Unless you’ve been living under a rock, you’ve probably heard of Bitcoin — the crazy cryptocurrency that people have been hyping up for years. Well, the hype may have been overblown at times, but 12 years after its invention, the technology is still around — and being used to transact over a billion dollars every day across the globe.
Bitcoin, and blockchain — the technology on which bitcoin works — is a brilliant innovation to solve a major problem in the world: Centralization.
When you use your debit card to spend $100 on Amazon, your bank updates the balances so you have $100 less, and Amazon has $100 more. And this system works because the Bank is the trusted middleman in this example, ensuring that the balances are accurate.
When it comes to storing and exchanging money, a bank basically just has to keep a ledger up to date to reflect how much money everyone has.
The role of credit card companies like Mastercard and Visa is to process transactions and handle the technical aspects of moving money around. But what if we no longer needed middlemen like the banks, and credit card companies? Would a decentralized financial system be better? That’s what the Bitcoin community believes.
The first problem with centralized financial systems is that they provide a single point of failure: Because all records are stored in your bank’s database that Database acts as a single point of failure.
Hackers can breach bank’s database systems and completely alter the record or steal important financial information — …and they do.
There were around 4000 KNOWN data breaches in the first half of 2019 itself, with over 4 BILLION records exposed.
Thousands of accounts, passwords, and social security numbers are being sold on the dark web everyday. Do you really think your bank’s cybersecurity people are the best in the world, capable of keeping hundreds of thousands of hackers at bay?
Another problem that cryptocurrency solves is inefficiencies with the existing mode of transacting.Credit or debit cards are an inefficient means of payment. Every time you pay a merchant with a card, MasterCard or Visa take around 2% of the transaction. American Express takes around 3%. This fee makes sense in an age where we have no other choice, but with cryptocurrencies, transactions can be made for a fraction of the fees. If there is a cheaper path to get the same job done, not taking it is inefficient. This matters more when amounts are large.
A small store that earns a million dollars revenue in card payments, is paying around 20 to 30 thousand dollars to credit card processors every year. For a company like Walmart, this can be a few billion dollars every year.
Finally, centralized financial systems also make people vulnerable to poor political and macroeconomic decisions by governments and central banks. Like the nonstop money printing that’s going on these days.
Enter Bitcoin. Bitcoin is a decentralized digital currency that allows peer-to-peer transactions using a blockchain ledger.
Lots of words there — let’s unpack that.
A decentralized currency means that there is no central authority controlling it. Fiat currencies like the US dollar are an example of a centralized currency, because the Central Bank can decide to print money whenever they’d like.
Peer-to-peer payments, which means you can send a payment to someone directly without a central intermediating authority there to supervise — similar to exchanging cash. Venmo, Paypal and Banks are all examples of centralized methods of payment.
So how is blockchain technology able to replace the function of traditional financial institutions like banks and credit card processors, using cryptography and code? To put it simply, Blockchain is just a trust mechanism — designed to store an immutable ledger of data without a central supervising authority.
Everyone on the network has a copy of this ledger. When you pay someone using Bitcoin, your transaction is grouped into a block and verified by miners who make sure the transaction actually occurred — in exchange for a small fee. After it’s verified, the block is added to the blockchain, and everyone’s copy of the ledger is updated. Once a block is added onto the blockchain, no one can alter it. It is immutable. How so?
The blockchain ledger uses something known as a consensus mechanism to identify the “truth” — this means that nodes on the network will rely on other nodes to determine the truth.
Hackers cannot just alter records, because they would have to convince the majority of the network — that is, alter everyone’s copy of the ledger AT THE SAME TIME, which is practically impossible in a well-distributed network.
This innovative method of achieving trust in a decentralized system allows for cryptocurrencies like Bitcoin. The applications of Blockchain go a LOT, LOT further than just cryptocurrencies though — decentralized storage, crowdfunding, gambling, voting and all kinds of other ideas are now in works because of Blockchain. Be sure to subscribe for our upcoming video about Blockchain!
Bitcoin supporters believe that Bitcoin is the perfect global reserve currency. Aside from the benefits of decentralization, Bitcoin has a limited supply — there will never be more than 21 million coins in existence. This makes it a deflationary currency unlike every fiat currency out there. Dollars, euros, rupees are all inflationary in nature because they are controlled by central banks that can print money as they need — and they do. But Bitcoin is finite — like gold, which is why some people often refer to it as digital gold.
While Bitcoin hasn’t overthrown the traditional financial systems just yet, it is gaining momentum. Just 12 years after it’s invention, Bitcoin is currently the 8th largest currency by monetary base. Around 1–2 billion dollars are transacted on the network every day, and it doesn’t suffer from problems like high fees, and limits on transactions. People have sent billions of dollars worth of BTC securely in a single transaction, and only paid a few hundred dollars in fees, less than one-ten-thousandth of a percent.
In countries like America, Bitcoin’s dollar price volatility is one of the main reasons people are hesitant to use Bitcoin. It’s hard to accept money today not knowing how much it will be worth tomorrow, and with cryptocurrency, the prices certainly are very volatile.
But in Africa, there is a strong cryptocurrency movement emerging. A lot of countries in Africa have very high inflation rates, accompanied by political and financial instability. Africa is notably underserved in the financial sector — in sub-Saharan Africa, 66% of people don’t have access to a traditional bank account. Cryptocurrency provides liquidity, a store of value, and a way to exchange money locally and internationally.
Bitcoin solves a lot of financial problems but it isn’t perfect. Currently, the network can only handle 3–7 transactions per second, but there is a new network being developed called the Lightning network, which should allow for much faster transactions and more throughput.
Bitcoin also consumes a lot of electricity because the verification process is extremely energy-intensive. In fact, the Bitcoin network consumes more electricity than the entire country of Switzerland.
Furthermore, Bitcoin’s price volatility is still a problem for day-to-day transactions, but as more money flows into the network, it becomes less and less of a problem.
Only time will tell what Bitcoin’s role is to be in the new financial age, but one thing is for certain: Like any major innovation, Blockchain and decentralized trust systems have unlocked massive new opportunities for the first time ever in history, and we’re excited to see how that will play out.
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