• 5

    Shares
5 Shares
Share

OPERATION OF A BITCOIN

Like any other currency, bitcoin transactions are also held in a ledger. Something that’s notable about this is that only a decentralized entity exists to maintain the ledger. Guess what? The ledger is preserved in public, where everyone has access to view and verify the transaction accounts!

To get a precise idea of the functioning of the bitcoin network, three landmarks could be talkedabout. The first one is the accounting of individual transactions, validating of the ownership of bitcoins being the second and chronological ordering of the transactions being the last.

Stages of Operation 1

#1 INDIVIDUAL TRANSACTIONS

Primarily, the individual transactions occur. A physical asset exchanged for a specific amount of bitcoins is an example of an individual transaction. In the present market, every bitcoin can buy you $5720 worth assets on an average (blatantly ignoring the frequent fluctuations in the market). Every person who has an account in the network possesses a private key and a public key as well. Now, when the transaction takes place, a message is generated and is sent out to all the computers. As public key of the receiver is visible to everyone, the payment, as well as the transaction message, goes to the public key of the receiver, and not the private key. The private key of the individual who receives the money creates a digital signature (which closely looks like a code consisting of numerals and letters), which is a combination of the private key and the transaction message. If this transaction has to be valid, rest of the nodes have to verify it by comparing the digital signature and his/her public key. The digital signatures are passwords to unlock the funds and they’re highly confidential, so there is no way it could be used again. The signatures vary with every transaction.

 

Payment of bitcoins

Let’s consider a transaction between Amy and Jerry, where Amy is the buyer and Jerry is the seller. Amy sends the payment to Jerry in bitcoins and receives the payment. The bitcoins are sent to Jerry’s public key.

 

#2 OWNERSHIP OF BITCOINS

Next step that follows is the authorization of ownership of the bitcoins. If bank account balance is the yardstick of measuring one’s financial status, the case is different here. When a transaction is made, the payment is doneusing bitcoins. In the absence of physical existence, the payment is in terms of what is called ‘inputs.' Inputs are the references to previous transactions in which the buyer has earned bitcoins, and they add up to make the account balance of the buyer. If more than one input is referred in the transaction, they need to add up to the amount of output (money to be sent out) required. In a situation where the money being sent out exceeds the amount to be paid, rest of the value of bitcoins is sent back, which is like the ‘change’ you get in a physical transaction. Just adding up the unspent inputs would make one arrive at the account balance of the individual

 

#3 ORDERING OF TRANSACTIONS

Transactions are ordered in the form of blocks. Every block enlists one transaction. When a new transaction occurs, it goes to a set of pending transactions. Pending transactions is the pool from which a transaction is picked to undergo the process of ordering. The picked transaction has to be added to a chain of transactions and this is the process of ordering. Adding a new block implies adding a new transaction to the list of transactions. This list of transactions is called blockchain. Blockchain can be defined as the chain of transactions occurred in the bitcoin network, put in chronological order. If a new block is to be added to the chain, a mathematical problem must be solved which is in the form of a cryptographic hash function.

Example:  Given down is a block chain and each block contains details of a valid, ordered transaction.

To build the fourth block, a transaction has to be chosen from the pool of pending transactions. In the example, whichever transaction is understood to have happened first (A’s transaction with B or C) by each individual, is chosen. The transaction which is agreed upon by majority of them will have the higher probability of solving the mathematical problem. Each person chooses the transaction whose message they received first.

 

Bitcoin Mining

 To reward the winners of this guessing game, a reward is given at every successful guess and the reward is in the form of bitcoins. This is precisely the process of creation of new bitcoins. This process of ordering the transactions through building blocks, thereby creating a blockchain and thus generating bitcoins is called bitcoin mining. The block builders are called miners.

The following is a pictorial representation of how a blockchain works:

 

The major criticisms of bitcoins:

Bitcoins are not yet accepted widely. Few businesses and companies accept imbursement in the form of bitcoins for goods and services.

If a virus corrupts the data and God forbid it gets lost, there is no good solution to restore the data.

Mining of bitcoins has become popular in the recent scenario and one major danger associated with this activityis that it takes up enormous amount of energy in the form of heat. Gigantic consumption of energy poses sustainability issues as well as tremendous heating up of the mining devices causes health hazards to miners.

The speed of bitcoin mining is dependent upon the speed of the computer’s processor. Over the years, with some tweaks and modifications, manufacturers are producing chips and processors which are tailor made to solve the mathematical problems at faster speeds. This gives rise to companies having huge capital wanting to invest in these chips and processors. A real threat emerges when few companies with their unlimited wealth and sophisticated technology crowd out the individual miners. This could undermine the decentralized feature, which arguably is the main essence of bitcoins.

REGULATIONS AND POLICIES

Considering‘decentralization’ as a feature of the bitcoin market as well as a loophole to illicit elements to thrive, it is very important to strike a balance when a nation decides to recognize the coins. Countries have shown diversity in their approach towards the acceptance and recognition of bitcoins. There are countries like the United States and Australia adopting a thorough positive approach to bitcoins, while a few countries like Bangladesh or Vietnam being contemptuous to them. There are also countries which maintain a neutral attitude, like South Korea or Cyprus.

Among the countries which recognize bitcoins and accept them as legal, what is common in most of their approaches is that they consider bitcoins as a commodity rather than a means of payment. In countries like the U.S., Canada, Australia, U.K. and Germany, bitcoins are seen as commodities and any exchange in terms of bitcoins is entered under barter transactions. Regulations in these countries go on to classifying bitcoins as money services businesses and therefore are subject to their respective anti money laundering laws. Existing under the ‘commodity’ status, they don’t escape the taxes at all. Tax types and the tax caps differ, depending on the utility - exchange or investment or mining. Japan is the only country that has opened up enough to bitcoins such that it recognizes the coins as a legal prepaid payment method. Accurate report, record and register of bitcoin transactions are mandated by law in Japan, as much as any other bitcoin-backing country.

Vietnam, Iceland, Bangladesh, Bolivia, China are presently a few countries which agree on the possible huge dangers the bitcoin economy could pose and a stage for criminal activities. They are in the course of banning the coins or have already claimed them as illegal.

India, clearly, doesn’t take any of the above mentioned stances. Rather than calling it neutral, it would be more appropriate to say that India looks at bitcoins indeterminately. As it’s been in various other cases, the regulatory bodies have shown slack in coming up with a clear framework to define the bitcoin market in our country. Bitcoin transactions are not illegal in India, but the lack of clarity has induced uncertainty about the credibility of coinswithin people which is a big enough hindrance for the bitcoin network expansion. What India needs to do the least and most primarily is to state its approach to bitcoins - be it as a commodity or a payment method – and encapsulate it in law.  Necessary regulations can be imposed to prevent money laundering. Rather than an existing government body to undertake the regulations, it’s more viable to establish a self regulatory body possibly consisting of mutual fund association, payment councils and the major bitcoin exchanges, as was recommended by Sandeep Goenka, cofounder of Zebpay, top bitcoin exchange in the country.

 

FUTURE OF BITCOINS

Here are a few views on the benefits of bitcoins as said by prominent people. Microsoft co-founder Bill Gates believes in the prospects of bitcoins and thinks it has become unstoppable.

Cody Littlewood, founder and CEO of multinational corporate, Codelitt shows her optimism on the future prospects of bitcoins.

“In 2 years from now, I believe cryptocurrencies will be gaining legitimacy as a protocol for business transactions, micropayments, and overtaking Western Union as the preferred remittance tool.  Regarding business transactions – you’ll see two paths: There will be financial businesses which use it for it’s no fee, nearly-instant ability to move any amount of money around, and there will be those that utilize it for its block chain technology. Block chain technology provides the largest benefit with trustless auditing, single source of truth, smart contracts, and color coins.”  

Famous bitcoin Evangelist Roger Ver empathized about regressive economic sanctions imposed by the UN Security Council against Iraq. The economic sanctions were initialized in 1990 on grounds of war with Kuwait and possession of Weapons of Mass Destruction. They pursued to implement the sanctions via executing stringent restrictions on imports of financial resources as well as consumer goods. Half a million kids were killed in the course of time due to malnutrition and poverty. Ver points to the fact that a scenario of such sort arose because the command over trade and money supply in the country was concentrated in the hands of few. He also went on to explain the obvious significance of a global economy in staving off an occurrence like this. 

“It’s real people and real lives. Bitcoin has the power to undermine everything that the U.S. government is doing to real people. They do it through sensual banking and control of money supply and bitcoin takes that away from them”.

Even thoughthe nature of bitcoin economy is characterized by frequent fluctuations, empirics show that the worth of bitcoins has been rising on manifold rates on an average and yet is not showing any sort of reluctance in maintaining record breaking trends. There is something more fascinating about bitcoins, and that’s its potential to mold a global economy. It can make transactions across any part of the world easily, without a confusion about the currency or its exchange – and that’s nothing but bees knees. Keeping in mind the unpredictability of the digital realm itself, bitcoins stand out with immense prospects in hand.

REFERENCES

 

What is bitcoin? (2015, March 20). Retrieved October 19, 2017, from https://www.coindesk.com/information/what-is-bitcoin/

How does bitcoin work? (n.d.). Retrieved October 20, 2017, from https://bitcoin.org/en/how-it-works

Bitcoin. (n.d.). Retrieved October 19, 2017, from https://en.wikipedia.org/wiki/Bitcoin

Graham, L. (n.d.). Another major country joins China and Japan in cracking down on bitcoin exchanges. Retrieved October 30, 2017, from https://www.cnbc.com/2017/08/17/bitcoin-faces-regulations-crackdown-by-asia-pacific-country.html

Bajpayee, P. (2015, April 15). Countries Where Bitcoin Is Legal & Illegal (DISH, OTSK). Retrieved October 23, 2017, from https://www.investopedia.com/articles/forex/041515/countries-where-bitcoin-legal-illegal.asp

Tax treatment of crypto-currencies in Australia – specifically bitcoin. (2015, May 3). Retrieved October 24, 2017, from https://www.ato.gov.au/general/gen/tax-treatment-of-crypto-currencies-in-australia---specifically-bitcoin/

What is the future of cryptocurrency? (2017, July 15). Retrieved October 30, 2017, from http://www.moneybrainnetwork.com/2017/07/what-is-future-of-cryptocurrency.html

Raghavan, T. S. (2017, July 23). Bitcoin economy should be self-regulated: Zebpay. Retrieved November 2, 2017, from http://www.thehindu.com/business/bitcoin-economy-should-be-self-regulated-zebpay/article19333127.ece

(Director). (2013, July 14). How bitcoin works under the hood[Video file]. Retrieved October 19, 2017, from https://youtu.be/Lx9zgZCMqXE

W. (Director). (2016, November 13). Bill Gates: Nobody can stop bitcoin[Video file]. Retrieved October 30, 2017, from https://youtu.be/JvF3FTS5cQ4

Everything You Need to Know About Bitcoin: VICE Podcast 027 [Video file]. (2014, January 9). Retrieved October 27, 2017, from https://youtu.be/SNssKmeXrGs

Image source: Bitcoin news. Retrieved from https://www.google.co.in/search?q=bitcoin+images&rlz=1C1CHBD_enIN704IN705&tbm=isch&source=lnt&tbs=isz:lt,islt:xga&sa=X&ved=0ahUKEwjG4YPx8dHXAhVIq48KHTtNCPEQpwUIHg&biw=1366&bih=613&dpr=1#imgrc=-hY6ZlD88UdgyM

 

 

 

Share this article

Written By Theerdha Sara

Intern, Xavierite, Economics Enthusiast

Leave A Reply