What is Bitcoin?

Let’s talk Bitcoin, shall we.

I first heard of the thing a few years back from an article in The Independent (newspaper). I got interested, excited even. But that excitement evaporated soon when I found out that it was costing more than 100 dollars and theway to obtain it seemed complicated and risky.

I accepted that I had missed the momentum and that it can’t get any more expensive than that and decided not to bother with Bitcoin at all. Fast forward 4 years and here I am, buying BTC faster than I can count.
Why the craze?

I only properly got into bitcoin recently when I needed to deposit money into an investment programme online which was set up with Bitcoin only, so it was a matter of necessity rather than choice really.
I researched the popular Bitcoin ewallets and signed up with Coinbase which is one of the biggest and most reliable bitcoin wallet providers and it has its own inner exchange platform, so you are able to buy and sell your bitcoin currency and switch it to dollars or euros or pounds. Very convenient and simplified.
I also have the option to buy using my credit card, so in these times when the price is shooting straight up, I’m not confined by the restriction of my ever-thin bank account. My money is spread really thin at the moment, so this is a really important feature for me.
Still, let me explain why am I turning all my available funds into BTC right now.
I started monitoring bitcoin quite late,  it wasn’t until March this year (2016) that I started to buy and use Bitcoin for my online business.
In March I bought BTC at the rate of $430-450 (the rates were fluctuating between these numbers),  sometimes going up to $460 but nothing too crazy.
Then in May I noticed that the price started climbing. Slowly at first ( I mean, 10-20 dollars a day seems slow but in Stock-Market exchange terms this is still a massive jump). By the end of May the price for one BTC had passed the $550 mark and kept climbing up.
June was a great time for speculators and big investors and from what I understand the government of China was buying massive amounts, thus forcing a rapid and unexpected jump of over $280 from the previous month. By the 19th June one BTC reached $775 – something that forecasts were predicting would happen close to the middle of July when the next halving will occur.

What Is The Halving and the Block Reward?

In order to understand what this is, it’s important to first understand how Bitcoin and its database works. The database that keeps track of which addresses have how many bitcoins is stored in the form of a “block chain” (imagine a vast number of servers linked together), which is extended by one block roughly once every ten minutes. Each block contains all of the transactions that have taken place during that time, and when a block is added to the chain, it signifies a consensus among the Bitcoin network that those transactions took place at that time. As time goes on and more blocks are added on top of that block, the consensus solidifies, and after four to six blocks, any attempt to fraudulently change the transaction history to your own benefit becomes impractical because of all the work that has already been done overtop. Blocks can be created by any node on the Bitcoin network, and to regulate the rate of block creation, the network imposes constraints on the form that a valid block can take, with the result that it requires a lot of trial-and-error work to find a block that is valid – so much work that the entire network only manages to find one roughly once every ten minutes. That is a constant; there is an adjustable parameter called the “difficulty” which the network collectively manages to make sure that the actual block creation rate never strays far from that value.

Because creating (or “mining”) blocks is so crucial to the security of the Bitcoin network and yet so hard, the Bitcoin protocol includes a mechanism to encourage people to mine: every time a block is added, the programmer (miner) who found the block is given free BTC as a reward. At first that was 50 BTC and at the time of the first halving that became 25 BTC. This happened in 2013 and we saw a massive and sudden rise of the price back then. This July we will experience another halving where that reward will be down to 12.5 BTC but we’re now seeing the price jump much earlier due to people’s awareness of the event and a lot of speculation too.  The block reward also has another function: it is the only way that new bitcoins come into existence. Any bitcoin that you send or receive was at one point somebody’s block reward.

Why is this happening?
The main reason why this was done is to keep inflation under control. The rate at which new bitcoins are introduced into the system was never intended to stay at 50 BTC per 10 minutes forever. Rather, Bitcoin has a monetary policy that was coded into the system right from the start that reduces the rate over time, until the generation of new bitcoins finally stops entirely at a maximum of 21 million coins in 2140. There will still always be one block coming out every ten minutes, but the number of bitcoins handed out as a reward in each block will come down in sharp steps, cutting in half about once every four years (precisely, once every 210,000 blocks). The event that will happen in July is exactly this.

One of the major faults of traditional, “fiat”, currencies controlled by central banks is that the banks can print as much of the currency as they want, and if they print too much, the laws of supply and demand ensure that the value of the currency starts dropping quickly. Because the only use for money is to exchange it for something else later, a currency that is rapidly decreasing in value becomes even less valuable for that very reason, leading to a hyperinflationary spiral.

Bitcoin, on the other hand, is intended to simulate a commodity, like gold. There is only a limited amount of gold in the world, and with every gram of gold that is mined, the gold that still remains becomes harder and harder to extract. As a result of this limited supply, gold has maintained its value as an international medium of exchange and store of value for over six thousand years, and the hope is that Bitcoin will do the same.

What Will The Economic Effects Be?

The question that most people are focusing on right now is what will happen to the Bitcoin price. Thought on the issue is currently split into two camps. Those in the first camp believe that the decrease in the block reward will cause a “supply shock” in the Bitcoin economy as the number of available bitcoins suddenly goes down, pushing the price up by as much as two times to compensate. This line of thought rests on two key hypotheses. The first is that the supply of bitcoins on the market is largely made up of miners trying to collect a profit, and current major holders play a smaller role. This hypothesis holds increasing weight as mining becomes more and more dominated by professional “mining companies” seeking to earn a profit, and was bolstered further in another way by a recent study by Dorit Ron and Adi Shamir which found that 78% of bitcoins currently in existence are not in active circulation.

The second hypothesis is actually the one attacked more frequently and what those in the second camp argue is that traders anticipating the change have already bought up bitcoins in the months leading up to the event with the intent to sell them after. If they are correct, then even if the supply of bitcoins coming into the market from miners will soon cut in half, the supply from traders will make up for it, and the price will remain roughly the same.

My understanding is that even if that happens, it can only be a short term trend given the ever increasing popularity of Bitcoin and the whole cryptocurrency market in general.
If we listen to the experts, it seems that the potential of Bitcoin to reach a real commodity status, equal to Gold and beyond has already begun.