Blockchain, Bitcoin, and Cryptocurrencies the Bare Basics
This article will be discussing the bare basics of the newly emerging world of cryptocurrencies and Blockchain technology. It is aimed at people with little or no previous experience within the cryptocurrency industry. It will touch on the history of Bitcoin, the bare basics of Blockchain technology, cryptocurrencies in general and the history of money.
None of the content within this article should be considered as investment advice. A person should always seek investment advice from a licensed financial advisor acting under the Australian Securities and Investments Commission (ASIC), and it is expected that a person completes their own research before investing in cryptocurrencies which are well known to be highly volatile and do not guarantee a return on investment.
At present, an average person’s knowledge regarding cryptocurrencies is very basic and poor. If a member of the public was stopped and questioned regarding cryptocurrencies such as naming certain coins, the most likely answer received back would be “Bitcoin”. Then with any further follow-up questions such as “what exactly is Bitcoin” and “how useful is it to the average person”? the most likely answer received back is “I don’t know”? the conversation has now stopped. To understand cryptocurrencies it is first important to understand where did Bitcoin come from and what was its original purpose. From the research and findings within this article, it is widely accepted that Bitcoin came about as a direct result of the global financial crisis (GFC) of 2007.
The global financial crisis (GFC):
The GFC originated in America, and there can be many contributing factors to its cause but it was ultimately the result of American banks continuing to lend out too many mortgage loans to home buyers who were deemed to be high risk or sub-prime.
Sub-prime was the term used to describe a person who had no form of deposit used to secure the mortgage loan to buy the house that they wanted. These people typically had low credit ratings and poor financial literacy, meaning that the chances of them being able to service the monthly required repayments on the loan back to the bank was very low. Interest-only loans were regularly approved by banks to new home buyers to entice more sub-prime borrowers to enter into the booming housing market by continuing to borrow money to buy more houses, all in the hope that the housing market would continue to increase in price.
However, within the terms and conditions of these interest-only loans was a time limit for when the contract expired (normally 5 years) whereby the mortgage owner had to now start paying back the principal of the loan (the total amount borrowed to buy the house). The homeowners could not pay back both the interest and principal at the same time and so started to default on their mortgages, this then forced the banks to now start repossessing their houses.
House prices throughout America now started to depreciate as it was easier for people to simply hand the keys of the house back to the banks and to stop paying the monthly repayments. The banks were now stuck with a house (an asset) that was now worth much less than what they had originally lent out and no one wanted to buy these houses back from the banks.
To make matters even worst the banks were also selling off the mortgage debts in the forms of government bonds to other foreign banks around the world classed as “mortgage-backed securities”, effectively moving the debt off to other parts of the world and doing this without the permission of the homeowners (think of a group of people in a circle playing a game of “catch” with a live hand grenade where the pin has been pulled!) these government bonds were being disguised as 'AAA" ratings to make them look more attractive.
Between the periods of 2007 and 2009 during the peak of the crisis major banks throughout America and the world had filed for bankruptcy, they were unable to recoup their lent out funds and the modern banking system was close to failing. Instead of letting the market go through a natural course of correction by allowing these banks to go bankrupt due to their gross incompetence and greed governments around the world opted to bail them out using taxpayer’s money and keeping them still in business.
The history of money:
Historians can trace back the introduction of physical money to the year 6000 BC. Before that time communities were acquiring goods through a bartering system for thousands of years. However, this system had its many drawbacks such as:
- Inefficiency because it relied on two parties needing to exchange two products both at the same time. For example, if watermelons are not currently available to trade with Apples then neither side can go ahead with the trade and an illiquid market exists.
- A lack of a common measure of value. Meaning that no one agreed on what one watermelon was really worth? Was one watermelon worth one apple or a crate of apples?
- Unable to be divisible. It would have been inappropriate to cut the watermelon up into multiple pieces in exchange for small apples.
- Food loses its value over time as it rots, apples and watermelons would have to be traded quickly to prevent this.
The introduction of money solves all of the above drawbacks of the bartering system because everyone within the community at the time accepted the value of money and accepted it as being a method of payment. However, now that all money is known as fiat currency (it's not backed up by gold it's just a piece of paper) it means that central banks have the ability and have been printing more and more fiat currencies to stimulate the global economy.
The centralized Banking system:
Disadvantages of a centralized financial service can be described as:
- Always the requirement for a third party to oversee any transaction of assets between two parties resulting in service fees being paid by the two parties (the middle man gets rich)
- Plagued with regulations that exclude many people from the financial system due to its stringent requirements e.g., you have to be an Australian citizen to hold an Australian bank account.
- Is at risk of fraud or mismanagement of funds from lack of transparency, this is how the GFC started and was allowed to continue.
- A third party holds sensitive information about their customers which can be exposed or sold off without the permission of the customer.
- A custodian third party (a bank) is trusted with safeguarding their customer's financial assets.
- Extended time to process customers transactions due to a third party having to examine all of the necessary paperwork to make sure that the transaction is legitimate and complies with local law.
Satoshi Nakamoto’s white paper:
In 2009 an internet domain was registered under the URL name of bitcoin.org by a person calling themself “Satoshi Nakamoto”, within the webpage was a link to a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. It is within this white paper that the idea of a “peer to peer” transaction method of sending “Electronic cash” from one computer to the other is discussed without the need for any 3rd party financial institution involvement. This was only made possible by utilizing a new technology called “Blockchain”. It must be noted that peer to peer transactions are not new ideas as they were first used back in 2002 by PayPal. However, what is unique is the idea of running the “peer to peer” transactions on a Blockchain platform that is completely independent of any 3rd party. The paper is set out in a standard university layout such as an abstract heading, the body of the review, the discussion, and ending with a conclusion proving that whoever wrote this paper must have already had a postgraduate education and had a good working knowledge of computer science. Whether Satoshi Nakamoto is a man, woman or a group of people acting together this person remains anonymous to this present day. There is speculation that Satoshi Nakamoto is in fact a British national due to the slang British words written within the paper and the perfect grammar and spelling due to very few Japanese people being able to speak perfectly good British English. Throughout the Cryptocurrency industry, Satoshi Nakamoto is credited with creating Blockchain technology whereby a bitcoin is able to travel on the Blockchain to its intended address.
What is a blockchain:
The technical explanation is that a Blockchain is a storage of digital blocks containing data all linked and time-stamped together in a chain (hence the name Blockchain), it is open source in the sense that any person on the network can view the data within the Blockchain. In layman terms, it would be as if 10 friends are playing a game of cards around a table and there is a huge piece of paper placed into the centre of the table. This piece of paper is now called a “Ledger”, and its job is to track every single time a person who is playing the card game places down a bet or wins a bet. The ledger is going to be open source meaning that anyone who is currently playing the card game can see all the information written into the ledger (the winners and losers). So if a player wins the card game and wins X amount of money then that figure X is inputted into the open-source ledger for all to see.
At no point can a player cheat the system by means of changing the numbers around on the paper ledger to make it seem as if they have won more money than they really have. Because everyone playing the game would immediately see that the numbers have been changed around. It’s basically the responsibility of the players within the game to make sure that every transaction is legitimate and that no one tampers with the open-source ledger in the centre of the table, also if one of the players makes a mistake within the game then they have the ability to go back through the ledger’s history and resolve any discrepancies.
Now replace all of the human players and turn them into computers called “nodes” which are all interconnected and located all over the world. Every time a person on the network sends any form of digital transactional data from computer A to computer B it is the responsibility of these nodes to cross-reference the transaction against their own copies of the ledger, they validate the integrity of every single transaction occurring on the network. If there are any discrepancies flagged by just one of these nodes on the network (their ledger is not matching the transactional data from the other ledger) then the transaction fails.
The case for Bitcoin:
- Bitcoin uses an open-source Blockchain as its underlining platform to send Bitcoin’s (Cryptocurrency) to anyone in the world securely. All a person has to have is an internet connection and a digital wallet. (same as you would need an email address to receive emails)
- Because there is no middle entity when sending a bitcoin (peer to peer), the overall cost of sending bitcoin is far cheaper than that of sending fiat currency the traditional way whereby the transaction has to go through a 3rd party to be authorised (a bank).
- Bitcoin is universal the fact that it does not matter if you are from Australia, Europe or South America. Bitcoin holds its value no matter where you are in the world.
- Once you own Bitcoin you truly become the owner of that Bitcoin and have autonomy over your own wealth whereas fiat currencies are controlled by governments and central banks.
- The Bitcoin Blockchain has proven itself to be reliable and has sound security. It is a fact that the Bitcoin Blockchain has never been hacked to this present day.
- The amount of Bitcoin is finite (capped at 21 million) theoretically meaning that Bitcoin should become more valuable in time as it is becoming more of a scarce asset and is immune to inflation, unlike central banks who can print more fiat currencies Bitcoin can not be printed.
Bitcoin can be crowned as the first-ever cryptocurrency to use a Blockchain network. Since its invention in 2009 Blockchain technology has drastically improved and at the time of writing there were 861 other Blockchains operating independently from Bitcoins Blockchain. Bitcoins Blockchain can be used as a proof of concept that the technology works and it is slowly gaining mass adoption throughout the world.
More time is needed to show if Bitcoin has succeeded in its original design of being a truly global “Peer-to-Peer Electronic Cash System”. This could be due to poor global internet infrastructure restricting people to its access or lack of education towards understanding what exactly it is. However, what is very evident is that Bitcoin has morphed into a tool to be used as a hedge against inflation, as central banks continue to print more fiat currencies the laws of economics state that the purchasing power of the currencies will go down over time. This coupled with negative interest rates in European countries makes parking your wealth into Bitcoin a much more of an attractive option. Also with the continued shift towards an ever-increasing digital world, it seems fairly obvious to say that Bitcoin (which is a digital asset) will play a big part in our future lives.