Confused by Blockchain and Bitcoin?
Introduction
Blockchain is a revolutionary, technically sound and secure technology. Cryptocurrencies (named hereafter ‘cryptos’, e.g. Bitcoin) are based on the blockchain. But many may vanish or be banned, because governments don’t like them as they lose control! They already are banned in some countries.
On the other hand, cryptos could grow enormously and become stable if governments allow and regulate them!
Market capitalisation of cryptos is over $US1 Trillion, of which Bitcoin is 70%. Armies of IT people continually try to improve them. ‘Altcoins’ are the improved versions (Alternative to Bitcoin)
Many industries use blockchains for a variety of non currency applications, so blockchains are here to stay. Examples are:
- Everledger is revolutionising the $13 billion per annum diamond industry. Every certified diamond in the world is being placed on a blockchain registry. 2.2 million diamonds have already
- The first blockchain powered government is Dubai. It has 20 blockchain applications for road, transport, energy, health and education. Records are secure, transactions are quick, simple and low cost
- Big pharmacy companies register every product they supply on a blockchain. This eliminates counterfeits, which kill around 7 million people a year. End users identify product authenticity easily, by secure means
- Colorado Senate Bill 086 wants blockchain technology to secure private data from cyber attacks and reduce paper records
- There are hundreds more, because the databases and information they hold are secure and unalterable. They are much better than any other system being used.
The explanation below explores how cryptos and blockchains work.
Simplifying a Complex Subject
This subject is complex, so to simplify, much detail is omitted. Hopefully, this bare bones explanation gives readers the basics. In part it relates to digital currency which will eventually replace physical notes and coins. Either by governments or the public. The advantages of a single world currency are obvious. The Euro shows how one currency can replace many.
Countries price goods and services according to the cost of local production, reflecting their fiscal strength and wealth. It has always been this way. Exchange rates are complex and costly. Charges by banks or exchange bureaus, passed on to customers can be high, often 6 to 7%.
Our previous blog, ‘CBDC – The Eventual Demise of Cash?’ relates. But CBDCs (Central Banks’ Digital Currencies) still retain that country’s currency. China is implementing their CBEP (Central Bank Electronic Payments) which will force other countries to act.
However Bitcoin or a better newer crypto, could be a single global currency, eliminating exchange rates. Don’t hold your breath. Conservative governments are involved! They and banks hate cryptos, but like the blockchain.
Blockchain
History: First thought of in 1982, further developed in 1991, Satoshi Nakamoto established the blockchain in 2008. He remains unidentified, but introduced Bitcoin in 2009, based on the blockchain.
So how does a blockchain work? Blockchain stores digital data in a block. New data sets are chained to the previous block. The data in each block is virtually set in stone and cannot be altered. Maybe, not even with a quantum computer according to experts. See Blockchain Security below. To hack blockchains, perhaps millions of blocks on multiple computers, back to the first block need to be altered. And quickly, within seconds.
Conventional Central Ledgers store databases that are owned and controlled by governments, banks or commercial organisations. But the blockchain is a digital ledger, distributed over a large number of computers.
No one owns the blockhain, although organisations or governments can set up and own applications. No one has central control. While this is very secure, users are unknown to the outside world. So the blockchain attracts criminals and terrorists to hide transactions. Government regulation would expose and eliminate this.
China’s digital currency, CBEP, does this, monitoring and taxing users, as would be expected of China! But users can transact, be given funds, bypassing bank accounts, for minimal cost.
Blockchain Advantages
- Highly secure, virtually hacker proof. See Blockchain Security below
- Transacting almost instantly
- Cost is near zero
- Digital currency such as Bitcoin may bypass banks and money transfer services
- Non financial use: secure ID such as passports, real estate transactions, fine art or jewelry authenticity. Ensuring big pharma drugs, chemicals are not fake. Voting, wedding and death certification.
- And many more. See Introduction above.
Cryptocurrencies
Cryptos loosely means encrypted or secret currencies. They may seem like ‘vapour’ with no backing. But that can be said of physical money, dollar bills, which can be printed at will. Governments abandoned the gold standard years ago.
The lack of government regulation and the consequent volatility give cryptos a bad name. ‘Cowboy’ investors, sometimes called ‘whales’ usually cause this. They pump and dump cryptos, manipulating prices to their advantage. To overcome this, some coins (called ‘stable’ coins) are tied to a basket of conventional currencies such as the US$, Euro, etc.
Many so called cryptocurrencies are not currencies at all, used for non financial purposes. While there are more than 4000 cryptos today, many are no more than Ponzi schemes. So use only professional advice if purchasing. Those with large market capitalisation are usually OK.
This is why regulation is needed. Joe Biden has selected Gary Ginsler to run the US Securities and Exchange Commission. Ginsler understands blockchains and says oversight of cryptos “is in the offing”.
Bitcoin ETFs (Exchange Traded Funds) approval is close in USA and already established in Canada. When this happens, many more individuals will invest. Increased volume will help stabilise prices.
Bitcoin
Bitcoin, the first and original crypto, is the world’s 5th largest currency. Only 21 million Bitcoins can be mined. As of February 24, 2021, over 18 million have been mined. This leaves less than 3 million to be released. So, like gold, the limited supply increases Bitcoin’s value over time.
Mining
Bitcoin miners receive Bitcoin as a reward for completing “blocks” of verified transactions which are added to the blockchain. Like all prospecting, competition is fierce. Whoever solves the block structure first, wins. It is costly in terms of time and power used. Only very powerful computers can solve these complex mathematical problems.
The collective electrical power used is higher than the total used by some countries and increasing! Further electronic miniaturisation and quantum computers should hopefully solve this problem.
When all 21 million bitcoins are mined (won’t occur until 2140!), miners will then be rewarded with transaction fees. Not all cryptos are mined but all need what is known as ‘proof of stake’.
How Are Cryptos Bought, Sold & Stored?
Investors buy and sell cryptos through exchanges with fiat money (e.g., dollars), the main exchanges by volume being:
There are hundreds more, but buying and selling in your own currency is preferable, so in Australia, Coinspot is very good. In USA, Bittrex is often used.
Cryptos can be stored on the exchange where purchased and 2 factor login is very safe, but hackers are clever. So it is wise to send your coins from the exchange to a hardware (off line) wallet such as Ledger or Trezor.
Once there, the digital key, an 8 digit pin, secured if forgotten, by a 24 word phrase must be kept safe. In your home or other safe place. Definitely not on your computer or phone. While hacks of exchanges occasionally occur, this is a hack of login details, not the blockchain.
Blockchain Security
This video explains how blockchains work and are secured.
While quantum computing power is enormous, the standards of encryption are improving exponentially. There are private blockchain technology companies working on solutions to make blockchains “quantum proof.”
One example is a blockchain project called Quantum Resistant Ledger. It is developing its blockchain technology from the ground up to be quantum resistant.
Just In
Now there are NFTs (Non Fungible Tokens, called nifties!) in the news. One offs, covering tunes, even one attributed to Elon Musk, digital works of art, all based on the blockchain. One artwork sold for $69M. Enough for now!
Clarification?
If you need clarification of any part of this blog, please ask in ‘Comments’ below.
References
3 Responses
Love your work Campbell.
I now have at least a very basic understanding of this topic which clearly means with a glass or two of a nice red I will be an absolute authority.
Cheers
A topic many are battling to understand and your blog certainly gives some clarity to those of us struggle with technology generally. It’s the value aspects of the Bitcoin that is hard to grasp. How does something of value get mined from a computer.
To me it looks more like a commodity than a currency. How do I buy my groceries and the car with Crypto? Will it be the new international currency or just be the new gold standard. Notwithstanding the reliance on blockchain security the fear is the ability to counterfeit by those ever improving computers and their operators.
Where from here? I too need a glass or two of red to get my head around it.
Keep up the good work
John
Good comments. Cryptos can certainly be confusing. It is early days for using cryptos to buy things, although a few merchants are accepting Bitcoin as payment. The problem is volatility. Governments including the US are sanctioning ETFs which will allow the general public to invest without the hassles of going through crypto exchanges. This should markedly increase the volume of investment and decrease the volatility. The Crypto community has been crying out for government regulation.
As for using bitcoin as a currency, I guess it is no less a medium of exchange than the dollar, both are man made. The advantages are the low transaction cost, as there is no middleman (banks, credit cards, high international exchange fees) and the simplicity of transactions. Just use a wallet on your mobile phone to transfer anywhere in the world. About 2 billion people don’t have bank accounts but most have mobile phones. Banks hate the idea and governments are cautious. But the blockchain is virtually hackproof, even with quantum computers (see blog). Scams in the past have been through exchanges, most of which so far don’t use the blockchain.