Bitcoins are numbers you can trade with. People would be ready to exchange goods and services with bitcoins as they value the bitcoin numbers. Compared to currency which is made out of thin air by a central bank, bitcoins and other digital tokens, require massive computational power to generate, and have a base in global energy prices.
This idea of using a set of protocol to transact and create new bitcoins securely was published by an Anonymous author using the pseudonym of Satoshi Nakamoto. The paper was titled: Bitcoin: A Peer-to-Peer Electronic Cash System by Satoshi Nakamoto
The global bitcoin economy is maintained by consensus among its users on who owns how much bitcoins. It relies on a system of decentralised ledger technology and triple entry accounting to prevent fraudulent entries. The bitcoin protocol is used to communicate with each other on the network.
The bitcoin economy has a unique system of rewarding bitcoins to anyone who would maintain the global bitcoin accounts. The rewarding mechanism of bitcoins creates an incentive for people to deploy computational resources to maintain the economy. This requires accounting for bitcoins according to a set protocol. The bitcoin protocol therefore requires ‘proof of work’ from its users in order to reward them with new bitcoins. The ‘proof of work’ is resource intensive and requires huge computational power. To learn more about how it is done, you may read my previous article on what are bitcoins – what is so different than fiat money?
Humans needed a strong, tamper-proof, irrefutable and immutable method of accounting. An accounting method which no amount of intelligence can influence. It was an awaited concept. People across the world were waiting for a panacea of accounting. And Indians needed it the most. The most corrupted countries needed the most amount of accounting.
On came the blockchain technology. It can be used to create a permanent record of transactions, which are mathematically undeniable. Even people cannot deny the entries, because people would need to digitally sign each and every transaction.
The problem was simple, the solution is complex. And it works. It works so much that the current valuation of transactions of all bitcoins has surpassed USD 16 billion.
NSA of USA is used to say that, “if you have nothing to hide, you have nothing to worry”. Well it is time for the governments to come clean. If governments have nothing to hide, they should accept the blockchain technology for transparent and open accounting.
Read more on this accounting principle: How blockchain is changing the finance industry: Triple Entry Accounting
What is ‘proof of work’?
‘Proof of work’ in the bitcoin protocol simply means a proof of expending resources towards maintaining the bitcoin economy. The more resources you expend would mean more seriousness about the accuracy of transactions.
This proof of expending resources requires solving quadrillions (1016) of intricate mathematical calculations. The result of which would be verified by the bitcoin protocol.
The bitcoin protocol maintains a level of difficulty and the reward amount, proportionate to the number of bitcoins in circulation, to treat the proof of work. The difficulty level keeps changing according to the number of bitcoins in circulation. More bitcoins in circulation would mean more numbers of calculations required to claim the reward amount. Along with the difficulty, the reward also keeps changing. More bitcoins in circulation would mean lesser reward and vice versa. In the beginning (~2006) the reward was 50 BTC per solution, as of now it is 12.5 BTC.
Mining is the act of solving mathematical calculations in order to receive bitcoins as reward. A hash is one of these mathematical calculations (read about hashing). You need 2,107,420,200 trillion hashes 1 to earn the bitcoin reward of 12.5 BTC as of today: 13th March ’17.
The value of bitcoins
Very sophisticated equipment are required to perform these mathematical calculations. The best equipment I would recommend for mining as of now is the Antminer S9 it costs USD 2400. The S9 runs on a 1.4 KWh electrical input. It can solve thirteen trillion hashes in a second. It would take 162109246 seconds or ~45000 hours to get the promised reward.
So, to earn 12.5 bitcoins you will need to expend about 63,000 KW as of now. The price of 1 KW in Ahmedabad on a High Tension Maximum Demand line as of now is 260 INR.2 63000 KW would therefore set you off by ~INR 1.64 crores.
Include the component of the cost of the mining hardware, and it would not make business sense for an Indian. However consider INR 5 to 20 per KW of hydroelectricity in northern China.
Therefore if we ever have to, we can only buy bitcoins from those who produce it cheaply. You can buy one bitcoin at INR 93,519 from Unocoin today.3
This global disparity in energy prices is driving energy advantaged nations to own more bitcoins than they should have. And although the makers of bitcoins sought decentralisation of economic power, it is nonetheless the way it is.
The disparity thus creates relative acceptance of bitcoins across the globe. Some countries are better placed to accept bitcoins than others. Not surprisingly Chinese people own 58% of the current global bitcoin circulation.4
Hacking, fraud and crimes with bitcoins
Although there has been a spurt in usage of bitcoin for criminal activity, it was more pronounced at a time when mining bitcoin was fairly easier, and the price of bitcoin averaged below 100 USD a piece. It happened that people could mine their own bitcoins, and once you have that capability you are answerable to no one. The scenario changed soon after.
Fortunately, or unfortunately, the circulation of bitcoins rose, and the per bitcoin value increased due to increase in difficulty to generate one bitcoin. While this might sound unwelcoming, but yeah INR/BTC touched the 1 lakh mark.
Interesting things happened due to the massive success. The difficulty of mining increased, not everyone can generate bitcoins now, it has narrowed down to only huge bitcoin farms, having investments of millions of dollars. When someone invests so much on a technology, they actively lobby for government attention and for legal sanctions.
SO, as of now, all those who mine bitcoins also seek legal sanctions and they put in all possible efforts to get the government to recognise bitcoins as legitimate currency.
Bitcoin companies also wanted the government to restrict mining of bitcoins, by restricting entry to the market. Governments came up with KYC norms for bitcoin users, and all over the world bitcoin usage got some sense of legitimacy. KYC puts in a legitimate but difficult hurdle for new bitcoin companies who do not have market reach.
As of now, you are free, and it is perfectly legal to buy, sell and transact in bitcoins in India if you are ready to furnish your identification documents. Just search ‘buy bitcoin India’ on Google.
And as bitcoins are permanently and publicly trackable, KYC binds your bitcoins to your legal identity, exposing you to legal troubles if you abuse BTC. It is getting fairly difficult to abuse BTC everyday.
Blockchain analysis firms
As I told you earlier, that the technology gives us an irrefutable new method of accountancy. The blockchain technology which we use to trade in BTCs, is nothing but a permanent publicly available ledger. So anyone and everyone can go through the ledger to find out transactions which ever happened on the platform.
So this new set of fintech firms arrived, who built softwares to go through the BTC ledger and find out bitcoins which have been used for illegal purpose. They coined the term ‘dirty bitcoins’ and ‘dirty accounts’ to refer to bitcoins which have at least once been used for illegal purposes.
These firms track down criminals and their bitcoin accounts5 and sell the data to law enforcement agencies who were not so equipped to handle BTC abuse6. So we have to be careful that the BTC we use is not a dirty BTC, otherwise we might get into trouble.
Chainalysis is one firm which is doing good in this business. They have a tool through which if you have a specific customer that you are interested in, or a ransom note with a Bitcoin address, the tool will automatically find connected dirty bitcoins and bitcoin wallets.
Did/Can bitcoins replace fiat money?
No not yet, governments have legitimised bitcoin transactions, that does not mean it is a legal tender which the central bank needs to respect. To understand why BTC cannot even replace fiat money, we have to find out why the RBI respects the INR and not any other currency on earth.
There are so many better and stronger currencies lying around, say the USD or JPY, or even the GBP. Much less prone to demonetisation 😀 However, they are also not legal tender because the law does not say so.
But what is legal tender? We may decide to settle our transactions with anything as we please. I might offer you 34kgs of carrot for your smartphone. And it is recorded in Indian History that we have used spices and seashells as currency.
It is in this perspective that we distinguish between currencies of different types with legal tender. ‘Legal tender’ is a status accorded to any currency by the law of the land. Acceptance of legal tender for discharge of debt is the mandate by law. By the power of the law no one can deny acceptance of the new pinky 2000 INR notes.
The RBI Act of 1934, which gives the Reserve Bank of India the sole right to issue bank notes, states that “Every bank note shall be legal tender at any place in India in payment for the amount expressed therein”.
The Finance Act and the other relevant laws of India accord legal status of currency to INR only.
To get BTC recognised at par with INR, we have to first make sure that the interests of all BTC users are aligned with the Indian economic and political interests. Is that possible? The answer is no, unless we as Indians are cool with the global order of things.
INR gives us a personalised and customised sense of security, we know if anything goes wrong we still have the power to correct it via the RBI. That is missing with the BTC, USD, JPY and other currencies.
We need to be cool with the fact that BTC is only for international transactions, and the high volatility of the BTC is not what we want our economy to go through.
Future/s in BTC
We have been trading in futures for a long time now, futures of every currency is available. Mt. Gox started out as a future trading platform for BTC with other currencies.
The future of BTC is supposedly much neater. Irrespective of all sensational media reports India is never going to criminalise BTC.7 It would only harm us when other nations use it. It is a game among all heads of states, of who gets to get the most out of BTC.
Although taxes, and other hurdles may get put in place depending on how smart our lawmakers are.
- Unocoin Technologies Private Limited, Mysore
- China’s Bitcoin Drama Isn’t A Financial Meltdown
- Nets partners with blockchain analysis firm to fight dirty bitcoins
- Danish breakthrough: Drug dealers can no longer hide behind bitcoins
- Exclusive: Should Bitcoin be allowed in India? Govt panel to meet on April 20 to discuss