Virtual currency as defined by the European Central bank in 2012 is “a type of unregulated, digital money, which is issued and usually controlled by it's developers, and used and accepted among the members of a specific virtual community”. Saying this, it sounds like they were most likely thinking about currencies used within single computer games, which can be traded for both real money, and virtual in game items such as swords and health packs which help players progress through the game. A better definition was made by the European banking authority in 2014, who said virtual currency is 'a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by a natural or legal persons as a means of payment and can be transferred, stored or traded electronically'.
The most well known real virtual currency at this time is also one of the very first decentralised ones. There is no central authority deciding how much a coin should be worth. No group manipulating the price by creating extra coins at will. No-one regulating transactions. This currency is called Bitcoin. Because this uses encryption as part of it's process to both create new 'coins' and to secure transactions, this is also know as a 'cryptocurrency'. Although it should be noted that not all virtual currencies are also cryptocurrencies.
So, you are probably wondering, if there's is no central authority, then who or what regulates the value, transactions and stores of this money? How can anyone trust it? Who decided the value and how can you have confidence in that value. The answer lies in the maths and algorithms behind the currency as well as the very public nature of every transaction. Nobody can cheat the system, because once it's set in motion, maths regulates the coins themselves and the only way to change the system of passing transactions is by consensus, i.e. a majority of the distributed 'nodes' running the system have to agree to make a change before it will come into effect. These changes are also restricted to technical aspects of the system and so shouldn't by themselves affect the store of value, only how data is passed via communications channels between the nodes and how information is recorded on the distributed database which is the backbone of the system.
The whole system is open source, which means that anyone can look at the code used to run it. There is no-where to hide backdoors, or deliberate vulnerabilities. Many well know security researchers, who's jobs it is to find weaknesses in computer code, have peer-reviewed the bitcoin code and found no issues. Indeed, they report that the code matches the claims.
Many people will have heard of big hacks resulting in Bitcoin's being stolen. In the media these are often portrayed as sounding the death bell for bitcoin. How can anyone trust it when these virtual robberies keep occurring? In reality, the core bitcoin infrastructure has never yet been found to have been hacked. The missing Bitcoins have all been stolen from exchanges. These (just like an entity dealing in physical cash such as a shop), hold a store of bitcoin on their own systems with which to actually carry out transactions (in the shop metaphor, this is akin to keeping actual cash in a till or safe). It is these stores of bitcoin, often protected and manipulated by proprietary code written by the individual exchanges which have been targeted in the reported hacks. Either bad code or insider information has been used to steal bitcoins. For example one of the biggest hacks took place on MT GOX, one of the first large exchanges. Based in Tokyo the exchange was estimated to have been handling 70% of all bitcoin exchanges at it's height. It was found that an error in the code running this exchange could allow a client, under special circumstances, to 'double spend' bitcoin. This meant that for every bitcoin the client had, they could forward it to two different places at the same time. It's important to note that this wasn't doubling the actual number of bitcoins, it was just pulling more bitcoins from the exchange's store than the client was due. The issue was only really noticed when they realised they were running out of bitcoins while the system was still reporting everything was fine. The exchange estimated the loss at first as being some 750,000 bitcoins, worth about 450 million dollars at the time. This was downgraded slightly when they found 200,000 coins that had apparently been kept in a different, 'offline' store. Unfortunately, the exchange was forced to close (with an arrest and pending legal issues). The missing bitcoins weren't paid back to the other clients who had been currently holding them on the exchange. There is some contentious allegations that the owners of the site may have lost less bitcoins to the bug than reported and instead stolen a lot of it for themselves.
Another more recent report has alleged a different path along which coins may have been stolen from the exchange. It looks like some of the private keys of the wallets used to store bitcoin ready for use by the Mt Gox systems were stolen in 2011. For 3 years bitcoins were supposedly simply stolen directly from these wallets.
The maths behind the system mean that there will only ever be 21 million bitcoins. This limited supply ensures that the value can't be diluted by creating more on a whim. As governments have the power to do on their own currencies with quantitative easing.
Due to the coins being digital, current communications channels mean that you can transfer them almost instantly for a small fee to anyone else in the world (or space?). The fee is is a payment incentive for people to run nodes (specifically 'mining' nodes) to verify and record transactions to the public database. This fee is also decided by the maths, varying depending on the number of nodes running, how busy the system currently is and so on.
Transactions are irreversible. There are no charge-backs, no secret mechanisms for grabbing the coins back. This is both good and bad. It's good in that any payments are final, therefore many forms of fraud can be cut out of the system. It's bad because if your coins are stolen, there is no way built into the system to get them back.
Due to the nature of the distributed system, no one person or group, or oppressive government can decide to regulate or block transactions. So long as people can connect to the internet then they can access their coins and use them.
The distributed database behind the system in called the blockchain. A good way to think of it is as a giant public accounting book in which all transactions are securely stored and recorded. Anyone can download a copy of the accounting book and make changes, which are then pushed back and cause all other copies of the book to automatically update.
Every record, every transaction, is recorded and publicly viewable on the blockchain, but is also annoymous. No-one can tell who owns which addresses without knowledge of relevant metadata (ie. you know you paid a friend for something, he shared his public address with you, now you know who owns that address) But they can just as easily move the money from that address to another and again you'd be in the dark.
The system behind bitcoin, blockchain as the orginal implementation in code, was created by mathematician and programmer Satoshi Nakamoto. No-one knows who this is, or indeed if it's even a single person. It may be a group of people working together under a psudonym.
He first published a paper in 2008 via a cryptography mailing list outlining the bitcoin protocol. About a year later he released the first version of the code. Several people have since analyzed the code and said although it was quirky, it was very well written, almost too well for a single individual. Either he was truly a genius, or had help. Since then he has faded into the background eventually falling completely silent and leaving ongoing development to the bitcoin community.
Why this person or group has not come forwards is a complete mystery. The media have made many attempts to uncover his real identity. Most famously targeting a 64 year old Japanese engineer and mathematician called Dorian Satoshi Nakamoto. Well at least the name partially matched. His response was that he'd never heard of bitcoin until newsweek had first got in touch with him, “I got nothing to do with it” he later said before pointing at one of the many reporters harassing him “Wait a minute, I want my free lunch first, I'm going with this guy”.
Others have put themselves forward as being the inventor, but as yet none have been able to prove their identity by relatively easy methods such as cryptographically signing an email with the private encryption key owned by the first records to be created by Satoshi when first testing the blockchain. Or even sending a message from one of the original email accounts Satoshi used to release his creation.
Satoshi potentially owns over a million bitcoin which he mined when the system was first built. For unknown reasons, none of these has even been spent. They may have been lost forever, stored in 'wallets' to which the keys are no-longer known. More likely they are sitting, waiting, the owner undecided what to do with them. They are certainly worth an awful lot. At one time in the past each bitcoin was worth about $1000, making Satoshi's stash worth about $1 billion. Although when you read this each Bitcoin could be worth zero dollars or a million. Whatever, it's certain that the technologies behind this cryptocurrency will be live on.
It's possible Satoshi worked for the government. Maybe they wanted to be first to create a cryptocurrency. Perhaps they are holding the first coins so that they can manipulate the price of bitcoin by selling them all at once. It seems unlikely though. Why would they want to create an uncontrollable cryptocurrency that, due to it's anonymous nature (just like cash), could be used for criminal and terrorist activity.
My personal opinion, based on nothing in particular, is that Satoshi may be holding coins to keep a reign on bitcoin forks. When the blockchain is forked (as with the contentious BitCoinCash split in October 2017) everyone with coins on one chain automatically get the same coins on the other fork. Hence if Satoshi felt a particular fork was harming the bitcoin system, he could use his massive horde of coins to manipulate it. He hascertainly foreseen and prepared for many other issues which have arisen. Why not this?
Maybe it doesn't matter who created the technology, maybe they wanted to hide in order to boost the profile of bitcoin through the media obsession with finding the creator. Maybe he just wanted people to focus on the technology rather than having a single personality who would be harassed for comment on every story.
One of the most famous episodes in the life of Bitcoin took place on may the 22nd in 2010. In a popular bitcoin forum called bitcointalk.org, a user called Lazlo Hanyecz posted the following message:
“I'll pay 10,000 bitcoins for a couple of pizzas.. like maybe 2 large ones so I have some left over for the next day.
I like having left over pizza to nibble on later.
You can make the pizza yourself and bring it to my house or order it for me from a delivery place, but what I'm aiming for is getting food delivered in exchange for bitcoins where I don't have to order or prepare it myself, kind of like ordering a 'breakfast platter' at a hotel or something, they just bring you something to eat and you're happy!
I like things like onions, peppers, sausage, mushrooms, tomatoes, pepperoni, etc.. just standard stuff no weird fish topping or anything like that.
I also like regular cheese pizzas which may be cheaper to prepare or otherwise acquire.
If you're interested please let me know and we can work out a deal.
One of the first replies was:
“10,000... Thats quite a bit.. you could sell those on
for $41USD right now.. “
After a several messages, Laszlo managed to get his food:
“I just want to report that I successfully traded 10,000 bitcoins for pizza.
Thanks jercos! “
As I write this, bitcoin is worth about $1000 each, so that makes the two pizza deal worth about $10 million dollars, rather more than the $41 dollars it was worth at the time.
May the 22nd is now known as Bitcoin Pizza day, to celebrate the most expensive pizzas ever bought.
The computing power of the entire bitcoin system is estimated (at the time of writing) to be about 40,000,000 Pflop/s. If you added all the top 500 supercomputers processing power together you would only get a value of around 250Pflop/s! This means the bitcoin network is running about 160,000 times faster than those supercomputers. That is a lot of calculations per second.
Except…..this is comparing apples to space rockets. This value is supposed to be a measure of the computing rate of bitcoin mining equipment…..which work on integers (measures in hashes) and can't do ANY floating point operations (FLOPs). The FLOPs value here is usually instead estimated using a simple conversion equation. This does, however, gives a very rough idea of the collective power of the bitcoin infrastructure.
All this begs the question, how much energy is being used by the system? This seems to be the main issue with this particular cryptocurrency. It's energy usage is huge.
It's estimated that just one bitcoin transaction may use about the same amount of electricity as it would take to power 3 US households for one day (I was amazed to discover that this works out to be the same as almost 11 UK houses!).
To understand why, you just need to remember that for every block of transactions, the transfer has to be verified by miners, and then every Bitcoin node in the world must expend energy updating it's copy of the blockchain.
Today the whole network is estimated to use about 1 million US homes worth of electricity. And the percentage of people using Bitcoin is still small. This is going to become a big problem as the network grows. However, to put it another way the power usage is the same as flying eight 747 planes at the same time. There are about 635 currently in use.
Like planes though, it's expected that the network will also become more efficient as time passes. Already changes are being discussed which will greatly reduce the electricity cost per transaction.
Also, bitcoin may be replacing more traditional banking functions and all the energy usage that occurs with running centralised servers, all the offices, connections and card reading equipment and other infrastructure which goes along with it.
There is some additional genius behind bitcoin. As mentioned earlier, so far encryption protocols have a life time of around 20-40 years. After which increases in the power of computers and mathematical discoveries such as flaws in the encrypting algorithms make it no longer viable to continue using that method of encryption.
This is true for the encryption on which bitcoin is based, Elliptic Curve Digital Signature Algorithm (or ECDSA). This type of encryption can be broken by quantum computers. These may already be in the hands of the NSA, after all if Google has one, The NSA is likely to have one a multitude of times faster.
However, yet another clever part of bitcoin is that because your public encryption key is only revealed when you spend bitcoins (it's sent as part of the transaction so that the recipient can verify who you are), then by the time any computer can break the encryption, the coins have been safely transferred. Most modern bitcoin wallets will use a new sending address for every transaction, therefore each transaction will have its own new set of keys.
The encryption doesn't need to be unbreakable. As long as it can't be broken in the short time between sending the transaction to the blockchain and the bitcoins being actually transferred to a new address, then it's still viable to use it.
Once this encryption has been broken, the bitcoin system, as designed, can just be updated to use a new method of encryption. It's an arms race.
The blockchain is not just useful for managing financial transactions. It can be used for anything which requires an airtight, verified record of information exchanges such as contracts, ownership deeds….almost anything. And this information would be shared between parties without needing to employ any central repositories or verifiers.
One of the better known ideas which might make use of this system was put forwards by Mike Hearn, an ex-google security engineer who moved to cryptocurrency development instead.
He proposed a system of automated taxis, connected to a marketplace run on a blockchain which he called the Tradenet.
Taxi passengers would, from a connected computer or phone, make a request on Tradenet for a ride, giving the appropriate details. The taxis would then compete for the job, the passenger choosing their preferred option of time, cost and route. This would also include things like changeable city tolls for taking certain routes based on things like traffic congestion and city specific preferred routes, So far, so relatively conventional.
Now it get a bit strange. The taxi isn't owned by anyone. It is owned by the software running the taxi. The fare it's making pays for it's own existence, it can even save a little for future costs. It would exist for the benefit of it's users, not as a for profit entity.
The cars would use the money to pay for repairs, insurance and fuel. But, they could also use the money to pay for software upgrades which would make them more efficient. At a further level, the cars could even club together to pay for a factory to build more cars, better cars. The new 'children' cars giving a small percentage of their profits to the 'parents' in thanks for being 'born' and inheriting a copy of their software.
Even if the use of cars declined due to economic conditions or such, then the cars could mothball themselves for a period in a designated parking area, or just move to another city which required more capacity. It would be an extremely efficient transport system, minimizing running costs, which in turn would minimize costs to the end users.
Such a system would only be viable using cryptocurrencies and a blockchain based trading system. Something like bitcoin would allow autonomous identities who can't have bank accounts the ability to trade and save. A distributed blockchain based system would allow the cars to make agreements between both themselves and the trading system which humans would also be using.
The point of all this is that, after the initial investment, the city (or wealthy philanthropists) wouldn't have to pay for further upkeep of the transport system. But at the same time, the system would be cheap for users. No-one will be scooping off profits. There would just be a big improvement to society.
The use of distributed databases such as the blockchain would be useful in all sorts of applications. Especially those which required traceable supply chains and shipment, voting systems, and land rights.
Records can all be processed and maintained more cheaply and with more credibility using blockchains.
2.5 billion people don't have access to bank accounts. They don't have access to credit cards or traditional banking services. However, they often do have access to a mobile phone. By allowing their phone to essentially be their own bank, these people will be able to more safely save, and trade with less risk and more convenience. Bitcoin provides a cheap, easy and quick way of moving money across borders. It's common for families in developing countries to have relatives who migrate to wealthier countries and then want to send money back home.
The cheap fees and near instant transfers of cryptocurrencies such as bitcoin allow them to easily send money back home. The country to country transfer fees are the same as for any bitcoin transaction (necessary to run the network, but hopefully minuscule) rather than the steep fees often charged by traditional financial institutes. No extra infrastructure will need to be set up. As long as the user has access to the internet then they can use cryptocurrencies. Of course, at the moment, the receivers will probably still need to convert back to local currencies. Startup companies are now appearing which allow users in these countries to easily and very cheaply convert back to their home currency.
It's also useful in countries with unstable currencies. The famous example is the hyper-inflation which took place in Zimbabwe around 2007. The country currently holds the record for the 2nd highest monthly inflation rate in history which was 79,600,000,000% in November of 2008 or prices doubling just over every 24 hours.
The highest monthly inflation rate was in Hungary in July of 1946, where prices doubled every 15 hours.
Following World War II, production was at an all time low. No-one had any money to pay taxes. The government decided to stimulate the economy by simply starting to print insane amounts of money. Obviously this was devastating to the Hungarian public. Workers became impoverished. Their savings wiped out.
Those with the means would have quickly exchanged their money for another, more stable, currency. Usually the US dollar. By exchanging local currency for cryptocurrency, users would have a route to avoid some of the inflation. Although, this would also possibly void the Governments plan to reinvigorate the economy. Which in the case of Hungary actually did work after several years.
Countries such as Argentina and Greece are already examples where uptake of cryptocurrencies has been large due to the instability of local currencies. In Greece in 2015 the people essentially had their money locked due to capital controls being enforced on all bank accounts. For several days no-one could access their own money. There was threats of seizures of savings over a certain amount, just as in Cyprus in 2013.
Even a year later, only 60 Euro a day withdrawals were allowed on consumer bank accounts.
There was a large uptake in bitcoin buying when the crisis hit the headlines. Interestingly though, it's not thought that many Greeks were buying it, not that they could fund it if they had wanted to. Just others, in different countries listening to the news and reacting.
There are many problems still to be resolved within the leading cryptocurrencies such as Bitcoin. Among them, rising transaction fees, slow transactions as more and more people start using the system, and the huge energy consumption of all the nodes and miners required to keep everything working.
The good news is that all of these issues are being addressed.
At the time of writing this, the first release of a thing called the 'Lightning Network' has just been finished. This is an additional layer which works in conjunction with the Bitcoin network, allowing for fast 'off chain' transactions. Bitcoin at the moment can only handle about 7 transactions a second (VISA can handle about 40,000 a second!).
The lightning network allows for smaller, everyday, less critical transactions to take place outside of the main bitcoin network. It works on a kind of escrow system where, first, a single bitcoin transaction is required to set up a payment channel between two users. Any amount of transactions can then take place over this channel between these two users over any time period. The channel can be closed by either of the participants at any time. And only then is a second bitcoin transaction required to mark the channel closed and record the final balances of both users to the blockchain. This should substantially lower the number of bitcoin transactions taking place.
There's also a second aspect to the lightning network where it's clever enough to make routes through multiple existing payment channels between multiple users to transfer money from one place to another, thus not every lightning transaction requires a brand new payment channel.
The future of bitcoin is uncertain. Anything could happen. What is in little doubt though, is that it looks like blockchain is set to take over the world.