Ever since El Salvador announced that it will accept Bitcoin as a legal tender, backers of cryptocurrency have got a shot in the arm. The raging debate over one of the most significant financial developments of the 21st century is now running full steam. At the same time, tech czars such as Elon Musk have kept the world on tenterhooks with their oft-changing takes on the future of cryptocurrency or crypto. In the midst of all this are people and businesses eager to invest in it.
So why is there so much interest in cryptocurrency? What is Bitcoin that everyone keeps talking about? And how to earn or invest in it? We answer these and some other questions through this guide.
What is cryptocurrency?
Cryptocurrency is a type of digital currency, which means it does not exist in physical form like the normal paper currency. Unlike normal currency, there is no central authority issuing crypto. And so far, only one government has accepted it as a legal tender. Crypto typically works under a decentralised control mechanism on the internet which usually is a blockchain, a publicly distributed record of transactions in digital form where each block contains information of transactions and is connected to the previous block thus forming a chain.
The reason why they are called “cryptocurrencies” is that they are created using a set of cryptography functions, including public-private keys, which secure the currency from third-party intervention and identification. This means that cryptocurrencies cannot be traced by governments or banks and their users can remain anonymous should they chose to be.
What are the advantages and disadvantages of crypto?
First the disadvantages.
Cryptocurrencies are extremely volatile, meaning that there is a sudden rise and fall in the price. The cryptocurrency market was valued at around US$ 2.2 trillion on May 16, 2021, but by May 23, it was at US$ 1 trillion.
The currency can be hacked and technical or human errors can lead to losses. In 2020, hackers stole cryptocurrency worth US$ 200 million from Singapore-based crypto exchange KuCoin. Even forgetting the password can be disastrous. A man in San Francisco was in the news earlier this year after he forgot the password to his stash of Bitcoins valued at US$ 245 million. This is not the only example. According to The New York Times, as much as $140 billion worth of Bitcoins, or 20 percent of all Bitcoins, are locked behind forgotten passwords. Since there is no central authority, password recovery is impossible.
Further, not all cryptocurrencies follow the blockchain route. This means that they are open to several issues, including a false sense of transactional security.
A major concern is the illicit use of crypto. Research by American global policy think-tank RAND Corporation highlighted the risk of an increase in the use of cryptocurrency by terrorist organisations primarily due to anonymity and lack of regulatory control. The paper warned that the widespread use of cryptocurrencies with enhanced security features will enable their use for illegal purposes.
Another problem is mining (more on this below), which consumes tremendous power. According to International Energy Agency (IEA)-backed report by Galaxy Digital, Bitcoin consumes 113.89 terawatts per hour per year (TWh/year) of electricity. But the same report also points out that the global energy consumption of the banking system, including ATMs, is an estimated 263.72 TWh/year and that of gold mining is around 240.61 TWh/year.
But this form of currency has advantages, too. User autonomy is the foremost. There is no intermediary for the users, which also negates things such as banking fees. The absence of a banking system as a regulatory authority means greater control in the hands of the users. Anyone can send or receive cryptocurrencies anywhere, any time with just a smartphone or computer with an internet connection. Also, exchanges have their own set of protections which can also be in the form of insurance against losses and storage of most of the information offline as protection from hackers.
What is mining?
Mining is integral to cryptocurrencies. It refers to the solving of a complex mathematical problem by multiple computers running a specific type of programmes to verify the transactions within a block and enable it to be added to the blockchain. This system is called ‘proof of work’ and the computers doing the problem solving are called miners. In Bitcoin’s case, whenever the mathematical problem is successfully solved, the reward, which is 6.2 Bitcoins (around US$ 204,000 at the time of writing), is earned by the miner (computer) which is the first to solve the problem. This reward shrinks by 50 percent every four years, which means that the total Bitcoin reserve will be exhausted only by around 2140.
Over the years, mining has become extremely difficult due to a large number of computers competing to solve the same complex problem. The computers, therefore, are powered by the most advanced hardware and programmes designed to mine cryptocurrencies more effectively. There are entire rigs designed exclusively to mine cryptocurrencies. Since miners operate 24×7, it has led to the energy problem debate around cryptocurrency.
Yet, many cryptocurrencies do not follow the high energy-consuming ‘proof of work’ system. They work under a protocol known as ‘proof of stake’. In this, validators are chosen based on how many coins of the cryptocurrency (which they intend to mine) they hold. This is the stake. The larger the stake, the higher the chance of the reward — which is network fees instead of a block. In 2022, Ethereum will completely transition to the ‘proof of stake’ system. This means that its users will have to stake Ether to be able to win a chance to validate the next block in the blockchain.
It is also noteworthy that amid mounting criticism over the risks to the environment from high energy use, a voluntary and open forum known as Bitcoin Mining Council was formed on June 10, 2021, by nine companies including MicroStrategy and Galaxy Digital. “The mandate of the Bitcoin Mining Council is to promote transparency, share best practices, and educate the public on the benefits of Bitcoin and Bitcoin Mining,” a statement on the official site reads.
What is Bitcoin?
Bitcoin is the first and the most popular out of more than 4,000 cryptocurrencies. Due to its popularity, the name “Bitcoin” has become synonymous with cryptocurrency. Yet, the fact is that Bitcoin is a part of the cryptocurrency universe but it is not the universe itself.
Bitcoin was created in 2008 by an identity known as Satoshi Nakamoto. The identity is a pseudonym but no one knows if it is of an individual or a group. Though the idea of cryptocurrency and its principles were in existence before Bitcoin’s arrival, it was Nakamoto’s white paper, “Bitcoin: A Peer-to-Peer Electronic Cash System“, which established many of the protocols and presented a much clearer understanding of cryptocurrency.
The first Bitcoin block, Genesis Block, was mined in 2009. Thus began the Bitcoin blockchain that is still on. Bitcoin did not become an actual mode of payment in the real world until May 22, 2010, when a person in the US bought two pizzas for 10,000 Bitcoins. The transaction established Bitcoin’s value at four Bitcoins per penny. At the time of writing, one Bitcoin is valued at US$ 35,372.
The cryptocurrency has a lifetime cap (total reserve), standing at 21 million Bitcoins. Just over two million Bitcoins are left to be mined as of now. It is not clear what will happen once all coins are mined.
What are the other types of cryptocurrencies?
Tether, Polkadot, Cardano, Dash and Litecoin are among the many other famous cryptocurrencies. Each has some features that are unique to them. For instance, the blockchain of Ethereum, the second-most famous cryptocurrency after Bitcoin, is more expansive than that of Bitcoin. Its ‘coin’ is called Ether and it is more than just a currency. Ethereum, which was created in 2015, allows the creation of new programmes by businesses, the creation of new cryptocurrencies using the Ether protocol, and the making of smart contracts which are set outputs when predefined rules are met.
There is also crypto known as Bitcoin Cash. It was created in 2017 after a difference of views emerged between developers and miners of Bitcoin. This kind of split in the cryptocurrency world is called a “fork”. The block size of Bitcoin Cash is larger than Bitcoin and thus more transactions can be stored in each block.
Dogecoin is another type of cryptocurrency. It started as a parody coin in 2013 and was named after a famous meme featuring a Shiba Inu dog. Though it was created as a joke, Dogecoin is today among the five largest cryptos by market capital. Dogecoin, whose coins are called Doge, works on the ‘proof of work’ protocol of Bitcoin.
How to earn cryptocurrency?
There are a few ways to earn cryptocurrency apart from mining. They can be bought on cryptocurrency exchanges that sell and convert crypto to fiat money (regular money) or other digital currencies. Bitcoin emerged on exchanges in 2010. Some famous exchanges are Coinbase — which is also one of the oldest, Binance, CoinEgg, Kraken and Gemini. Others like PayPal and Robinhood also allow cryptocurrency trading on their platforms. All that one needs is to create an account and start trading. Cryptocurrency can also be exchanged between two people over the internet, just like normal currencies.
Security and fees structures are two of the most important features to look for before zeroing in on an exchange. It should always be remembered that exchanges, however big they appear, may themselves not be secure. In 2014, Tokyo-based Mt. Gox, at the time the world’s largest Bitcoin exchange, collapsed. In its bankruptcy filing, the company said that hackers had stolen around 850,000 Bitcoins (worth around US$ 480 million) from its reserves and there was another US$ 27.4 million that was reported missing from its bank accounts. Yet, despite what was prophesied by many at the time, the Mt. Gox disaster did not bring an end to either Bitcoin or cryptocurrency. On the contrary, the market has continuously expanded.
Is Bitcoin legal?
On June 9, 2021, El Salvador became the first country in the world to make Bitcoin a legal tender. Bitcoin has some recognition under tax laws in the US, Canada, Australia, the UK and European Union. Some companies in the US allow payment in Bitcoins. But it is not accepted in Russia, Vietnam, Bolivia and China among others. The debate over cryptocurrency is a raging one and its legality differs from country to country.
Interested? Recent developments you should know
Statements by Elon Musk, the CEO of Tesla, have led to sharp spikes and falls in the price of Bitcoin. In February 2021, he stated that his company will accept Bitcoin as a payment for its cars. That led to a surge in price. But on May 13, he tweeted that Tesla had stopped accepting Bitcoin due to environmental concerns over mining. By May 19, the price of Bitcoin dropped more than 50 percent from its record high of US$ 64,895, which it had reached in April. Yet, on June 13, he reversed his position tweeting that Tesla will accept Bitcoins “When there’s confirmation of reasonable (~50%) clean energy usage by miners with positive future trend.”
— Elon Musk (@elonmusk) May 13, 2021
This is inaccurate. Tesla only sold ~10% of holdings to confirm BTC could be liquidated easily without moving market.
When there’s confirmation of reasonable (~50%) clean energy usage by miners with positive future trend, Tesla will resume allowing Bitcoin transactions.
— Elon Musk (@elonmusk) June 13, 2021
On the other hand, Twitter’s billionaire CEO Jack Dorsey recently indicated that it is “only a matter of time” before the social media giant or its project, Bluesky, accepts Bitcoins as payment.
Only a matter of time
— jack (@jack) June 11, 2021
Cryptocurrency, however, has bigger concerns. Chief of which comes from governments taking a stand against it. In May, Chinese Vice-Premier Liu He and the State Council issued a statement calling for a “crack down on Bitcoin mining and trading behaviour, and resolutely prevent the transmission of individual risks to the social field.” It is important to note that China has the most miners of Bitcoin. University of Cambridge’s Bitcoin Mining Map, which was last updated in April 2020, reveals that China’s average monthly share of total hash rate is 65 percent. By comparison, the second-placed US has an average monthly share of merely 7.24 percent. According to Coindesk, a hash rate is the total combined computational power used to mine and process transactions on a ‘proof of work’ blockchain. Expectedly, therefore, the price of Bitcoin fell immediately after the Chinese vice premier’s statement.
The US, too, has said that any transfer worth US$ 10,000 or more will have to be reported to the Internal Revenue Service (IRS). In a statement, the Treasury Department said, “Cryptocurrency already poses a significant detection problem by facilitating illegal activity broadly including tax evasion. This is why the President’s proposal includes additional resources for the IRS to address the growth of cryptoassets.” The same statement also noted that cryptocurrency “transactions are likely to rise in importance in the next decade.”
(Main image and Featured image: Executium/@executium/Unsplash, Jürg Kradolfer/@bitcoin_schweiz/Unsplash)