking into ways to tax it. Bitcoin is now on the mainstream’s radar and, regardless of its fortunes going forward, it’s probably a good idea to understand what it is and how it works.
In simple terms, Bitcoin is a cryptocurrency and, to get a better idea of what that means, it’s worth dissecting the word.
‘Currency’ is a term that will be familiar to nearly all readers. For our purposes here, think of a time thousands of years ago in which traders exchanged material goods – such as grain for meat. This bartering system soon had to evolve, given that organic goods spoil and their value decreases rather quickly. The need for something of value that lasts longer than food gave rise to the use of precious metals (coins). The coins changed hands until eventually, there were more coins being exchanged than there were actual goods to trade. So money over time evolved into what we call ‘fiat’ currency.
Fiat currency is a note from a bank that promises to pay the bearer of the note; it has no intrinsic value – you can’t eat it or use it as building materials for shelter. Central banks and governments agree that these are worth something and consumers can exchange the notes for goods and services instead of bartering – ie exchanging goods for goods.
Basically, fiat currency requires central bank and government regulation as to the value – and the debt – attached to the money, but it also requires that consumers agree that the money has value. This system requires faith in a centralised banking system, regulated by the government, to set, control and verify value transactions.
Just like goods turned into metals and metals to cash notes, today’s fiat currency exists not in the physical realm, but as digits in a set of secured, centralised, electronic servers that know exactly who is doing what transactions.
Cryptocurrencies are the logical next step in the evolution of fiat money. One that requires less faith, but the same amount of agreement as to their value. The ‘crypto’ part of cryptocurrency refers to ‘cryptography’, which is a computer technology that, among other things, makes information secure.
Cryptocurrencies, then, are electronic capital that have been constructed with the technology to make secure transactions, legitimise the currency’s worth and protect the identities of anyone who uses it – just like cash, but without a central bank.
At the time of writing, the most wellknown cryptocurrency is Bitcoin. Bitcoin is a trade name. It was invented by someone called Satoshi Nakamoto in 2009. To this day, the true identity of Nakamoto remains a mystery – no one knows whether Nakamoto is one person or a group of people.
What’s important is that Nakamoto authored a paper that put forward the idea of Bitcoin, an electronic peerto- peer payment system for online transactions that wouldn’t rely on any intermediary – such as a bank.
The spine of this system, blockchain, is a digital framework that allows peerto- peer verification while decentralising the ownership of the data. That last part is particularly important with reference to Bitcoin, because it explains why this cryptocurrency became so appealing.
A decentralised currency is one that no bank or government can control.
If a nation suddenly found itself in a state of emergency and there’s a run on the banks for cash, the relevant government or central bank could easily freeze assets to preserve the value of the currency – essentially preventing citizens from accessing their money.
There are two questions most onlookers have regarding Bitcoin – how is it made and why does it have any value?
Bitcoin is created through a process called ‘mining’, whereby all the information that makes up the blocchain digital system is verified. The point of this is to make sure no information can be falsified.
This means each Bitcoin transaction is secure. It also makes each transaction a permanent exchange.
Because Bitcoin mining requires a lot of computer power, miners work in exchange for Bitcoin that is in circulation.
The cryptocurrency’s value is a little easier to explain. The value of one Bitcoin is determined by the number of users, but the supply/number of Bitcoin that can be mined is capped. However, a single Bitcoin is infinitely divisible, so more people than the whole number of Bitcoin in circulation can own some.
While big businesses have been reticent to adopt it en masse, the number of vendors (and consumers) that use it as currency is steadily growing.
It has been estimated that 125 000 vendors in the US alone now accept Bitcoin as payment. It’s that agreement and acceptance that gives Bitcoin its value. After all, the value of anything in a free market depends on what a vendor can successfully sell it for. Currency is just the same, except that it’s a moving asset whose value depends on what it can purchase. It’s actually not too far from “I’ll give you this sheep for 400 cabbages”.
Bitcoin may not be worth its weight in gold, but it is worth looking into as more businesses and consumers adopt it.