Home > Strategy > Simplifying the Bitcoin Mystery.

Simplifying the Bitcoin Mystery.


Majority of us would have never heard about the ‘Bitcoins’ till recently. However, since last few weeks, the low lying bitcoins are donning the headlines in business and financial news. Although a lot of newsprint has been devoted to the bitcoin hype in recent days and the phenomenon has generated a lot of interest in the in this new ‘currency’, but, many of us are still wondering about what exactly is the ‘bitcoin’ and why so much hype around it? I have tried to answer a few questions to help de-mystify the mystery.

What is a ‘bitcoin’?

Bitcoin was introduced by a pseudonymous developer named Satoshi Nakamoto in a paper published in 2009. Simply put, it is essentially a decentralized digital currency based on an open-source with peer-to-peer protocol which generates new additions to this number series. Not much is known about the real name of the person and the person himself and the attempts to search ‘Satoshi’ have yielded no results. Satoshi was very actively engaged with the users and other developers involved the evolution and drafting of the protocol and rules around the bitcoins till 2011 when he faded away and ‘moved on to other things’.

The logic that governs the creation of a bitcoin ensures that no more than 21 million bitcoins can be created out of this; 11 million bitcoins are already in existence.

The ‘owners’ or the bitcoins store them in ‘bitcoin wallets’ which are managed by a few companies that provide the bitcoin wallet service. So, essentially it acts similar to a bank account for the traditional currency, only that one does not get any interest. Also, there are online ‘bitcoin exchanges’ where the bitcoins can be purchased, exchanged and converted. Of late some companies have started accepting payments in the form of bitcoins giving it the status of a ‘legitimate trading currency’.

Why is it in news?

The bitcoins have always been a topic of interest and discussions on various internet forums. It’s been almost two years that I have been tracking the developments on the bitcoins. The bitcoins have made it to the mainstream news only recently because of the sensational rise in the price of a bitcoin. The price of a unit of bitcoin has risen from $13 in mid-January to almost $170 in April 2013. This along with the suspense around the connection of increase in trading transactions of the bitcoins to the Cyprus economic debacle has helped propelling the bitcoins into the headlines.

Can it replace the traditional currency?

Each bitcoin has a unique identification number which is similar to the ‘serial number’ we have printed on the currency notes. That is one part, but the more attractive fact that attracts people to bitcoins is that only 21million bitcoins can be made. This is a very good factor which will help in controlling hyperinflation. Also, with a majority of the monetary transactions moving online, many analysts around the world have started talking about the feasibility of bitcoins replacing the traditional currency. But, will it be possible for bitcoins to replace the traditional currency? My answer is that shifting bitcoins (or for that matter to a completely virtual currency) will take very long time. I do not see it happening in near future. Bitcoins can exist as an alternate method of payments but cannot replace traditional currency. There are multiple reasons for my view here but I would like to bring forth only a couple them from the list I have:

First, the bitcoins currency is a de-centralized currency. There is no ‘Nationality’ attached to it. The traditional currency has an inherent factor of ‘Nationality’ built into it. Believe me, although the idea of ‘one world’ and ‘one currency’ might sound very lucrative but is not practical. The idea of one region-one currency was tried in EU and it failed.

Second, the bitcoins are anonymous. This makes them perfect for illegal deals on the internet. Tracing the origin of the deal and the people involved in the transaction is very difficult- if not impossible. Abandoning traditional currency for bitcoins will be a huge compromise on security and traceability of transactions. In case it has to be done, some central agency will have to take up the issue of identification and security protocol.

Third, the issue of taxation. The fact that bitcoin deals are anonymous and have no nationality attached to it, brings in the factor of difficulty of applying taxation on the bitcoin transactions. No government would want to lose tax revenue due to shift to bitcoin transactions.

Grand Theft!

There is another major issue with the use of bitcoins- theft. The critics might say that the same issue also exists in the case of traditional currencies as well. But, consider this- The six biggest hacking, theft and fraud incidents involving Bitcoin exchanges, wallets, or investment vehicles have resulted in a total 1.2 million Bitcoins being stolen. This is out of a total of 11 million bitcoins in existence today. This means that more than 10% of all the bitcoints that exist in the world today are stolen! Whatever might be the dangers and risks involved in the transactions of a traditional currency, the ‘theft’ numbers have never been so high.

Is the current rise in bitcoin prices a Bubble?

According to my knowledge of economics, the answer is yes. This is because the prices of bitcoinc are rising because people are buying them and people are buying them because the prices are rising. So, the price rise is fuelling the demand and the demand is fuelling the price rise. Secondly, there is not much evidence of people using bitcoins for online transactions for buying or selling goods or services. Until that starts happening, which will be an economic driver, the rise of price for bitcoins is nothing more than speculation.

The bitcoins phenomenon might sound very exciting, but there is a need to contain this excitement. Considering bitcoins as a hedge in the case of economic crisis or considering completely shifting to bitcoins from the traditional currency might be a farfetched idea. There might be a time in the future when the currency will go virtual, but that time is not now.

Categories: Strategy
  1. Naveet
    June 18, 2013 at 1:37 pm

    Wonderful article…We are waiting for next one…

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