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Bitcoin and Blockchain Technology
Introduction
The widespread use of electronic money has become commonplace for a modern man. In 1999, Nobel Prize-winning economist Milton Friedman said, The one thing thats missing, but that will soon be developed, is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B, without A knowing B or B knowing A. Today, Friedmans prediction has become an everyday reality. Cryptocurrencies have become well-established means of payment for goods and services. The most appreciated currency among all virtual ones is bitcoin. Despite the popularity of this digital asset, some other countries are not looking kindly on using this type of money. Furthermore, there are five countries that have banned bitcoin legally because of the speculations that bitcoin is a bubble, or it is not backed by anything. However, such a suspicious attitude at the governmental level is completely false and unjustifiable. Bitcoin is totally safe-and-secure-to-use currency with a positive outlook for further development. To prove that this argument is substantiated and not populist, one needs to analyze various points of bitcoin as a currency and a payment system such as issuance, an organization of processes occurring inside the system, investors interest, and prospects.
Organization of Processes
Bitcoin (BTC) is decentralized virtual currency based on a peer-to-peer system, a public ledger, and cryptography. It means that the system has no controlling element. Any user can take part in its functioning, and it will take place on equal terms for each of them. Bitcoin became a full-fledged means of payment through a conscious arrangement of people rather than some spontaneous processes. Also, BTC has never had a commodity value based on demand since its price has been determined by the exchange rate only. Considering the above-mentioned properties, bitcoin is contrary to several aspects of the theory of the origin of money. However, this fact does not interfere with the BTCs growing popularity and solid entrenching among world currencies.
Bitcoin uses a blockchain data structure, which means no central administration. The systems participants use the processing power of their hardware to carry out the maintenance of the system. This avoids interference from the state. The downside of the absence of any administrative authority is the lack of protection in the case if one of the parties violates the transaction. For example, the buyer paid for the goods but cannot receive it, or the item does not conform to the characteristics given to him by the seller. In this case, the customer has no one to ask for assistance. It should be also noted that all transactions in BTC are irrevocable, thereby playing in favor of the unscrupulous sellers.
In turn, the positive side of decentralization is that the state cannot control the Bitcoins currency rate. Bitcoins are controlled publicly, and, therefore, they have no central point they can be manipulated from. The number of issued coins cannot depend on any government. If one looks at the past, it is possible to find that governments of many countries were unable to control their currencies at some point in history. Governments are the causes of inflation, hyperinflation, and funding wars. They cancel huge debts to other countries and print money to finance the budget deficit. While bitcoin has a limited amount and no president or government can issue it at will.
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Issuance
Any member of the BTS network can issue a bitcoin using the computing power of his or her hardware. Participants cannot generate an infinite number of bitcoins since the issuance is limited by the algorithm, which provides its gradual reduction. Due to the computational complexity, issuance is carried out via the GPU processors. The process of generating bitcoins, the so-called mining, provides miners with remuneration by distributing bitcoins in proportion to the computing power each of them expended.
Whether a controlled supply is the very guarantee of the fact bitcoin is not a bubble? It was the controlled supply that does not let Bitcoins rate falling down to zero after Peoples Banks of China has banned participation in transactions with Bitcoin to all financial institutions.
Figure 1. Bitcoin Volatility Index.
The chart of Bitcoins volatility index clearly shows that BTC/USD volatility is high enough, although it has declined significantly since 2010 (Fig. 1). Despite this, BTC still has a number of advantages over the US dollar. One of them has been already mentioned, namely controlled supply. In turn, the USD issuance is based on the needs of the American economy and has often a controversial affect on the global economy. The so-called Third World countries are at highest risk due to the US dollar issuance. Moreover, the US economy is gradually decreasing, and the dollars gold-backing and oil-backing is declining as well, which in turn leads to deterioration of the economies of most countries of the world due to the so-called dollarization. It results in a gradual abandonment of the dollar in the countries with growing economies, making investors shift their gaze from dollar to the growing popularity of bitcoin.
Investors Interest
BTC arouses more and more interest of investors. This interest stems from the fact that BTC is supported by organizations such as PayPal, Google, Baidu (the Chinese Google analogue), Boost VC, eBay and many others. The attitude of individual economic areas towards bitcoin also affects the flow of investment. For example, Cyprus appreciated the virtual currency due to the banking crisis occurred there. After the Greek banking crisis, the Spain citizens panicked and chose bitcoin instead of fiat money because of due to distrust banks and the situation in Cyprus. Germany became the first country to recognize bitcoin as a legal tender officially. The country regards BTC as a private money, which compete with Euro-currency. The most proactive approach was taken by the United States, who declared bitcoin currency legal. At the same time, the FBI conducted a large investigation on the BTC system as well as its users.
Investors interest in virtual currency increases with the growth of the popularity of bitcoin among individuals, with the number of organizations that support it and the number of states that recognized it. However, this trend will remain until the countries start to collect taxes for carrying out transactions with bitcoin. It is possible that the level of investment will decline after this, but it is not yet known whether the countries are going to control the Bitcoin flow in the near future or not.
Prospects
In the period from 2009 to 2011, Bitcoin was in beta phase. Coins practically had no value, and their issue was available to any owner of a standard PC. The phase of initial adaptation began in 2011. Against this background, the first generation of Bitcoin companies emerged and built the infrastructure of the system, namely wallets, shopping and operational processes, system of exchange. In other words, they built all user interfaces.
The period from 2012 to 2014 was marked with a venture capital phase. Google Ventures and Benchmark started to invest in the development of second-generation Bitcoin companies. Figure 2 shows the change in the value of Bitcoin from 2010 and 2015. Its price peaked at the end of 2013 at the level of 1100 US dollars. Despite the significant drop in the middle of 2015, the bitcoin price continues to rise until today.
Figure 2. Bitcoin price index chart.
Figure 3. Growth dynamics of the number of bitcoins in circulation.
The Wall Street phase seems to have begun in fall 2014. In that time, financial institutions began to recognize the digital currency as an asset: they traded it, invested in it, and built products to work with it. This means that Bitcoin entered a breakthrough phase and wide recognition of the cryptocurrency is soon to come.
Figure 3 shows the dynamics of growth in the number of virtual coins in circulation. As can be seen from the chart, the bitcoins circulation grows constantly. Perhaps, at this rate, BTC could significantly undermine the US dollar. Some views suggest that Bitcoin could significantly disrupt the USD by 2021. Thus, bitcoin is a real threat to the world fiat monetary system controlled by central banks. Bitcoin had a very significant effect on the results of modeling, forecasting and, ultimately, understanding of monetary decision-making process even with at unstable growth rate and an average rate of penetration into the economic reality. In the future, the central banks and governments all over the world will lose a significant part of their control over monetary circulation.
Thus, the next decade could be a big one for bitcoin. Some experts believe that it will become the sixth largest global reserve currency within 15 years. Others argue that bitcoin will gain the dominance over other currencies in the next decade if it becomes an underlying asset for Exchange Traded Funds or any other financial instrument. Finally, a German global banking and financial services company Deutsche Bank believes that blockchain technology will alter the business model of many financial businesses and will become widespread since 2020.
In any case, bitcoin and blockchain can completely undermine and usurp the role of fiat money in the next decade. However, such an outcome will depend on whether citizens will actively use Bitcoin or not. Despite bans and prohibitions by some states, civil society is exactly the one who must decide whether it needs an alternative to fiat money or not.
Conclusion
Bitcoin seems to be the most low-risk currency in the world with crises resistance, no inflations, and transparent system. One can carry out transactions on hundreds of millions of dollars through the system via blockchain. This means that people hold the private key to this machine in their own hands. They do business without intermediaries, with a public bitcoin open book, using individual keys. For example, one can make a bargain for a year on the transit of oil through the pipeline in an honest and trustworthy manner, with a public ledger and the individual keys. This deal does need a dollar: one gets genuine and irreversible payments in bitcoins passed through a pipeline. Bitcoin and blockchain do not require any centralization, SWIFT system, company, contracts, and lawyers. It is all about math.
Year by year, bitcoin makes increasingly confident steps to the top of the world banking hierarchy. Finally, bitcoin offers attractive financial opportunities for people from different layers, strata, and countries. After all, there are no barriers of race, language, and income on the Internet.
