Is Bitcoin a replacement for money?
“If it was created out of thin air and it vanishes, there is nowhere to get it back from”
Bitcoin is just the latest in a series of attempts to create a digital currency which is a medium of exchange, a unit of account and a store of value. The early micropayment systems such as egold and GoldMoney used precious metals to perform the “store of value” function.
In 1996 egold, a micropayments system backed by bullion was launched and by 2008 it had more than $US2bn in transactions. Unfortunately the anonymity it provided account holders facilitated criminal activity and the business was found to be money laundering.
GoldMoney enabled precious metals to form the basis for instantaneous transactions in an on-line patented currency. It had extensive money laundering and customer identification security. By 2011 it had over $2bn of customer assets in the form of stored precious metals all fully insured and independently audited, but in early 2012 it decided that it’s future was as a savings process and turned off the payment process citing poor demand and the high costs of regulatory compliance.
Bitcoin which was devised in 2009 was a cryptocurrency which means that it used cryptography to create and transfer money.
Bitcoin created a network of its users’ computers, and used an algorithm to release new bitcoins into the network, beginning with 50 every 10 minutes and halving the pace of issue in increments until 2140 when the limit of 21 million bitcoins was reached.
The protection against fraud was the maintenance of a public ledger of every transaction. If a user was able to crack one of a number of cryptographic puzzles and was the first to do so there was a “prize” of 50 new bitcoins. The public ledger was secured using public-key encryption which generates a private key retained by an individual and used to approve any transfers to another’s account; and a public key used to encode payments. This was not a fool-proof system but it was enhanced by the use of the cryptographic techniques of hashing and forced work. A hashing algorithm converts a message into a number described as a hash value or a digest. If the number is large enough it provides a unique representation of the original and could not be reconstructed.
All transactions were analysed in portions referred to as “blocks”. For the latest block to be valid, there is a forced work task of using the valid blocks and the new transactions to generate a digest comprising 256 bits, and the task is complete when the system’s algorithm provides a hash value below a preset target. Bitcoin’s view was that it would be necessary for an intending fraudster to control over half the network’s capacity in order to have a fictitious block created and validated. The system has been “hacked” successfully so this has not offered sufficient security.
Does this make Bitcoin a substitute for money? It was accepted as a medium of exchange by some but it only had a limited issue and it could function as a unit of account, but it failed as a store of value as its only value was what someone else would pay for it, and the value was highly (and unpredictably) volatile .
Bitcoin could not survive in the US unless it was issued by, cleared by or settled through a supervised bank which means it would have to incur regulatory costs. Remember that GoldMoney found the regulatory costs too high. JPMorgan Chase now has a patented method of making anonymous payments, through a Payment Portal Processor (PPP) an enhanced electronic wallet with automatic credit and form-filling features, that provides the user with a secure and guaranteed form of virtual cash . What distinguishes it from Bitcoin is that payments will still be processed using existing Electronic Fund Transfer (EFT) networks and the e-wallets will be stored on a host web server controlled by a bank.
What have we learned?
- Never boast that your internet system is “totally secure” it just attracts hackers who successfully hacked Bitcoin
- Do not avoid the regulatory authorities because they will not allow unidentifiable participants as part of your business
- There is a role for a cheaper way to transfer funds internationally, but Bitcoin is not it.
By Rae Wilson Dragon Wild Blue Pty Ltd
