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Making Sense of Bitcoin - Part 1

Bitcoin is rapidly emerging from the primeval swamp land of crypto anarchists to be of significant interest and potential impact to the established payments industry.   Now well beyond its nascent stage, the bitcoin network is one of the largest distributed computer network on earth – it would be prudent therefore to ask if it is doing anything useful.

Since the bitcoin price bubble in early 2013, bitcoin is now widely reported about in the mainstream media.  Even Jeremy Paxman is talking about it on BBC Newsnight.  There is plethora of news and information and communities, including an industry body foundation.  

Bitcoin is simultaneously both a digital currency and a payment system.  If it was either one or the other, it might be able to integrate it more easily with what already exists for ecommerce.  That fact that is it both means it is a radical alternative to existing payment methodology and merchant adoption is a huge challenge.

Unlike existing proprietary established payment systems which were designed long before the internet existed, bitcoin is an open source P2P electronic cash system the likes of which have not been seen before.  The fact that Satoshi Nakamoto successfully disappeared after unleashing his invention generally helps endorse its mystique, well-articulated in this article regarding the block chain of infinite mystery.    Satoshi the high priest and the bitcoin disciples have for once made the inherently dull subject of payments systems interesting - a huge achievement in itself.

Unfortunately, it is impossible to explain bitcoin to the uninitiated without sounding bonkers.  Bitcoins exist in what is described as a giant distributed electronic ledger (called the block chain).  Through a distributed P2P network of computing nodes, the block chain maintains the integrity of the crypto currency, and for example ensures there is no “double spending” of bitcoins.   The generation of bitcoins by “miners” on the network is regulated by the bitcoin protocol.  The process of mining means carrying out a series of complex mathematical  calculations to create additional blocks in the block chain, in which miners are rewarded with bitcoins. The level of mining complexity is regulated in order to create a uniform supply of new coins until threshold of 21 Million coins is reached.  Thereafter, no further coins can generated, and miners only source of new revenue thereafter will be the fees associated with transaction verification of the block chain.

The concept of virtual currency is not new, and most people already use various types of currencies in their lives without much of a second thought, e.g. airmiles.    However, bitcoin transcends this concept into a secure global open currency that can be globally and instantly exchanged without restrictions from person to person (with no controlling intermediary such as governments or banks).  This concept excites the libertarian school of thought. It is conversely considered to be potentially subversive to the established governments and central bank’s monopolistic control of the nation state fiat money supply.  A recent report by the ECB highlights how seriously the subject of virtual currency is taken.

Bitcoins are now starting to be used to trade goods and services across the internet, in what is now effectively an unregulated alternative payment infrastructure.  This is different to any previous form of privately owned digital currency e.g. Beenz or Flooz on the basis of being an open standard without central control or ownership.  Many companies are now evolving to provide facilities to make bitcoin easier to use and enable merchant integration such as bitpay and coinbase.  Regulation in the form of KYC,  AML and money transmission is starting to be enforced where bitcoins are exchange to and from fiat currencies and into the existing banking system.

In my next post, I will attempt to make some sense of bitcoin by comparing it to the existing established payment system providers and its drivers for adoption.


Comments: (1)

Jane Adams
Jane Adams - Currently looking for a job - Edinburgh 16 August, 2013, 10:47Be the first to give this comment the thumbs up 0 likes

Dave Birch has a good way of explaining Bitcoin to the uninitiated based on a story from Milton Friedman.

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