BitcoinNovember 29, 2017
What is bitcoin?
Bitcoin is a decentralized digital currency that enables instant payments to anyone, anywhere in the world. Bitcoin uses peer-to-peer technology to operate with no central authority: transaction management and money issuance are carried out collectively by the network (Bitcoin wiki).
The Bitcoin network holds a record of all transactions as a “chain of blocks”, called the blockchain. The blockchain is basically a chain of multiple “blocks”.
It is all of these following characteristics:
- it is a technology because anyone can build services on top of it,
- it is money, because it can be a medium of exchange on a payment platform and store of value,
- it is a commodity because its supply is finite,
- it is a database because it records the transactions fully searchable on a public ledger,
- it is a protocol as it carries rules on how miners and nodes should determine the validity of each transaction made on the network,
- finally, it is stock because its value is directly related to its utility across these five factors mentioned above.
Is bitcoin secure?
Yes… as long as you use it correctly.
Bitcoin’s main security is based on its decentralized infrastructure governed by the agreement, or consensus, of machines (nodes) distributed around the world.
Decisions about whether a digital event had occurred are made by consensus. The nodes in the network validate each transaction by reaching a consensus that it was not double-spent. Then the miners integrate it into the next available block. They do so by competing with each other to have their block written to the chain to represent the true state of the blockchain (proof-of-work algorithm). So, it is difficult for an outsider to tamper successfully with the blockchain record.
One-way hashing ensures that data, once hashed, cannot be converted back into the original data. The hashed data is an encrypted digital representation of the original data.
The use of digital signatures and private keys in a transaction ensure that your bitcoins are transferred in a digital environment governed by public key cryptography. Therefore, you can be sure that the bitcoins you have received have come only from the address with which you have transacted.
Is bitcoin encrypted?
This question is too broad. Before answering it, we should explain that there are two iterations of bitcoin. There is ‘Bitcoin’ the network and ‘bitcoin’ the cryptocurrency.
The communication and transaction data in ‘bitcoin’ currency transactions are not encrypted. The Bitcoin protocol does not use its own encryption standard. Instead, the protocol implements the SHA-256 cryptography standard for its proof-of-work algorithm and verifying of transactions.
Is bitcoin anonymous?
The Bitcoin network is not anonymous as the transactions are displayed on a public ledger for all to see. However, it is pseudonymous as the users’ identities are hidden behind their bitcoin addresses.
Though having said this, the absence of encryption at the transaction level makes it easier for your ISP or an agency such as the NSA to derive your personal identity by tracing your bitcoin address to your IP address.
Using a cold wallet such as one that lets you validate your transactions or store your private keys locally will increase your anonymity. However, should you use a hot wallet (web-based or one that uses SPV nodes), the clients will broadcast your bitcoin addresses.
Is bitcoin still used mainly on the dark web?
It is a widely-held belief that most of the activities on Bitcoin are on the dark web and are of a criminal nature. This is not the case and there are three reasons for it:
- The criminal fraternity has found that the transparent nature of the Bitcoin blockchain creates too many breadcrumbs that can lead security agencies to the machines that those criminal networks use;
- Leading on from the first reason, there are altcoins in the cryptocurrency space that do a better job with anonymity than bitcoin. Monero and DASH are two such coins that have a more established presence on the dark web than Bitcoin;
- Bitcoin is entering the mainstream world. Shone Anstey, from Blockchain Intelligence Group, reported to CNBC that the proportion of illegal Bitcoin transactions is falling to below 20%.
What are the advantages of bitcoin being decentralized?
A decentralized network does not rely on a third-party service to carry out the network’s functions. Instead, transactions occur directly between users (peer-to-peer) through an automated process. The advantages are manifold:
- Trustlessness – you are not required to trust the security or honesty of the network since the funds are held by you in your personal wallet and not by a third party.
- Privacy – users are not required to disclose their personal details to anyone.
- Downtimes are extremely unlikely because multiple networks run the chain.
- A decentralized network is well-suited to transactions that require multiple signatures, such as an escrow payment.
What if the internet goes down? Will I lose my bitcoins?
If the internet goes down, it will surely be due to circumstances that will be of much greater concern to you than your bitcoin wallet. However, the decentralized nature of Bitcoin is that downtime in one region will not affect the network as a whole.
When you acquire bitcoins, it is essential that you store them in a digital wallet… more specifically, a wallet where you control your private keys and can recover them if need be. You control the movement of your bitcoins by using your private keys that come with the wallet. Should there be an internet outage in your area, you will still have your wallet and your keys.
What is the basis of bitcoin’s value?
This has been a topic of much debate. Users and investors have expressed various bases for bitcoin’s value. A large section of them see bitcoin as a world-changing technology, some regard it as a better store of value than gold or silver while others have pointed to market sentiment about the price being on a long bull run, use as a payment processor or simply have heard of it by word of mouth. See the Lendedu survey on bitcoin investing, here.
Assessing bitcoin’s value in terms of market price, the value can be influenced by a combination of internal and external factors:
- Changes to the Bitcoin Core rules by means of forks. These rules may affect the fee structure, the difficulty level of mining, the speed at which the network processes transactions, or likely changes to the block size;
- Uncertainty surrounding contentious forks. Contentious forks occur when the blockchain bifurcates due to disagreement among miners and users about a change to the Bitcoin rules;
- A security failure at one of the larger exchanges;
- Changes to the purchasing power of fiat currencies;
- Decisions or announcements made by regulatory authorities in countries with significant Bitcoin activity e.g. USA and China;
- New money coming into the Bitcoin network.
This last point goes some way to answering the next question.
Why is the bitcoin price rising so fast?
The bitcoin price has exploded during much of 2017. Much of the increase, however, is due to falling confidence in East Asia about the strength of the fiat currencies. A related factor has been devaluations in BRICS countries’ currencies with the Indian rupee, Russian rouble as well as the Chinese yuan all experiencing devaluations. Investors in these countries, China particularly, have come to see bitcoin as a safe haven asset that can protect their equity.
Recently, Japan and South Korea have experienced surges in demand for bitcoin.
With the spot prices of traditional safe haven assets such as gold and silver manipulated to unrealistically low levels and with the East’s growing assertiveness in exploring value outside of the US dollar architecture, the way has become clear for bitcoin to be seen as a new asset that offers equity and integrity.
What are all these forks I keep hearing about?
The forks are the means by which the Bitcoin network carries out its upgrades. The upgrades come in the form of new rules for the network to follow. Forks can appear in two different ways: benign or contentious AND hard or soft.
They can be hard or soft:
- Soft fork – where new rules are added to the existing rules and still remain backwards-compatible e.g. Bitcoin Core’s introduction of segregated witness (SegWit) to its chain,
- Hard fork – where the new rules conflict with those existing and so become backwards-incompatible. Should the hard fork proceed, those miners and wallets and nodes that had signalled for the hard fork would reject those blocks that bore the rules of the legacy chain e.g. Bitcoin Cash rejects Core’s blocks, Bitcoin Gold rejects ASIC-mined blocks, SegWit2X would have rejected 1Mb SegWit blocks.
Forks can be benign, in that the entire network shifts to the new rules e.g. in 2010, Bitcoin set the block size limit to 1Mb. The examples of hard forks, given above, were contentious in nature.
Currently, Bitcoin’s most critical issue is the growth in the quantity of transactions to such a degree that they exceed the capacity of the network to confirm those transactions. This is known as the ‘scaling issue’. During 2017, Bitcoin had been dealing with this problem by implementing forks so that the network could resolve the scaling issue in a manner that would be transparent.
In Bitcoin’s attempt to resolve the issue, it has split into two solutions that are in opposition:
- increasing the block size – various forks such as Bitcoin Classic, Bitcoin Unlimited and Bitcoin Cash have advocated for the block size to be increased beyond the 1Mb threshold. Bitcoin Classic advocated for a 2Mb limit, Unlimited advocated for 16Mb while Cash allows block sizes of up to 8Mb;
- reconfiguring the transaction data – Core has seen no need to increase the block size from its current 1Mb limit. It believes that using SegWit will facilitate further innovations that will reduce the bottleneck of transactions awaiting confirmation that do not require block size increases.
This year (2017), Bitcoin has undergone three major forks in an effort to resolve the impasse between the side of Bitcoin that favours SegWit and the side that favours larger block sizes:
- Bitcoin Core (August 1) – user-activated soft fork (UASF) that activated SegWit. Further details, here.
- Bitcoin Cash (August 1) – a hard fork from Bitcoin Core that preferred larger block sizes. Further details at the time of the fork can be found here.
- Bitcoin Gold (early November) – a hard fork from Bitcoin Core + SegWit that wished to re-enable GPU and CPU mining. (GPU mining had been feasible on Bitcoin until the advent of large, specialized, mining technology that increased the hash power requirement beyond a level that GPU miners could handle.) Please read Steve Thompson’s analysis for Blockchain Intelligence Group, here.
November 16 was supposed to witness a fourth major fork, from Bitcoin Core + SegWit, in the form of SegWit2X. SegWit2X proposed an expansion to the SegWit-enabled block size to 2Mb. This fork has been suspended due to a lack of consensus in the network. Blockchain Intelligence Group analyzed SegWit2X in this article.
Is the mining of bitcoin really as energy-intensive as some studies have claimed?
There have been a few studies out recently, such as this one by Digiconomist, that states that the energy requirements of Bitcoin are 24 Twh/yr (TerraWatts per year), mirroring Morocco’s annual electricity demand. We expect to see similar analysis based on this research in the near future.
We, at Blockchain Intelligence Group, do not run similar studies but we do invite our readers to pay close attention to the benchmarks that these studies may or may not use. Some will be accurate but our readers should be aware of the following biases and inaccuracies:
- they use the term “mining bitcoin”. As it is blocks that are mined for a reward of 12.5 bitcoin, it raises the question about whether the studies really are measuring the cost of mining one bitcoin OR whether they are in fact measuring the cost of mining a block but then erroneously labelling the sum as a bitcoin cost,
- studies that base their analyses on inaccurate data about mining costs will go on to make incorrect calculations about the energy required to execute a bitcoin transaction,
- they may also choose data from a specific time period where the hashing power had peaked. This is particularly important now as the hash rate has become more volatile since Bitcoin Core’s August 1 effort to resolve the scaling issue had triggered a set of hard forks from the Core network.
The Digiconomist’s analysis has attracted the most attention from the mainstream media. However, other studies have come to more modest conclusions about Bitcoin’s energy consumption, such as this analysis from the SRSRocco Report, November 1 2017. This report arrives at 11 TWh/yr. The report has used the term “mining bitcoin” when it compared the cost, in barrels of oil, of bitcoin and gold. However, the term has referred to bitcoins rewarded and has not attributed “bitcoin mining” to block mining.
The benchmarks and calculations that such studies employ are going to need to take into consideration the finite supply of bitcoin and its deflationary design. (SRSRocco does this better than the Digiconomist.) They also need to be set out clearly and to use valid figures so that the analysts who, for instance, make comparisons between the energy consumption of a bitcoin transaction and that of a house, such as in this article, can reach reliable conclusions. This way, those that are new to bitcoin and crypto-economics are not misled by sensationalist polemic.
Is all that energy consumption wasteful?
If you regard the energy consumption of mining on the Bitcoin network in isolation from the purpose of that consumption, then, yes, it does appear wasteful. However, the energy consumption is demonstrating the transparency and efficiency of the network. The Bitcoin blockchain undergoes a process of continuous auditing and validation of transactions and blocks, all published on the clear web. Please see these charts on Blockchain.info, here.
Similar auditing and verification occurs in the running of banking and financial systems. Banks, payment processors, clearing houses, notaries, accountants and central banks all expend energy but we have no idea of the actual energy cost of their work. Furthermore, it is not straight-forward to determine a reliable yardstick for measuring the full financial cost of running a centralized global economy and the information is usually kept private.
In blockchain, the audit is carried out not by centralized institutions, in private, but by decentralized miners and full nodes, in public. Bitcoin expresses the energy consumption of its network in terms of performance, measured as the hash rate in TH/s (TerraHashes per second). Please see this link that shows the hash rate. This hash rate can be used as a reliable benchmark for calculations in TerraWatts over any time period. So, the blockchain’s own methods of securing the network are certainly not wasteful… instead, they are more visible than those of the legacy financial system.
When is the right time to buy?
We are not financial advisers.
How do I buy my bitcoins?
You can mine them yourself or purchase them. Purchasing can be done at a bitcoin ATM, direct trade with a holder of bitcoins, or at an exchange.
Where do I store my bitcoins?
You can store your bitcoins on a range of platforms.
Exchange – An exchange is a bourse where users trade fiat currency with bitcoin. If you have purchased your bitcoins at an exchange, it is not advisable to store them with the exchange. Exchanges are not covered explicitly by financial regulation, their security is not failsafe and they have often been subjected to hacks. Two recent examples have been Bitfinex (August 2016) and Bithumb (July 2017) where millions of dollars’ worth of bitcoins had been stolen. Though exchanges follow KYC/AML regulations, there is no further regulatory oversight that protects or insures bitcoin balances on those platforms.
Wallets – A wallet is software (or hardware) that entitles you to move a given quantity of bitcoins. Storing your bitcoins on a wallet gives you the following benefits:
- Privacy – your wallet refreshes with a new deposit address so as to avoid re-using existing addresses,
- Simplicity – you should not have to carry out too many operations in order to make a transaction,
- Security – the private keys are under your control and can recover your wallet in the event of a network outage.
You can store your coins on a web-based wallet, a wallet on your cellphone, a desktop wallet or, if you plan to store your coins over the longer term, a hardware wallet. Please see this link for a closer look at wallets.
What is to stop me from spending my bitcoins more than once?
The consensus protocol has proved to be effective in curtailing blocks that contain double-spent bitcoins. Should you try to spend your bitcoins to more than one recipient, the nodes will spot it and orphan (reject) the block that had included your double-spent transaction.
However, if you hold X number of bitcoins and a fork occurs that bifurcates the Bitcoin blockchain (as we have seen recently with Bitcoin Cash), your bitcoins get duplicated. This means that despite acquiring your bitcoins on one occasion, you can spend them on one blockchain while your balance on the new blockchain would remain unchanged.
One major caveat before you go out and try this: it is the responsibility of the forking chain to write replay protection for its supporting wallets to deploy. So, before you attempt to duplicate your coins should another contentious hard fork occur, please ensure that you use a wallet that has replay protection. Replay protection prevents you from, for instance, spending 3 bitcoins from your less valuable side of the fork only to find that you have spent, unintentionally, the same 3 bitcoins on the more valuable side of the fork.