THE BLOCKCHAIN
It’s a little complicated. And it should be—it’s cryptography. Every requested transaction is packaged into a block with a timestamp, and broadcast to every machine on the network, the nodes, to be verified. Once it is, the transaction goes through, the block is added to the chain, and all nodes are updated with the new longer chain. This blockchain is essentially a list of transactions.
To verify a transaction, the chain must be checked to ensure sufficient coins have been added to your account to cover the output. These are then not considered valid for future transactions. Coins are kept in a wallet application, protected by cryptographic keys—one public, one private. Your transaction is encrypted using your private key and the recipient’s public one, to ensure only they can receive it, and they know it’s from you
Before a block can be added to the chain, each must contain the answer to a complicated math problem, created using a one-way cryptographic hash function, which essentially turns input into a mass of tangled data. To unlock this requires the network to guess a number which, combined with the previous block, gives the correct answer. Thus, each block is cryptographically locked to the previous one.
These puzzles take considerable power to unlock. To reward those who go through the hard work, successful solutions receive Bitcoins. Each block can contain multiple transactions, limited by the block size: currently 1MB, with typically 1,700 transactions for a Bitcoin. The difficulty level is periodically recalculated, to ensure security is maintained, and that each block takes about 10 minutes to process. Every four years, the block reward is halved—it’s currently 12.5 coins.
Security is tight. Nodes only accept the longest verified chain, and any erroneous block quickly disappears. To force the system to accept a modified transaction would involve taking on the combined mathematical power of all the nodes. Blockchain technology isn’t limited to cryptocurrencies; coins can represent anything, such as shares, copyright registrations, digital identities, contracts, votes, or anything else you want to keep on a secure verifiable ledger. Or the tokens can be the data itself—distributed secure cloud storage is being worked on. You are going to hear a lot more about blockchain apps. but there’s none of the fun of mining, or watching values bounce around.
Mining coins offers the tantalizing prospect of “free” money, and it’s this aspect of cryptocurrencies that catches the eye of many. Fortunes made by adopters of the first currencies have fueled a healthy interest in new launches. Getting in early is key: Hit on a coin that rises, be one of the first to mine, and you’re a millionaire in days. Yeah, well, probably not. It’s not 2012 anymore, and anything that looks to have a chance of being remotely successful has serious computing power thrown at it in short order. Despite what the sellers of mining machines may say, it is a tenuous business to run on a small scale, unless you hit the right vein.
LOSING MONEY
Any cryptography can be broken. The early years saw a number of large losses. In 2014, 650,000 coins were stolen from what was at the time the biggest exchange—Mt. Gox, in Japan—leading to its bankruptcy, and the halving of Bitcoin’s value. Technology is improving, but there will always be the shadow of hacks, as there is in all electronic banking systems, generally originating from inside the company. The foundations of Bitcoin have proved to be robust enough to survive early glitches, though.
As with any digital property, duplication is easy. If there can be one, there can be many. There are currently over 600 cryptocurrencies, and frequent new launches. Their values drop as you scroll down the lists, from Bitcoin’s billions to virtually nothing for new contenders. There’s Titcoin, which is, ahem, designed to pay for “adult services.” And PotCoin, which is, well, you guessed. Others are just plain scams. At the bottom of the market, it’s like a frontier town out west: wild.
Last year, one of the senior Bitcoin developers, Mike Hearn, rather publicly left, and told the world why. He claimed it was a “failed experiment.” He bemoans the fact that, while founded on libertarian principles, Bitcoin was effectively controlled by five people who have the authority to change the source code, and that there was much dissent between them. The other problem he cited were the big miners: 95 percent of the network is controlled by a handful of people with big data centers. “The fundamentals are broken, and whatever happens to the price in the short term, the long-term trend should probably be downward.”
His points about the control of Bitcoin are valid; his prediction on price is anybody’s guess. However, Bitcoin is increasingly looking to be a solid bet in
the long term. A number of big players have made considerable investments in cryptocurrencies: venture capital names and hedge fund managers, through to key figures in the tech business.
Snapchat’s Jeremy Liew went as far as postulating a Bitcoin value of $500,000 by 2030. If that sounds optimistic, he is not alone. Facebook’s Chamath Palihapitiya said that “it’s the ultimate insurance policy against autocracy, currency curbs, and other forms of value destruction.” The digital version of gold under the bed, in case all else fails. Cryptocurrencies are popular in countries that have experienced financial disasters, such as hyperinflation, or have lived under oppressive governments. Not quite what its originators had aimed for, but still. Big names invite confidence, and it’s this that keeps Bitcoin and its friends afloat. Bill Gates believes in it, and that’s good enough for most.
Predictions of any authority on the cryptocurency market in the short term are next to impossible. It is young and volatile, and we can expect more spikes and crashes along the way. As markets mature, they tend to coalesce. Many smaller currencies will fade. Can Bitcoin make it? In one form or other, probably. Most likely as an investment unit; it’s just too slow in its current form for everyday money transfers. It may not remain the main player, but it’s attracted enough investments to ensure it can survive pretty heavy weather.
There are some terribly enthusiastic supporters for Bitcoin. They talk of a revolution, of values hitting $250,000 a coin by 2020. A tantalizing possibility. Given its limited supply, it would take much investment capital moving from gold or shares into Bitcoin to send values skyward. It has reached a point for many where a coin or two in a balanced portfolio is well worth considering. Bitcoin cannot be manipulated by governments; you cannot simply create more. Soon it will be readily tradable for goods and services, and be part of the monetary system. Then you may well be glad you have one. There are issues, which Mike Hearn highlighted. It may be free from government control, but it is still under control, and currently by a rather small group. There are interesting times ahead. Yes, Bitcoin could crash and burn, but so can any monetary system.
It’s clear that digital currency is here to stay. To those raised on hard cash and checkbooks, cryptocurrencies look odd. There’s no collateral, nothing underneath. But the genie is out of the bottle, and our kids won’t know a world without them. Meanwhile, there’s one clear winner: Satoshi Nakamoto. He/she/they mined a lot of the early coins, a million or so.