Bitcoin

Foreword

When I first heard the term Bitcoin, I thought that it was only a virtual alternative for investing money and making profits. Since I had not been very interested in investment strategies, even though I had been having economy lessons for approximately two and a half years, I was not paying attention to it. At the time when the worth of the Bitcoin was increasing rapidly and this topic could be found in the media every day, I coincidentally watched a television program about it and I realized that it was not only an investment method, but also an alternative currency. That was the moment when I got interested in Bitcoin and I decided to write my Matura paper about it.

Introduction

In a world where the technical innovation is continually improving, the people involved tend to develop the payment methods further and further into virtuality in order to simplify monetary transactions. Earlier, the old-fashioned bartering was replaced by coins and bills that were given different values. Later, monetary systems started to get developed into virtual money, the balance being written down in booklets, even a long time before the invention of the internet. However, since then, money matters have not become simpler at all, although the payment methods have become easier thanks to credit cards and online payment procedures that include the use of those credit cards.

With all the national and commercial banks controlling the worth and amount of money in circulation, complex monetary systems have been established. In almost every country, there is a different currency, which is produced and controlled by the banks. Additionally, the nation is able to control taxes and interests, which leads to the society’s financial dependence on the government and the banking system.

In the past few years, more and more people have come up with the idea of a completely new and different monetary system. It is the vision of an alternative currency, called cryptocurrency, which is completely virtual, created out of nowhere and decentralized, which means that it cannot be controlled by anyone. This principle is based on a system called cryptography. The best known and most promising cryptocurrency is the Bitcoin. It is often utilized as an investment strategy to multiply money easily, but its function as a potential future global currency remains a vision so far. Whilst various investment experts have diverse opinions about the security and reasonability of investing in Bitcoin, the discussion whether it will be able to substitute conventional money throughout the world causes even more controversy. Nevertheless, the number of companies and shops accepting Bitcoin as payment is constantly increasing. However, there are not a lot of people using this payment method yet due to their deficient knowledge of the trade with Bitcoin.

It is the purpose of this paper to tell the story of Bitcoin and to give an understandable explanation of its technical functionalities . Furthermore, it will convey the fundamentals that are required for being able to trade with Bitcoin. Additionally, this paper will illustrate the advantages as well as the disadvantages of Bitcoin and its possible function as a global currency.

The History of Bitcoin

Prior to Bitcoin, there had already been different attempts to create a new currency based on the internet and with the main purpose of making online transactions more secure. However, all those attempts had not turned out to be successful over a long term. A short overview of some of them is given here: The first noteworthy electronic cash system was Digicash, which was created by David Chaum and launched in 1990. It had some technical disadvantages such as the dependence on centralized structures and the inability of preventing double-spending entirely. Due to this, it was doomed to fail in 1998. Other reasons for its failure might have been the lack of technological knowledge in people’s minds and the arising of the online payment system PayPal, which enabled electronic transactions using a credit card, but without directly interfering with a bank. Another mentionable attempt was a digital currency as an equivalent of gold and with the suitable name E-Gold. The cause for its failure was the dependence on its founder, Douglas Jackson. The currency was abolished as he confessed running an unlicensed money-transmitting business as well as laundering money. There were several more digital currencies, but the two above were the most successful ones, even though they were unable to survive.

Then, on 1st November 2008, the concept of a new, decentralized digital currency, the Bitcoin, was brought up. An unknown person or group with the pseudonym Satoshi Nakamoto published the announcement of Bitcoin on a cryptography mailing list. This announcement explained the purpose of Bitcoin and a detailed instruction of how it should work. This new currency was supposed to prevent double-spending with a peer-to-peer network, which means that the transactions are conveyed directly from the sender to the receiver without the involvement of any third parties such as banks. Another key property was that all participants would be guaranteed anonymity. Furthermore, new virtual coins would be created when transactions are made rather than being generated by a central force, explaining the term „decentralized“.

However, since Bitcoin’s code was rewritten many times, and only about a third of it is originally from Nakamoto, it is wrong to say that he is Bitcoin’s sole author. One important co-author is Hal Finney, who was one the first to believe in Satoshi’s concept and cooperated with him (or the group), trying to improve the code. Finney was also the first person to receive a real Bitcoin, sent by Nakamoto in the beginning of 2009. Slowly, the cryptocurrency, as the programmers Gavin Andresen and Martti Malmi called it, began to take off. However, in early 2010, although the technical aspects were looking good, there was still nothing to buy with this new money. It was in April of that year when the first purchase with Bitcoin took place. An enthusiast called Laszlo Hanyecz got someone in a Bitcoin forum to send him two pizzas with the value of about 25 US dollars in exchange for 10,000 Bitcoins, which would have been approximately 200 million US dollars at the moment when Bitcoin reached its all-time high at the end of 2017.

Until July 2010, there was still no comfortable way of trading with this currency. This changed dramatically when Jed McCaleb launched the Bitcoin exchange platform called Mt. Gox. Now, everyone was able to buy and sell Bitcoins for „real“ money. In February 2011, the first products could be bought. A person identifying himself as Dread Pirate Roberts started the online

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