Digital Currency for the Digital Era

August 17, 2016
Editor(s): Tracey Lin
Writer(s): Cheryline Toh, Frea Disa Alfian, Henry Han

Bitcoin has another time appeared in newspaper headlines when an Australian business Craig Steven claimed to be Satoshi Nakamoto, the pseudonym of the inventor of Bitcoin. Followed Bitcoin, other digital currencies, such as Litecoin and Dogecoin, became widely known by the public. All of these digital currencies share many of physical money’s properties.

As an internet-based medium of exchange digital currency allows instantaneous and borderless transactions. Digital currencies, such as Bitcoin, are decentralised currencies. That is, they do not have any central depository and authority that guarantee and control the money. Thus, they are more volatile and risky compared to other forms of finance.  Since they exist outside the institutional banking system and the control of government, it is often linked with the idea of libertarian (Henwood, 2014). However, digital currencies also have their own system to ensure the security of transactions. They are protected by encryptions techniques that are used to regulate the generation of every unit of currency. Moreover, to prevent double spending, every transaction is verified and recorded in a publicly distributed ledger called block chain.

Unlike virtual currency that can only be used in a certain virtual community or group, Bitcoin is widely accepted as a means of transaction. Bitcoin became the most popular and well-known digital currency for many reasons. As a digital asset with a peer-to-peer payment system, Bitcoins can be transacted quickly as the transactions take place directly without any intermediary. As they “are scarce and have an innate mathematical beauty”  (Redman, 2016) and were the first pioneer that introduced the concept of block chain and popularized the digital currency, Bitcoins became the digital currency that have the biggest market capitalisation among all digital currencies. Another very important is that you can mine your own money.

 

What is Bitcoin mining?

Bitcoin mining is a process of bringing new Bitcoins into the circulation. It serves as a means to verify the transaction, to prevent double pending, and to increase the Bitcoin supply.

Bitcoin miners were competing in finding new blocks that contain the Bitcoin transactions details. The miners are those who approve the business transactions. The recent transactions are compiled into a block where the miners are contending to add the block into the ledgers by solving a computationally difficult puzzle. Similar to gold mining, the fight against the puzzle is found through a brute force of search. Miners’ profits will depend on the hardware costs, electricity expense, and the current price of Bitcoin.

The first miner who solves the puzzle gets to place the new block to the block chain (the ledger) and claims the reward – newly released Bitcoins – and transaction fees. According to the Bitcoin protocol, the reward halved every 210,000 block.  It is estimated that, by the year 2140, the amount of Bitcoin will approach 21 million. After that, the only income is transaction fee (Blain, 2013).

Is Bitcoin safe to use?

It depends on how you manage it. Bitcoin can be stored online and offline, although barely any digital device is really offline these days. You can store your Bitcoin in the following devices.

  1. Your own computer. The code file representing Bitcoin can be stored in the plain, official Bitcoin software, or other desktop ‘wallet’ software with enhanced security.
  2. Mobile apps, which provides payment convenience – Online wallet operated by specialized third-party websites.
  1. Physical gadgets, such as USB ledger and hardware wallet.
  2. Paper note. Two QR codes are printed on a card. You can put it into your safe/vault.

If Bitcoin is digitally stored, security concerns would be hackers, malware/virus, discredited third parties, or unintentionally touching the ‘delete’ key. If it is physically stored, you could lose it as easy as you lose your old-school money.

 

Who are the users and investors?

In the last 30 days, 95% of Bitcoin trading was denominated by Chinese Yuan. The second largest proportion, approximately 4%, is made by US dollars.

Source: http://bitcoincharts.com/charts/volumepie/ at 11/5/2016

Bitcoin’s high price volatility is ideal for speculators. Individual investors and venture capitalists buy Bitcoin outright or speculate in Bitcoin CFDs (contract for difference). Bid/ask spread and transaction fees apply. As for retailing, you may pay Bitcoin in exchange of flight tickets or a glass of craft beer, although choices are limited.

However, is it legal?

It depends what you do with it. If you use it for things other than drugs or things alike, it is OK. In fact, the debate on whether Bitcoin is just a temporary geeky idea, a currency to change the world of money, or a commodity like gold and crude, has never ceased since its birth. Some countries have made their decisions as such:

  1. In 2015, the European Court of Justice classified Bitcoin and related alt-coins as currency, instead of goods or property.
  2. In the United States, Bitcoin is taxed as a ‘property’ by IRS since March 2014. U.S. Financial Crimes Enforcement Network, U.S. Commodity Futures Trading Commission, as well as SEC, all have their eyes on Bitcoin.
  3. In 2013, Chinese regulator barred banks from providing all relevant service to Bitcoin and claimed Bitcoin would not be treated as currency. But individuals are allowed to possess and trade Bitcoin freely as a ‘commodity’.

While a few countries express their concerns on Bitcoin’s possible disruption against existing financial system. few countries explicitly forbidden the use of Bitcoin.

Crime and Bitcoin

Currency is used to purchase goods and services. Bitcoin is unique as a ‘currency’ because of its advantages, such as anonymity. As early as in 2011(two years after Bitcoin’s birth), an article titled ‘The Underground Website Where You Can Buy Any Drug Imaginable’ (Chen, 2011), revealed Bitcoin’s usefulness in the underworld’s black market in darknet. After people realized that they could make untraceable transactions paid by Bitcoins, the cryptocurrency’s value started to surge, as people use it to feed their insatiable, dirty desires. A 2016 research by King’s College London finds an “overwhelming” presence of content related to illegal activities on easily-accessible dark websites (Moore & Rid, 2016). ‘Services’, such as computer hacking, drug dealing, human trafficking, child porn and even assassination, can be ordered with Bitcoin payment. Bitcoin, instead of bags of money, becomes a preferred payment method for kidnappers and hijackers (Popper, 2015).

Silk Road is one of the most notorious black market places. The authority repeatedly shut it down but it always resurrects. The original founder of the website was arrested in 2013 and sentenced to life in prison in 2015. Two US federal agents were arrested for involvement in siphoning from Silk Road’s seized Bitcoin account. However, a month after Silk Road 1.0 shutdown, 2.0 was brought online by former administrators. On January 11, 2015, Silk Road Reloaded launched with more sophisticated technology with greater anonymity (try access through this link: http://silkroadreloaded.i2p/).

Investing in Bitcoin

Like any commodity in the world, Bitcoins can be invested in. At the point this article is being written, 1 Bitcoin is currently worth $623.97AUD, according to the CoinDesk. This price is phenomenal considering that Bitcoin was only invented 6 years ago and only really started to gain traction about 3 years ago.

Any financial savvy investor would know that high returns often require taking a proportional amount of risks. While early adoptees could have bought them for almost close to nothing, Bitcoin prices have historically hit more than $1000USD per coin that is about 2.5 times more than its market rate in the US today. Just in the past year, the price of Bitcoin has fluctuated anywhere between about $200 to $500 USD per coin. Investors who believe that Bitcoin and block-chain are the way to the future believe that the price of Bitcoin will continue to soar further. However, it is skeptical that Bitcoin will actually have a substantial increase in price in the future. Because a newer and better system may come up, replace the block-chain technology behind the Bitcoin and, thereby, make Bitcoin redundant.

Bitcoin in the future

Bitcoin is a powerful tool because of its decentralised nature. However, if Bitcoin were to become the common currency of the future, it makes it hard for the reserve banks to control the money supply or the cash rate. This means that there would be one less tool for the government to manage interest rates and inflation (The Daily Bell, 2015).

Although it is skeptical that the idea that Bitcoin — or at least the current form of Bitcoin — can fully replace the system we currently have, we see it more as something that exists in symbiosis with the current system because both have their strengths and weaknesses.

Nonetheless, all industries are investing the technology that Bitcoin was developed on. While we believe that the power of Bitcoin is somewhat limited in the long run, block-chain technology could very well be the future and we would be keeping an eye out for it.

References

Redman, J. (2016, February 10). Diamond Market meets Bitcoin through Bitcoin.de. Retrieved May 20, 2016, from Bitcoin, http://bitcoinist.net/diamond-market-meets-bitcoin-through-bitcoin-de/

Blain, L. (2013 February 19). The rise of bitcoin : Bonaza or bust. Retrieved from Gigmags: http://www.gizmag.com/bitcoin-creation-value-overview/26325/

Chen, A. (2011, June 2). The Underground Website Where You Can Buy Any Drug Imaginable. Retrieved from Gizmodo: http://www.gizmodo.com.au/2011/06/the-underground-website-where-you-can-buy-any-drug-imaginable/

Henwood, D. (2014 September 2014. Bitcoin the Future Of Money. Retrieved from The Nation: http://www.thenation.com/article/bitcoin-future-money/

Moore, D., & Rid, T. (2016, February 1). The darkness online: Cryptopolitik and the Darknet. Survival: Global Politics and Strategy, pp. 7-38.

Popper, N. (2015, July 25). For Ransom, Bitcoin Replaces the Bag of Bills. Retrieved from New York Times: http://www.nytimes.com/2015/07/26/business/dealbook/for-ransom-bitcoin-replaces-the-bag-of-bills.html

Will Bitcoin Replace the BIS? (2015, November 27). The Daily Bell. Retrieved from: http://www.thedailybell.com/news-analysis/will-bitcoin-replace-the-bis/

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ, its Partners and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.