While we’re all used to the idea of digital currencies — spending and receiving money that isn’t physically in front of us — cryptocurrencies, like Bitcoin, remain a mystery. How can we use the money in the future? And can we even trust cryptocurrencies? In this quiz we ask Dr. William John Knottenbelt, director of Imperial College’s Center for Cryptocurrency Research and Engineering, to help us better understand this kind of mysterious currency.
Bitcoin is a form of electronic money. This means that he has no physical form. Instead, e-currency units are exchanged over a computer network that has some unique features: There is no central control point (there are no “banks”).
There is no central transaction storage point (a central database with an overview of all executed transactions).
Instead, it operates on a global network with thousands and thousands of nodes — a machine within a network such as a computer or other device — processing and storing transactions together.
With thousands of nodes, it is difficult to have a common record of all transactions, but a technology called blockchain makes this possible. Blockchain is a shared record of transactions. It prevents anyone from “double-spending” bitcoins and makes it extremely difficult to modify historical transactions. It is very difficult, if not impossible, to stop or interfere with it.
Node: A machine that joins the global network by running bitcoin software.
Blockchain: A database of financial transactions that continuously grows as new transactions or “blocks” are added, forming a continuous and public data chain.
cryptocurrency: Digital and decentralized currency that uses cryptography for security.
cryptography: The science of encrypting and decrypting messages and data in a secure way. For example, through encryption.
2. Where does it come from?
Bitcoin was first published in 2008 as an idea on an electronic mailing list for computer scientists studying secure communications (or cryptographers).
The author uses the mysterious pseudonym Satoshi Nakamoto, but so far no individual (or group of people) has been definitively identified as Satoshi.
3. Is it still used and where can it be used?
Bitcoin is still in use and very actively traded on cryptocurrency exchanges, which allow users to exchange “regular” money, such as pounds, for bitcoin.
To use bitcoins, the first step is to create a wallet (which can be online, a mobile application or, for added security, a hardware device). This protects the secrets used to enable the movement of bitcoins under your control.
Your wallet manages several “addresses” which, like bank account numbers, can be used to receive bitcoins. It also verifies the secret password needed to authorize sending bitcoins (technically known as the private key). If you lose your private key or it gets stolen, you essentially lose control of your bitcoins, just like someone discovers your PIN.
4. Why would anyone want bitcoins instead of “normal” money?
The “regular” silver we use today is actually quite unusual in the history of silver, in that it itself is no longer valuable (like gold coins).
If you read the promise on a 10 pound note, it reads (in very small letters):
“I promise to pay the bearer ten pounds upon request.”
(Next time you find a ten pound note in an old pair of jeans, check it out).
That’s not too much of a promise when you consider that the guarantee authority (like the Bank of England) just needs to print another piece of paper to keep that promise.
As money is created, it erodes the value of existing money in circulation. People don’t necessarily notice this erosion because the face amount of their money stays the same; however, they find that their weekly groceries, restaurant meals and movies are costing more and more money.
Bitcoin is different.
The supply of bitcoins is carefully controlled and limited, and no one can create or spend more bitcoins at will. There will never be more than 21 million bitcoins, and each bitcoin is itself divisible into 100 million units called satoshis. This helps prevent the kind of value erosion that affects the “normal” currency (a phenomenon that people in Zimbabwe and Venezuela are all too familiar with).
5. Can Bitcoin Make You a Millionaire?
Bitcoin is a speculative and volatile asset with a high risk. Like many high-risk investments, it goes through boom and bust cycles, and depending on when you buy it (or acquire it), it can either make you a millionaire or ruin you.
In the early days, bitcoin traded at $1 per bitcoin; it peaked at about $20,000 in 2017 before declining to about $3,000 and then stabilizing at around $8,000.
Like a stock or a house, bitcoins are worth no more or less than what other people are willing to pay for them.
6. What is bitcoin mining?
Bitcoin mining is the process of adding new groups of transactions (called blocks) to the shared transaction record (called the blockchain).
A major global competition – called the mining race – is constantly taking place to win the right to add a new block to the blockchain.
To enter this competition, users have to purchase specialized mining hardware that consumes a lot of electricity; the hardware itself is likely to become obsolete quickly due to the constant invention of more efficient hardware – so it’s not a profitable venture for most people.
People who engage in this activity are called bitcoin miners. They participate in this competition for two types of rewards:
- the block reward (currently 12.5 BTC) issued to the issuer of each block
- transaction fees – fractions of bitcoins that incentivize miners to include transactions in published blocks.
To make matters worse (from the miner’s perspective), the “difficulty” of competition increases as the number of miners involved increases, in order to avoid issuing new bitcoins too quickly. The block reward is also halved every four years, making them much more expensive to produce.
7. Can cryptocurrencies be trusted?
As in any rapidly developing space where new technologies spread, there are high quality cryptocurrencies and low quality cryptocurrencies.
Faced with often shrewd marketing operations, many ordinary people find it difficult to distinguish between cryptocurrencies that have real potential and show real points of technical novelty, from cryptocurrencies that are mere clones of other currencies or, worse, real scams.
Sometimes schemes like One Coin pretended to be cryptocurrencies only to turn out to be nothing more than well-organized pyramid schemes, backed by a centralized database.
8. Could cryptocurrencies become more popular than physical currencies in the future?
It is theoretically possible, but it will probably take many years and many technical, economic, regulatory and legal problems before it becomes a reality.
For example, the Bitcoin blockchain can currently support far fewer transactions than traditional centralized payment networks such as Visa or Mastercard.
One category of cryptocurrencies that is proving to be very popular and perhaps will become more popular than physical currencies is “stable currencies”, i.e. cryptocurrencies whose value is linked to “normal” currencies such as the US dollar, euro and pound, so unlike bitcoin cannot be worth £26,000 a year later and £6,000 two years later.