An Insight into Bitcoin
by Richard Zhou
In the past decade, Bitcoin has evolved from being a social and computing engineering experiment to becoming one of the most speculative and volatile currencies in the world. Many of us have heard about Bitcoin on the news or even traded cryptos ourselves, but what exactly is Bitcoin and how has the cryptocurrency (crypto) changed the market and society?
What is Bitcoin?
The rise of cryptos is largely due to the development of blockchain technology. Blockchains are essentially digital ledgers which keep an unalterable history of a digital asset. Think of blockchains like a group working on Google Docs. A Google Doc allows the document to be distributed to all participants. Every participant has access to the document and can simultaneously work on the document. However, every edit a participant makes is recorded in real time and available for everyone to see.
Blockchain technology functions as a decentralised platform for users of Bitcoin to openly buy and sell the currency on the market. Each user has an account which contains a unique address and each transaction is publicly recorded and added to a “block” which is then placed together with previous “blocks”, creating a digital chain of blocks.
How does Bitcoin work?
Unlike traditional currencies such as the US dollar which is backed by and controlled by the Federal Reserve, Bitcoin is not backed by any financial institution or government, which means there is nothing to guarantee its value. Bitcoin is created through a process called “mining”, where new blocks are added to the string of blocks. There are only 21 million coins in existence and mining each coin requires computers to solve complex puzzles to verify transactions. “Miners” who successfully solve one of these puzzles are then rewarded in bitcoins.
Who are the main users of Bitcoin?
The original intended purpose of Bitcoin was to utilise its decentralised platform where users could send and receive payment. While some businesses such as Microsoft are accepting Bitcoin as a payment method, the vast majority of vendors do not accept Bitcoin due to its volatility as a currency.
However, applications of Bitcoin have expanded as it transitions into a commodity that is traded on an open market. Many retail and institutional traders have now utilised Bitcoin to diversify their investment portfolios alongside equities and bonds. Traditionally, gold has been used as a hedge against inflation and geopolitical uncertainty. However, with the rise in digital technology, Bitcoin has become a potential store of value. This was seen throughout the COVID-19 pandemic as the price of Bitcoin rose due to the uncertainty of traditional currencies such as the US dollar. This was in most part due to the quantitative easing measures implemented by central banks around the world and the potential inflationary consequences that would occur as a result.
What are some of the concerns with Bitcoin?
The main ongoing concerns with Bitcoin that are preventing its widespread adoption are its lack of regulation, volatility and environmental impacts. Due to Bitcoin’s anonymity and decentralised system, it is commonly used as a payment method on the black market. Since users of Bitcoin are only identifiable by an address, it allows users to hide their identity and purpose for making a transaction. As a result, tracing transactions becomes difficult which has allowed Bitcoin to become the go to payment method for black market transactions.
Another concern regarding Bitcoin is its volatility. While traditional currencies such as the US dollar are floated on the Foreign Exchange (forex) market and subject to price movements, Bitcoin’s volatility completely overshadows this. Due to its highly speculative nature, Bitcoin prices can rise and fall rapidly due to news that is circulated. For example, as Tesla announced in February 2020 that it bought 1.5 billion in Bitcoin and began accepting it as payment, prices of Bitcoin surged by more than 45% in just 2 weeks. However, with the Chinese government crackdowns on digital crypto in May 2020, Bitcoin has fallen more than 30% in just 2 weeks. This volatility is an ongoing concern that leaves buyers and sellers hesitant to use Bitcoin as a payment method thereby preventing the widespread adoption of Bitcoin.
The final concern over bitcoin is its negative impact on the environment. Bitcoin mining requires huge amounts of electricity to support the processing power of computers that solve the complex equations. According to the Cambridge Bitcoin Electricity Consumption Index, the energy consumption from cryptocurrencies exceeds that of entire nations such as Malaysia. While some of the energy may be generated from renewable energy sources, some of the energy is created through fossil fuels, adding to the earth’s carbon footprint and creating unnecessary greenhouse gases. This was the main reason why Tesla ceased the acceptance of Bitcoin as a payment method.
Bitcoin has the potential to revolutionise the way we make payments and become a store of wealth in the digital era. However, its volatility and negative impact on the environment leaves a gaping question. Can it become the “digital gold” of our generation?