Bitcoin

When Santoshi Nakamoto, an anonymous author wrote a paper entitled: Bitcoin: A Peer-to-Peer Electronic Cash System in 2008, Bitcoin was born. The paper discussed the conceptual and technical details of a payment system that would allow people to send and receive payments without involving any intermediary financial institutions.

What is Bitcoin and How it works?

Bitcoin is a peer to peer currency. Peer-to-peer means that no central authority issues new money or track transactions. These are managed by networks. Bitcoin the most famous amongst all the cryptocurrencies floating around the internet. Other cryptocurrencies are Litecoin, Ethereum, Zcash, Dash, Ripple, Monero etc. Bitcoin uses blockchain technology that would allow payments to be sent from one party to another without the need of any financial intermediary. Blockchain also known as distributed-ledger-technology, is a public ledger which maintains all cryptocurrency transactions. It is digitized and decentralized. The nodes of the ledgers are the anonymous users of cryptocurrency. The blockchain is continuously growing with completed blocks which includes the most recent transactions. Each transaction is being verified by again anonymous users. The users are called the ‘miners’. They do mining of solving complex math problems to confirm the transaction and add it to the general ledger. Miner gets a reward with some amount of cryptocurrency when a new block is confirmed. This reward keeps the miners participating in the block chain to keep the transaction rolling. Each transaction is time stamped and linked or hashed to the chain of blocks in a chronological order. Each block is connected to the next using hashes. Each hash is unique to the block. So, if the block is changed after being added, the hash would also change.  The connection works as a digital wax seal which creates a permanent record of each transaction that cannot be altered or erased. That means no need of intermediary or central record keeping to verify and keep track of the transactions such as bank.

In nutshell, Bitcoin uses public-key cryptography, peer-to-peer networking and proof-of-work to process and verify payment. Bitcoins are sent from one address to another with each user having many addresses. Each payment transaction is broadcast to the network and included in the blockchain so that included bitcoins cannot be used twice. Each transaction is locked in time by the massive amount of processing power that continues to extend blockchain. It is believed that Bitcoin provides fast and very reliable payment network.

What next?

 It is all rage again. This week, it races past $15000 mark for the first time. The price of the bitcoin rose about $5000 during the last week expanding its advances this month to 50 percent. CBOE Global Markets Inc. has said that it will start trading bitcoin futures on December 10 while CME Group Inc.’s contracts are set to debut on December 18. Nasdaq Inc. is planning to offer futures in 2018. Cantor Fitzgerald LP’s Cantor Exchange is creating a bitcoin derivative and startup LedgerX already offers options. ASX Ltd., the main exchange operator for equities and derivatives in Australia will soon start using blockchain, the technology that underlies bitcoin, to process equity transactions. Portfolio advisers are encouraging cryptocurrency diversification. The danger is that the investors consider the soaring price itself the signal to buy, creating price bubble. In theory, the bubble occurs when the price of the asset detached from its fundamental values. In equities, there are various models to find the intrinsic values. Some of them are Dividend discount model, Growth models, Capital Asset Pricing Model etc. Investor buy equity stocks when they see the price rising, without any change in discount rate, risk tolerance or in the projected dividend stream. They are the drivers of equity value. But it makes sense to ask which fundamental services Bitcoin provides. There is no prospect of Bitcoin paying dividend as there are no earnings. The chief benefit of Bitcoin is the transaction privacy and efficiency but it might have a limited value since government across the countries are skeptical about the currency and trying to create laws to discourage the promotion and its transaction. When the use of Bitcoin to evade laws and regulations reaches a sufficient scale, that will necessitates regulatory measures that reduces the usage, long-term appeal and the value of Bitcoin.

Despite all these, sunny side of it is that the blockchain technology would result in massive cost savings. Goldman Sachs recently publishes report suggesting the technology could potentially save stock markets about USD 6 billion a year. It also offers companies to simplify their processes. It appears that central banks in some countries are exploring implementation of blockchains to create their own digital currencies.

The advent of blockchain technology and skyrocketing prices of Bitcoin are heralding future of cryptocurrencies or are they just an another Tulip Mania leading to formation of bubble getting ready to burst, that remains to be seen.