Technology

Bitcoin And Blockchain Technology: How Do They Work?

The initial value of a bitcoin, set in the year 2010 was less than 1 cent, seven years later, it has crossed $19,000. Despite coming to public recognition only in 2013, the original cryptocurrency bitcoin was created by an anonymous cryptographer (or multiple cryptographers) in 2008, known only by a pseudonym – Satoshi Nakamoto.

Bitcoin Ban
TheDigitalArtist / Pixabay

Despite the keenness around Bitcoin initially dwindling down due to governments worldwide refusing to acknowledge the cryptocurrency, steps have been taken for wider acceptance of the bitcoin. In the latest of news, future trading in bitcoin has now commenced on two of the largest US exchanges – the Chicago Mercantile Exchange (CME) and Chicago Boards Option Exchange (CBOE).

As many warnings say – perhaps the recent price surge is a bubble. Or not, maybe it is a belated recognition by the financial community that cryptocurrencies like the bitcoin are going mainstream. Regardless of what happens in the future, it is high time to nail down what exactly is bitcoin and what is blockchain technology.

What is Bitcoin?

By definition, Bitcoin is a digital currency which permits the user to perform peer-to-peer transactions without the assistance of third party like for e.g. banks and governments. At its core, bitcoin is a set of protocols for generating digital tokens.

They are for tracking online transactions in a way that makes it difficult to re-use the tokens or counterfeit. Its value is solely dependent to the extent that its user agrees to.

At the heart of bitcoin is blockchain – a technology that is publicly available – but largely anonymous online ledger that records bitcoin transactions.

What is Blockchain Technology?

Blockchain technology is an online ledger that simplifies the way we carry out transactions. Similar to the way Wikipedia operates, it allows its users to manipulate the ledger in a secure way without interference of a third party. Unlike a bank’s ledger which has a centralized network, blockchain protects the user’s identity and is anonymous. Therefore, making it a more secure way to carry out a transaction.

Co-founder and Ex. Director of Blockchain Research Inc, Don Tapscott explains in his article

“The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”

How does Blockchain Technology Work?

Picture, you making an online transfer using a bank’s services. The bank ascertains that you have funds and then depletes that amount from one place in a large database. Then it credits the same amount in another. You can see the proof of this transaction when you log into your account, however, the bank has the authority over that transaction. You are trusting the bank to remove the accurate sum of funds and the bank is responsible for making sure you don’t re-use those expended funds again. The blockchain is a database that carries out those tracking functions. But, without the bank or any central authority.

American entrepreneur, investor and co-founder of Netscape, Marc Andreessen explains –

“…Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.”

How does Bitcoin Blockchain gain its value?

Much of its value is based on the large network that blockchain provides. This large network is where multiple validators reach a consensus that they witnessed the same thing (transaction) at the same time. In simpler terms, the size of the network is important to make the network secure. One of the biggest plus points of blockchain is its large size and the computing power it amasses.

Who carries out the function of banks?

As mentioned above it is done by an agreement on a decentralized network. Bitcoin transactions can be done via sites that provide electronic “wallets” that upload the data to the network. New transactions are bundled and created into a batch to be broadcast to all the nodes of the network. However, how do you attract enough computing power to service the network to make it secure? This is where mining comes to play.

What is mining and who gets to be a ‘miner’?

The blockchain mining is based off on a unique approach to an economic theory, i.e. the tragedy of commons. In reference to the blockchain, by offering a computer processing power to service a network, the user gains an award for one of the computers. Therefore, the user’s personal interest is used to assist in servicing the public.

As to who can be miners? The answer is anybody – as long as you – a) have crazy fast computers b) desire to solve puzzles and c) a lot of electricity. The transaction data is encrypted that can be unlocked via trial and error guess game. These miners put their large-scale computing power to work and compete to solve the puzzle first. If the miner’s answer is verified by others, the bundled-up data is added to a chain of blocks (of data) and the miner is rewarded with shiny new bitcoins.

How does blockchain prevent counterfeit?

As blockchain comprises of data containing blocks linking to the earlier blocks, an attempt to spending the same bitcoin twice would be mean changing the entire link in the chain. Furthermore, as miners are competing with each other, each one checks the others work thoroughly at every stage.

Ian Khan, a Technology futurist and author comments –

“As revolutionary as it sounds, Blockchain truly is a mechanism to bring everyone to the highest degree of accountability. No more missed transactions, human or machine errors, or even an exchange that was not done with the consent of the parties involved. Above anything else, the most critical area where Blockchain helps is to guarantee the validity of a transaction by recording it not only on a main register but a connected distributed system of registers, all of which are connected through a secure validation mechanism.”

What is the Blockchain Appeal?

While blockchain enthusiasts see it as a new way of doing all sorts of business, costs could be decreased with blockchain, as it cuts the middle man who keeps track of the transactions (and charges for it). Retailers are using the technology to ensure food safety, meanwhile, banks/ stock exchanges are investing heavily in blockchain development.

What is the current situation regarding Bitcoin?

While the bitcoin got a huge boost when CBOE started futures trading tied to the digital currency, the recent introduction of bitcoin by CME futures Exchange witnessed lower culmination after opening higher. It settled at 5.25%, a stark contrast to the 19% surge in CBEO bitcoin futures on their first day of trading. The European stock markets closed at the highest level in six weeks, following Wall Street’s lead.

Even so, the global average bitcoin prices continue to surge supported significant premiums on Asian exchanges.

What Causes Bitcoin price Surge and Dwindling?

The price surge may be due to the news of largest exchanges offering bitcoin futures contracts. Plus, risk takers can bet on whether the bitcoin prices will rise or fall. Because futures contracts are derivatives, they permit investors to bet on bitcoin without actually owning it. This can be seen as a reason for expanding bitcoin’s appeal to investors. Plus, as bitcoin’s software assures only finite supply, this creates a situation of FOMO (fear of missing out) for investors.

Ronnie Moas, the founder of Standpoint research opines –

“The end-game on bitcoin is that it will hit $300,000 to $400,000 in my opinion, and it will be the most valuable currency in the world…I don’t know how much gold there is in the ground, but I know how much bitcoin there is, and in two years there will be 300 million people in the world trying to get their hands on a few million bitcoin.”

Commenting on the subject of bitcoin’s futures market, he continued-

“(I’m)’really not too concerned’ about the nascent bitcoin futures…they serve as a “celebrity endorsement” of bitcoin but will not have a significant impact on the asset’s price over the long-term”.

On the other hand, however, the ability to trade on bitcoin without owning it could also lead to decrease in demand for cryptocurrency resulting in prices to eventually dwindle down – even if the psychological interest in Bitcoin continues to grow.

Analysts at ING explain how bitcoin owners hoping to sell it at an even higher price may be disappointed, they write –

We are enthusiastic about blockchain technology, and the current attention for Bitcoin could boost blockchain and digital currencies’ development. But as we have argued above, we doubt whether Bitcoin itself has what it takes to become a serious mainstream payment systems contender. Instead, we think it is more likely for Bitcoin to return to its roots as a niche payment system. A niche asset adopted worldwide could still have a substantial user base and hence value. It is therefore impossible to say whether the current Bitcoin market price is “too high” for a niche asset.

 Then again, we join the crowd of analysts observing typical bubble characteristics: the idea of an asset that is new, revolutionary, almost magic – hard to understand, but let’s invest anyway because it will become huge. This idea is a form of “this time it’s different”-thinking. “Yes we know about all those previous bubbles that popped, but Bitcoin is really, really different.” We are not so sure”.

While many prominent people like JPMorgan Chase & Co. Jamie Dimon and ex- hedge Fund manager Mike Novogratz have called cryptocurrencies like bitcoin a “bubble”, both have invested in them. Regardless, if you are thinking about buying/investing in bitcoin, be warned, even those who believe in bitcoin predict a wild ride ahead.

Article by Mike Collins, Intelegain

Like Us On Facebook - For Business And General News: ValueWalk - For Tech And Science News: ValueWalk Tech - For Tech Insights, Technical Questions and Queries: Follow Our COO, Sheeraz Raza.