The Internet era has ushered in the need for digital currencies. Bitcoin is one such currency, and with its' stock price soaring over $400 for the first time in nearly a year last week, according to Forbes, the digital currency is garnering renewed mainstream attention. Let's examine some of the basics of Bitcoin.
What Is Bitcoin?
Bitcoin's website describes it as 'A Peer-to-Peer Electronic Cash System.' Bitcoins are a digital currency, or cryptocurrency, that can be purchased using real, physical currency. Bitcoin uses cryptography to control creation, administration, and security. The system allows online payments to be transferred from one user to another without the need for an established financial institution as a middleman.
The system requires digital signatures to reduce the likelihood of double spending and a record of time-stamped transactions is kept as proof of all events witnessed. Transactions are automatically included in a shared log called a 'block chain' that helps to confirm that the party attempting to spend Bitcoins owns them. A block chain
Why Is Bitcoin Needed?
The increasing relevance of e-commerce requires a more functional means of processing electronic payments. Banks now serve as trusted third parties in these electronic transactions, and they are responsible for mediating any disputes that arise. Two of the largest weaknesses in the current system are trust and the inability to complete non-reversible transactions.
Trust issues make merchants understandably wary of their customers and many hassle customers for more personal information than needed as a result. The possibility of reversal only heightens this trend of distrust, as a certain percentage of fraud is inevitable in the current system. Bitcoin's electronic payment system builds on a record of cryptographic proof, rather than trust. The idea is to eliminate the need for a third party by giving individuals the ability to initiate directly secure transactions.
How Does Bitcoin Stack Up Against Traditional Currencies?
The major fundamental difference between Bitcoin and traditional currencies is the fact that Bitcoin is almost exclusively digital. You can purchase physical Bitcoins from several companies, but its' primary application remains as a digital currency. Many experts believe that physical Bitcoins are an unnecessary novelty because Bitcoin balances are easily converted to physical currency at a bank or online brokerage.
Another key difference is that Bitcoin utilizes peer-to-peer (P2P) technology free of oversight by a central supervisory organization. The network issues all currency and is responsible for processing transactions and verifying payments. Conventional currencies are distributed by a central bank that regulates national monetary policy.
Conventional currencies are issued without limit, but Bitcoin production will not exceed 21 million. The mining process creates 25 new Bitcoins in ten-minute intervals. This number is cut in half every four years so that the limit isn't approached until the year 2140.
Bitcoin also has limited acceptance in comparison to traditional currencies. Acceptance levels are likely to increase as digital currencies continue to gain popularity, but there are currently very few tangible retailers willing, or able, to accept Bitcoin as a valid form of electronic payment.
How Does Bitcoin Work?
The process of utilizing Bitcoins for electronic transactions starts by installing a digital 'wallet' on the user's preferred device. The user downloads open source software that generates addresses where the user can store Bitcoin balances. Users can install three distinct types of Bitcoin 'wallets.' The first is a software wallet installed on a computer. The second resides on a mobile device, and the third is located on the website of a service provider capable of hosting Bitcoins.
Every Bitcoin address has a balance, and users can create additional Bitcoin addresses whenever they desire. There are multiple ways to acquire Bitcoins. Users can purchase Bitcoins from a currency exchange or via a service that handles the transfer of funds between Bitcoin exchanges. This service must support a variety of mechanisms for accepting electronic payments.
Security and Insurance
Bitcoin utilizes public key encryption for security purposes. Every time a new Bitcoin address is created the system generates a cryptographic key pair that contains both a public and private key. These keys are unique strings of letters and numbers. A couple downsides to this system are the time required for transaction confirmation and the fact that most transactions are irreversible.
The current system does not allow for insurance on Bitcoin balances. Bitcoins that are lost or stolen, for any reason, cannot be easily recovered. Bitcoins can be lost if your computer hard drive crashes, the Bitcoin exchange where a balance was held goes out of business, or a hacker steals your Bitcoin digital wallet.
Bitcoin In The News
A group of ethical hackers recently claimed to have found evidence of Bitcoin funding, in the amount of $3 million, linked to ISIS terrorists responsible for the Paris terror attacks. Deutsche Welle had previously reported on the Islamic State's experiments with digital currency and Bitcoin specifically.
This report detailed a Bitcoin wallet that received nearly $23 million in a month and the hacker group has confirmed, to NewsBTC, that ISIS is utilizing Bitcoin to fund continued operations. By tracking Bitcoin activity, the group was able to detect signs of the impending attacks in Paris, and they are currently working with U.S. government officials to collect further evidence in the ongoing investigation.
A Future For Digital Currency?
Despite links to the radical Islamic State, the future of the technology behind Bitcoin's electronic payment system remains bright. According to Gil Luria, an analyst at Wedbush Securities, 'We believe Bitcoin and its associated blockchain technology have the potential to disrupt the existing financial infrastructure over the next several years and believe the value of the Bitcoin currency will benefit from this trend.'
The European Union recently confirmed Bitcoin as a currency and the Cyberspace Administration of China believes the accompanying blockchain innovation may prove 'revolutionary.' It seems clear that Bitcoin has a legitimate platform on which to stand, and its' role in phasing out third-party financial institutions in electronic transactions seems likely to grow in the coming years.