Bitcoin and Cryptocurrencies
One of the most interesting things to happen in the past few years in finance has been the introduction of the first cryptocurrency, Bitcoin. The money you have in your wallet or your bank account only has value because a government says it has value. Bitcoins were designed to replace those government issued currencies.
One of the big selling points of Bitcoin is that there is a finite amount of them in the world. More Bitcoins are being mined every few minutes, but when we get to a certain point there will be no more bitcoin. The US government can always print more dollars. There will be no more bitcoin. This means you won’t have inflation.
With Bitcoin, you have an account number. The person you are paying has an account number. You have the number of bitcoins you are paying, and you have the fee you volunteer to pay. The list of the two account numbers and the number of bitcoins is called the blockchain. There are guys out there called miners, who solve a math problem to add a bunch of transactions onto the end of the blockchain. Once the blockchain is updated, a lucky miner is paid with one brand new bitcoin and the transaction fees of the transactions he decided to do.
The higher you decide to make your fee, the more likely it is that they will process your transaction. If you make your fee too low, you could be sitting around for hours or days waiting for your payment to officially process and become part of the blockchain. Your account number is completely anonymous, and the transaction is now public record. This means there are no arguments about what happened.
Anonymous | Good and Bad
The bad thing about being anonymous is that all someone does to steal from you is find your account number. Then they initialize a transaction, it becomes part of the blockchain, and your bitcoins are gone. The other problem is that you are not going to remember your account number. You need to use a digital wallet application to make transactions. But then the digital wallets applications can be hacked. This has happened a few times. Early on with Mt. Gox $350 million worth of bitcoin were stolen, which holds the record for the most amount of money lost to a hack.
One thing that is often confusing is why bitcoins have any value. To me, it is just about as confusing why anything has any value. The only reason anything has value is that you can trade it for other stuff. People are willing to trade bitcoins for dollars, so bitcoins have value. The people that claim gold has intrinsic value say it has been deemed beautiful, used in jewelry, and have been a medium of exchange for centuries. But it is a worthless metal, in that it is not hard. Which is why it is used in jewelry. And we just think it looks beautiful because we have been told for centuries that it is worth money. Plutonium is rarer than gold but we aren’t saying plutonium should be a medium of exchange.
The US dollar may fluctuate in value, but nothing like bitcoin. Bitcoin can go up or down 10% or more in a day. That happens often. This means bitcoins aren’t useful to have sit around like dollars for stuff you have to use in the near future. If you are investing, you don’t have everything in the stock market and then take it out a few seconds before you spend it. You have money you know you will need to use for the next few months or move out of the stock market into cash so you don’t have to worry about paying your bills.
Another drawback of bitcoin is that each block mined can only be 1 MB. That means you can only have about 8 transactions a second. That sounds like a lot, but if millions of people are using bitcoin for commerce and people are trading it often like a stock that 8 transactions a second breaks down quickly. Just a few days ago bitcoin increased the blocksize to 2 MB. But this is just a temporary fix. Eventually you won’t be able to do everything you want to do with bitcoin. This means the transaction fees are forced up, because you want the miners to put your transaction in the blockchain. You are forced to compete with other people for the finite amount of transactions executed.