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Understanding Bitcoin: fraud, or the future of money?

Is the digital currency a liberating innovation that helps consumers free themselves from punishing government regulations globally? Or, flipping the Bitcoin, is the online currency a grand delusion — even a move that benefits the world of crime?

Written by Praveen Swami |
Updated: November 27, 2017 9:31:40 am
In 2009, the first block of that currency, known as Bitcoin, went online, with a message that explained why it exists: “The Times 03/January/2009 Chancellor on brink of second bailout for banks”.

Satoshi Nakamoto, as the man — or women, or men — who began it all called himself, was born in Japan on April 5, 1975. He might in fact be a Nick Szabo, Dorian Nakamoto, Hal Finney, Shinichi Mochizuki or Craig Wright, all computer scientists and mathematicians of eminence. Though many have investigated Satoshi Nakamoto’s identity, no one has settled the debate. Today, Nakamoto owns some $ 7.5 billion worth of the currency he invented, none of which has ever been spent.

In 2009, the first block of that currency, known as Bitcoin, went online, with a message that explained why it exists: “The Times 03/January/2009 Chancellor on brink of second bailout for banks”.

Today, with this strange digital currency at an all-time high, opinion is divided on whether its value is a sign of a growing rebellion against a monetary system controlled by corrupt, predatory governments, or, alternately, whether it is providing a haven for criminals. There are also those who believe that Bitcoin and other digital currencies that have since emerged are simply a giant, collective delusion. It’s clear, though, that Satoshi Nakamoto — whoever she or he might be — transformed our world.

Bitcoin’s emergence was organically linked to the implosion of the global financial system in 2007-08, which led some to lose faith in government-controlled currencies. Ideologically, Bitcoin appealed to a spectrum of libertarians and anarchists, who saw in it a kind of new gold — a commodity whose value would be determined purely by demand and supply, not by the actions of central banks.

Like all cryptocurrencies, Bitcoin functions in the same way as cash or gold, but it can also serve as a certificate or bond, a clearing house, a settlement layer. To its proponents, the principles underlying Bitcoin make it a democratic alternative to the commercial banking network, and even central banks.

In essence, Bitcoin uses cryptography to securely conduct a transaction between a sender and a recipient. The cryptographic technology means you don’t have to trust others on the network, as you might a bank or a clearing house.

To get a sense of the technology, imagine having banknotes protected by combination locks with over 100 digits — locks which, moreover, can’t be removed without destroying the note itself.

In addition, each confirmed transaction is recorded on a public ledger, called a blockchain. The blockchain is shared between all users of the Bitcoin network, and updated in real time. The underlying mathematics makes it impossible to make duplicate copies of Bitcoin, or use it for more than one transaction at a time. Each time a new block or set of transactions is consolidated into a block, it verifies all those before it. In general, six verifications mean a transaction is 99.99% likely to be genuine.

Like gold, Bitcoin is “mined”, though by giant, power-hungry computers, which are today thought to be collectively using more power than many European countries.

In essence, Bitcoin miners solve the complex mathematical problems needed to verify transactions and thus build the blockchain.

In return, they are issued a certain number of Bitcoin.

Eventually, when 21 million Bitcoin are in use — a target which experts estimate will be reached around 2040 — no more will be created. Then, the verification of blocks will be rewarded by fees paid by users on the network.

READ | Year after note ban, black money reborn as cyber-cash

To use Bitcoin, users have to first get a digital wallet, which can be used on computers or mobile devices. Every wallet can contain one or more unique addresses, which are like account numbers. An address — a string of characters like 17qK9JftEQoTzEeHxVwnRJLHZhG9k6ezaA — lets a user receive or buy Bitcoin. It is the only information you need to give out. In addition, every user has a private address, never shared with anyone else, which lets users send Bitcoin.

It is possible to send and receive any amount of money almost instantly anywhere in the world at any time — no borders, no limits imposed by governments, no holidays. Though technologies do exist to help law enforcement organisations link individuals to Bitcoin transactions, it is relatively simple to ensure the defeat of such efforts.

For many users, Bitcoin’s attraction is that it frees their money from the actions of government. In countries where inflation is high as a consequence of government policies, for example, Bitcoin allows individuals to insulate themselves. Argentinians, for instance, invested in Bitcoin to avoid rampant inflation, as did Cypriots during the country’s 2011 financial crisis.

For the same reason though, it is a useful tool for money laundering and tax evasion. Bitcoin, after all, records transactions only between digital addresses, not explicitly identified individuals. Since 2011, law enforcement agencies across the world have been increasingly concerned over the use of Bitcoin, and other cryptocurrencies, for crime.

That year, the Federal Bureau of Investigation (FBI) shut down the notorious dark web marketplace Silk Road, where encryption and cryptocurrency allowed narcotics, stolen credit cards and hacked passwords to be sold anonymously. Ross Ulbricht, Silk Road’s founder, is now serving a prison sentence — but other digital marketplaces like it continue to pop up. The misuse of cryptocurrencies by criminals means some major financial institutions will not touch it. But others see it as the future of money, and some countries like Russia are working to create officially-backed versions.

Even as the price of Bitcoin and other cryptocurrencies rise ever-higher, opinion remains divided on Bitcoin’s underlying fundamentals. For Jamie Dimon, the head of financial giant JPMorgan Chase & Co., Bitcoin is simply “a fraud”. Eric Posner, professor of law at the University of Chicago, has described it, alternately, as relying on “collective delusion”.

The numbers, however, show these prognoses aren’t cutting much ice with investors, increasingly fearful of a global financial system that seems irrevocably broken.

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