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The basics of digital currency bitcoin

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By JOHN WALUBENGO
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I have been singing ‘Blockchain Technology’ in the recent past and some readers were asking me why I was not specifically talking about the currency bitcoin, given its recent record-breaking behaviour on the financial markets.

WHAT IS BITCOIN?

Clearly, this bitcoin ‘thing’ is raising a storm and the public wants to be part of it but perhaps are not sure what it is, how it works, who owns it or whether it is a ponzi scheme bound to collapse like all others.

Due to public demand, here are the basics of bitcoin, based on what would be the most frequently asked questions.

Bitcoin is a digital currency with its own model of production, circulation and exchange.

The Kenyan shilling or the US dollar is known as a fiat currency. Its value is basically determined by the government of the day through the central bank. In most cases, the central bank gets the currency value right through prudent economic management, but in other cases, as with Zimbabwe, it gets it wrong.

Even in more stable economies, governments can get it wrong, as seen from the 2007-8 US financial crisis that led to negative financial impacts around the world. This particular US financial crisis is widely considered as the motivation behind the creation of bitcoin.

HOW IT BEGAN

Essentially, Satoshi introduced a new way of minting and circulating a digital currency called bitcoin – without the need of a centralised authority like the central bank.

The rationale was that the centralised authorities were responsible for the 2007-8 global financial mess and therefore the world needed a different financial system that was immune to centralised interventions.

One centralised role and characteristic of the central bank is essentially to mint money and introduce it into the economy, based on various financial indicators that include the supply and demand dynamics.

Satoshi defined an electronic coin, the bitcoin, which is digitally minted and introduced automatically into circulation by computing processors owned collectively by various participants.

The rate of minting coins and their introduction into the economy is therefore pre-determined through computer logic or code. This is designed to prevent inflationary and deflationary pressure that would otherwise be unilaterally dictated by centralised agencies.

CHALLENGES

However, one major challenge that Satoshi had to solve is known as the double-spend problem.

In the physical world, if you have a one thousand shilling note and you spend it at the supermarket, you cannot then spend that same note at the petrol station because you already spent and left it at the supermarket.

In the electronic world, you could potentially spend the same digital coin twice by sending the same coin to two different people.  Essentially you could cheat the system by purchasing two different items, but using the same coin.

To solve the double-spend problem, Satoshi introduced a new concept – ‘blockchain’.

Blockchain is a public ledger where all transactions are recorded in the order of the time in which they happen. It is public in that all participants in the network are able to tell if a particular coin had previously been spent and should therefore not be acceptable or recorded as a valid transaction.

That means that for any transaction to be entered into the public ledger, it must be validated and accepted through consensus by all participants. The validation and consensus process is all automated through computer logic or algorithms and does not require interventions from any centralised agency.

This is the ingenuity unleashed to the world by Satoshi Nakamoto. It is also the underlying technology that makes electronic currencies like bitcoin a practical reality.

The bitcoin network is open to any willing participant, who simply downloads and starts using the digital wallet. This wallet allows users to participate in the bitcoin network in any, or all of the three roles – general user, validator or software developer.

The validator role requires that your device takes a block of pending transactions and checks it against previous blocks of transactions to eliminate double-spend. The validator is then tasked to search for a randomly selected value in order to solve a difficult mathematical puzzle.

The first participant to solve this puzzle gets rewarded with some bitcoins for their effort – after the other participants confirm the solution. Validating participants are also known as miners, because they ‘mine’ bitcoins when they earn them through their validating processes.

The incentive given to the validators in terms of earning bitcoins for every successfully validated transaction ensures that there will always be more honest participants competing to solve the puzzle than dishonest ones wishing to compromise the system.

This is the market economy par excellence. It is supply-demand dynamics on steroids. It is also how bitcoins are introduced into circulation, in a self-propelling way without a central agency.

In summary, bitcoin is not a Ponzi scheme, and neither is it owned by one individual but by all participants engaging and participating in their different roles as general users, miners and software developers.

The value of bitcoin is currently overheating and giving it a ‘Ponzi-like’ phenomenon. Hopefully this will self-correct in order to bring back the basic behaviour as per the Satoshi Nakamoto design.

Bitcoin Market Price

Ponzi Scheme

US Financial Crisis

Bitcoin Blueprint

Publicly Available Algorithm

Total Circulation – 21 million’

Digital Wallet

Mr Walubengo is a lecturer at Multimedia University of Kenya, Faculty of Computing and IT. Email: [email protected], Twitter: @Jwalu

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