Cryptocurrencies – Bitcoin and The Future

The sudden appreciation in electronic cryptocurrencies has seen investors take an interest.

Cryptocurrencies rely on a ‘peer-to-peer’ network of computers all talking to each other with no single centre to verify transactions and make sure each coin is genuine. So unlike traditional currencies that are controlled by national central banks, cryptocurrencies have no central authority overseeing their integrity.

Spending cryptocurrencies

Cryptocurrencies are a type of money that exists only electronically in a similar way you might use a credit card – there are no notes or coins available – but can be used to buy things online or on the high street.

Getting their name from the heavy-duty cryptography that is used to verify transactions, Bitcoin was the first & is the most established whilst remaining the most popular of what are known as ‘cryptocurrencies’.

The convenience & appeal

Paying in bitcoin means avoiding the chain of transactions – and associated delays and charges – that are part of converting money into different currencies. While it doesn’t have a lot of advantages over other currencies, using bitcoins can be more convenient for some people as a quick, low-cost alternative to international exchange.

The reach of bitcoin is spreading. A growing number of small-scale retailers – often in the tech industry – will accept them and some mainstream companies have started accepting them as well, including PayPal, Dell and Microsoft.

It is believed that the growth of cryptocurrencies will be limited as governments crack down on potential anti-social aspects. This is due to cryptocurrencies offering people a degree of anonymity when making any online transactions. While there may be legitimate and good reasons for this, it has drawn attention as a mechanism of exchange for black markets in drugs and a vehicle for money laundering and tax avoidance.

The blockchain

One key area of innovation is a piece of software that sits behind cryptocurrencies called blockchain.

Each transaction is coded into a ‘block’, recording how much of the bitcoin was exchanged and the bitcoin addresses of the payer and the payee. These blocks are linked together into a chain that stays with the coin as it moves from owner to owner. Quite simply, blockchain is a way of keeping track of every transaction that an individual unit of a cryptocurrency has been part of. This means every virtual coin comes bundled with a chain of information authenticating its history.

The transactions are verified using what is called public-private key cryptography. The parties in a transaction exchange public keys to initiate a transaction, then use their private keys to verify it, at which point the block in the chain is written.

The cryptography is what keeps the blockchain secure. The block can’t be amended without both the public and the private key. And because the blockchain is held across a network of computers, rather than centrally, no single person can change it without everyone knowing.

These elements combine into a powerful combination – an independent virtual unit of exchange where transactions can be securely verified.

Beware – Bitcoin transactions are more expensive than you think

As previously stated Bitcoins are sometimes marketed as a low-cost alternative to traditional payments but they’re not as cheap as you’d think.

A core element of cryptocurrency is the lack of any central authority. Nodes on the network verify transactions which are rewarded with transaction fees and in the case of bitcoins, newly minted bitcoins go with each verified block of transaction. From the verifying nodes’ perspective, these new bitcoins are mined. Hence they are referred to as “miners”.

One of the central issues of cryptocurrencies is trust. How can the rest of the cryptocurrency network trust the verification work done by miners? How to do transactions take place in such a world without anyone getting robbed?

For example, malevolent miners could verify blocks of fraudulent transactions in which bitcoin is taken from victims and sent to their own wallets, or where the same bitcoin is spent several times.

Miners recieve a block reward. The miner whose block is selected to be added to the chain currently receives a fee. At current BTC prices, the block reward clearly and vastly outweighs the fees of normal currency transactions. Mining is a no-brainer for individual miners, but the benefit to society at large is much less obvious.

The Future?

Bitcoin may be the pioneer, that demonstrates that virtual currencies are reliable and secure. As an investment asset, however, it has nothing but sentiment backing it up, and its use in the drug trade and other underworld activities leaves it vulnerable to government sanctions.