General
Imagine a scenario where four friends A, B, C, and D meet at lunch at a fancy restaurant where A pays the bill and all of them mutually decide to distribute the expense amongst each other equally. Once B transfers his share online to A, his transaction gets through without a problem, however, once C and D try to do so, their transactions do not get through and get declined despite trying many times. There could be multiple reasons; some technical issues with the bank; account malfunction/hacked; daily transfer limit reached exceeded; or even hidden charges being levied on each transaction. This led to the emergence of the concept of Cryptocurrency. This article is aimed at explaining, at a very basic level, to the readers what happens behind the scenes of Bitcoins and Block-chain networks without getting overly technical for the ease of readers.
The Origins of Cryptocurrency
Cryptocurrency is an alternative form of payment (digital/virtual) created using cryptographic techniques/ encryption algorithms. The name itself indicates the fact that all of its trans- actions are highly encrypted making them extremely secure. These are immune to counterfeiting; do not require a central management authority (bank) and require strong and extremely complex encryption algorithms. According to one estimate, there are over 21,000 cryptocurrencies in the market (November 2022) out of which roughly 9000 are active including Ethereum, tether but the leading one remains Bitcoin.
The Shortcomings of Current Transaction Systems
A few shortcomings of the current transaction system include:
⦁ Transaction and settlement time was relatively longer.
⦁ Presence of intermediaries like banks etc. added to inefficiencies.
⦁ If an intermediary (bank) is compromised through cyber-attacks, frauds etc. risks increase.
⦁ In the case of credit cards, merchants have to face a large pile of paperwork besides high onboarding costs.
⦁ A large number of people around the world do not have bank accounts, thus resorting to other payment procedures.
The Origins of Bitcoin
On 15 September 2008, Lehman Brothers, the fourth largest Investment Bank in the United States filed for bankruptcy with over 25,000 employees worldwide losing their jobs. Organizations and individuals lost vast sums as they invested in Lehman Brothers and its related businesses. At that time, it had $639 billion in assets and $613 billion in liabilities. Its failure had devastating effects on the financial and international banking system resulting in the loss of people’s faith in banks to an extent that in January 2009, a new form of currency, which even did not have any formal bank at its back, came into existence, the “Bitcoin”. Satoshi Nakamoto (person or persons) presumably developed bitcoin during the financial crisis and later wrote a white paper on it too.
What is Bitcoin?
Bitcoin is a digital currency that is quite different from other non-digital currencies. It is neither owned nor controlled by anyone which makes it quite decentralized, open, and public. It is like an online version of cash and can be used to buy products or services like other paper currencies, however, as of November 2021, a total of nine countries (Algeria, Bangladesh, China, Egypt, Iraq, Morocco, Nepal, Qatar and Tunisia) have banned cryptocurrency completely. On the contrary, according to one survey, companies have started accepting Bitcoins including Wikipedia, Microsoft, Burger King, KFC, Subway, AT&T and the list goes on.
How Does Bitcoin Work?
Bitcoin relies on peer-to-peer software and cryptography. It exists on its own network that facilitates fully encrypted, online transactions directly between its users/accounts without the need for an intermediary (bank/ credit card company) to validate its transactions. This simply means that people can send Bitcoins to each other at any time, from anywhere in the world without involving any bank or money transfer companies/services.
A large number of machines (called nodes) around the world run the Bitcoin software that provides the network with its essential functions. This vastness, across the entire globe, makes it practically decentralized and extremely difficult to shut down should any government or organization ever wish to do so. The success of Bitcoin is generally referred to the fact that no government or organization can control its value as well as to its highly transparent and automated monitory mechanisms. Every transaction is auditable, irreversible and there for everyone to see. This is primarily because every confirmed bitcoin transaction is added to a public (for all to see) ledger, called the “Blockchain” maintained by the miners.
What is Bitcoin Mining?
The creation of new bitcoins and bringing them into circulation is known as Bitcoin mining. It is a process to ensure Bitcoin transactions are validated on the Bitcoin network and added to the blockchain ledger. It is done by solving complex mathematical and cryptographic puzzles to verify blocks of transactions that are updated on the decentralized blockchain ledger. Solving these complex mathematical puzzles requires sophisticated hardware with immense computing power. When a bitcoin is successfully mined, the miner receives a predetermined amount of bitcoin which is then released into circulation. Hence, through mining, one can earn bitcoins without having to invest money in them.
Fixed Supply-No Indefinite Production of Bitcoins
Government-issued currencies can be printed indefinitely giving rise to problems like inflation and decreasing buying power. There is no such thing as the indefinite production of bitcoins as there will never be more than 21 million bitcoins. Since an indefinite number of bitcoins could generate wild price swings, the inventor set a 21 million bitcoin limit to control the sup- ply and eventual price fluctuations. As of today, out of 21 million bitcoins created and added to the network, only around 19 million have been mined with only 2 million bitcoins left to be mined.
Why Only 21 million Bitcoins?
Bitcoin’s inventor, Satoshi Nakamoto, capped the upper limit of coins at exactly 21 million. It could be due to the scarcity of coins as a limited number of coins is an advantage to its holder. The scarcer an asset is, the more valuable it will remain. Keeping it limited will ensure that it remains steady for years.
The limited number could also act as a hedge against inflation. A finite number of coins will also keep inflation under control which can rise from an unlimited number of bitcoins. Historically, gold and real estate have been standard assets that were considered protection against inflation. These days, Bitcoins managed to work as a hedge against inflation that also delivers massive returns.
What is Bitcoin Halving?
We have seen that the supply of paper currencies rises and falls under the supervision of central banks, but the total number of bitcoins is fixed and immutable (21 Mn coins only). At present, slightly over 19 million bitcoins have been mined meaning there are just under 2 million left. Satoshi Nakamoto programmed the bitcoin protocol in a way that every four years, Bitcoin halving occurs with a view to preventing bitcoins from becoming less valuable over time.
Bitcoin halving is when the reward for bitcoin mining is cut in half. This halving protocol was deliberately writ- ten into the Bitcoin mining algorithm by Satoshi Nakamoto to counter in flation by maintaining scarcity. Theoretically, if the bitcoin issuance rate re- duces, there will be an increase in price if the demand remains the same. For example, currently, bitcoin’s annual inflation rate is approximately 1.8% (only to decrease over time) compared with the over 25% annualized inflation rate in Pakistan. So, even if the reward for miners is cut in half, the actual value of bitcoin increases considerably encouraging the miners to keep on mining and earning more coins as a reward.
Bitcoin Halving Timeline
The Bitcoin algorithm (code) has de- fined that after every supply of 210,000 coins or roughly after every four years, the reward would come down by 50%.
Bitcoin Halving 2012
The first Bitcoin halving was carried out on 28 November 2012 after re- leasing a total of 10.5 million BTC after making the first 210,000 blocks with the coin valued at US$ 11.
Bitcoin Halving 2016
The second halving was done on 9 July 2016 after releasing a to- tal of 5,250,000 BTC mining a total of 420,000 blocks (another 210,000 blocks since the last mining) with the coin price fluctuating between US$500
⦁ US$ 1,000 before finally touching US$ 20,000 in December 2017.
Bitcoin Halving 2020
The latest halving was done on 11 May 2020 after releasing a supply of 2,625,000 BTC. The coin price at that time was US$ 9,000 reaching US$ 30,000 by December 2020.
Effects of Halving on Miners
After the first halving in 2012, the reward (earned by miners who successfully add new blocks to the end of BTC’s blockchain) for miners was reduced from 50 BTC to 25 BTC (exact half); after the second halving in 2016, the reward was further reduced from 25 BTC to 12.5 BTC (exact half); the latest halving in 2020 reduced the reward from 12.5 BTC to 6.25 BTC (exact half) and the next halving in March 2024 would further reduce the reward from 6.25 BTC to 3.125 BTC (exact half).
This permanent change in the re- wards system for newly-minted Bit- coins is Satoshi’s vision for designing a deflationary, digitally-scarce crypto asset. If the rewards were not halved and made permanent at 50 BTC by Satoshi Nakamoto, the supply of coins would have been exhausted long ago. So, it is safe to say that halving actually extends the life of Bitcoin. If there are lesser people who mine in the coming years, it will take even longer time to reach 210,000 coins ensuring that the reward will remain the same for a long time.
What happens after the next Bitcoin Halving?
The next BTC halving is expected in early 2024 with a coin release supply of 1,312,500. As mentioned above, the miners’ reward will further be reduced from 6.25 BTC to 3.125 BTC. Bitcoin’s halving is one of the major reasons for its increasing rate today. Had there been no halving, it would still be worth only a couple of dollars.
What after all 21 million BTC have been mined?
It is estimated that around 2040 all BTCs will have been mined and this would be the point where the halving schedule or process would stop and the miners will no longer receive rewards in the form of newly minted coins. However, miners will be incentivized to continue validating transactions through the reward of transaction fees paid by users. Given the enormity of the BTC network at that time, it can safely be assumed that the transaction fee will also be high, there by rewarding and encouraging miners for continuing to support the network.
Will 21 million BTC be mined by 2040 or 2078?
The halving mechanism introduced by Satoshi Nakamoto actually halves the number of available BTC by every three years and 9 months and if this trend continues to be as such with all other factors as constant, all 21 million BTCs will be mined by 2078. The confusion surrounding the BTC supply end date as 2040 is primarily because people assume that halving is done after every four years instead of three years and nine months.
Can the limit of 21 million BTC be increased?
The number is fixed; known as the hard cap and is encoded in Bitcoin’s source code. Can it be changed is an interesting question. Miners, who spend a lot of resources would like to defend their revenue stream by removing the limit, however, for the reasons mentioned below, this change will not occur:
⦁ Removing the hard cap would affect its core philosophy i.e., its scarcity. Organizations and individuals con- sider this scarcity as a motivator; a fundamental driver for its growing value and they would not like it.
⦁ Removing the cap may slightly increase miners’ revenue, however, there would be a big dent in the faith of people in the Bitcoin network which may result in an irreversible price collapse affecting miners as well. In short, if Bitcoin prices reduce, miners lose.
⦁ There are hundreds of Bitcoin source code versions and tens of thou- sands of nodes in the Bitcoin network that run independent software (both old and new versions) and it would be virtually impossible to convince these large number of nodes to adapt to any changes.
⦁ Miners are merely producing new blocks and validating transactions. They do not set or control rules. When they produce a new block to the network, these large number of nodes independently verify this block and make sure that it produces an appropriate number of new bitcoins. These nodes will reject any/all blocks that violate these rules.
Bitcoins Pros
No Physical Boundaries and Liquidity
The biggest advantage of crypto- currencies is that it sees no borders and BTC is no exception either. It can be used to buy goods from an ever-increasing list of places accepting it which makes spending easier in any country. Besides BTCs can be sold at any time, at any place.
Fast Transactional Speed with Lower Transactional Fee
Conducting payments across different countries may cause a delay which could be frustrating for firms and even individuals who regularly conduct online transactions. Unlike paper and other virtual currencies, Bitcoin transactions are much faster with extremely low transaction fee primarily because such transfers do not involve any banks (no processing fee, bank charges etc.).
Payments through your Mobile Phones
Transactions can be made with your mobile phones besides purchasing online goods and services with your digital wallet.
Reliance on Blockchain Network
Bitcoin uses the Blockchain network (explained in subsequent paragraphs) during transactions which thorough- ly verifies each transaction. The data stored in a block can then not be edited, altered, or deleted which makes the transaction secure.
Extremely High Return Potential
In March 2017, Bitcoin was priced at $975.50; in December 2017, it went as high as $20,089 and in April 2021, it touched $64,000. Yes, it appears volatile but is also considered a digital currency with high return potential. Some believe that Bitcoin will even reach $500,000 in 2025. With the growing number of investors and businesses deciding to adopt it, it could be a reality too.
Bitcoin Cons
Highly Volatile
Despite its glaring advantages, Bitcoin is also considered highly volatile owing to its uncertain future (what will happen once 21 million BTC are mined) and what if businesses decide not to accept it as a mode of payment in the future.
Absence of Government Regulations
The absence of intermediaries (banks) is considered a benefit, but it can also be viewed as a disadvantage as unlike paper currencies, Bitcoin transactions do not come with legal protection.
Irreversible Transactions
With no reversal mechanism embedded in the system, transactions sent to the wrong recipient are practically lost. Besides, if the wrong amount is sent, cannot be corrected, either.
Risk of Loss
In case, the Bitcoin owner who keeps his investment in a cryptocurrency wallet loses his public key, could lose his investment.
Limited Acceptance Throughout the World
Despite the fact that large organizations like Microsoft, Burger King, KFC, and Subway are accepting BTC, it is still not widely accepted which puts a limit on where one can spend money.
Is it worth Investing in Bitcoins?
Despite some glaring advantages of using cryptocurrencies, particularly Bitcoin, many still view it as a risky investment. Understanding how crypto wallets work, how the crypto market operates, what are the associated risks and how much you are willing to lose in case it happens would be vital before taking any decision.
How is Bitcoin related to Block- chain?
Blockchain is just a technology and many cryptocurrencies including Bit- coin use Blockchain in order to carry out secure and anonymous transactions. Blockchain is merely a mechanism with much more uses as com- pared to Bitcoin which only deals with the exchange of digital currencies. Blockchain is a transparent mechanism as compared to Bitcoin which operates on anonymity.
How is Crypto related to Block- chain?
Blockchain is a storage technology used for saving data on decentralized networks and enables the existence of cryptocurrency beside other things whereas Bitcoin is the best-known cryptocurrency for which blockchain was originally created.
What is Blockchain?
Historically, in order to make transactions of anything valuable like money, people and organizations have been facing problems regulating trust amongst each other and thus relying on third parties; intermediaries; a central authority like banks or governments to ensure trust and avoid fraud. These banks or intermediaries perform a host of functions to insert trust into the transaction(s), however, over time, this reliance on third parties has given rise to problems for which the idea of blockchain emerged which can cater for the trust deficit and other fraud-related issues. For example, a bank can mistakenly transfer $2000 instead of just $20 and not only will it take days for you to figure out the mistake, but it will also take weeks to get the money back. There could be another host of other issues in bank-dependent transactions. Blockchain allows us to take back some degree of control without the need for a middleman (bank). Let’s take another example; the only thing needed in a simple money transfer is a registered transaction. Can this transfer be done without involving a bank? Can we somehow maintain a transaction log between both (or multiple) transacting parties only instead of some centralized bank doing it for us? Yes, this is precisely what Blockchain is supposed to do. Without a middleman, Blockchain allows consumers and suppliers to connect directly. According to IBM, “Blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network.”
Why is it termed as “Block- chain”?
Blockchain takes its name from the way it stores transaction data i.e., in blocks that are linked together to form a chain. With an increase in the number of transactions, blockchain also grows. These blocks record the time and sequence of transactions, which are then recorded into the blockchain within a discrete network and governed by rules agreed on by the network members.
As can be seen in figure 1.1, each block contains a “hash” (a unique ID), recent valid transactions, as well as the hash of the previous block. The hash of the previous block actually links the two blocks together; does not allow any block to be modified/altered, or even does not allow any block to be inserted in between thereby strength- ening the entire blockchain.
Why use Blockchain?
Greater Transparency
Whenever a transaction takes place using Blockchain technology, every single member can see when was the transaction made; how much money was transferred/exchanged, etc. This visibility makes the transaction clear, speedy (in minutes) and anyone can verify the same.
Enhanced Security
Cryptocurrencies are independent of third parties thereby minimizing hu- man interactions and free from bias- es. Cracking blockchain would require extremely efficient hardware with ex- orbitant computational power and a lot of time. It is free from fraudulent
activities as the system independently processes the transactions. Theoreti- cally, it may still be possible to crack blockchain but in reality, it does not make sense for anyone to try.
Optimum Efficiency
Blockchain simplifies things for everyone. With the minimal cost of transactions coupled with extremely low time to complete a transaction, it proves to be extremely beneficial for executives, business partners and in- vestors alike.
Completely Digital
With the kind of transparency block- chain has, there is nowhere to hide. Everyone has a detailed record of every transaction. If someone still tries to do something bad, one’s account can be linked to the bad act; and made to suffer by increasing one’s insurance costs.
Data Protection
Blockchains are popular for being Immutable i.e., data that has been verified and added into the blocks cannot be altered or deleted in any way.
Instant Traceability
Industries these days are wary of counterfeiting or fraud; a problem Blockchain can easily resolve by creating an audit trail that documents everything at every step. Sharing data about provenance directly to the customers is also possible. instant traceability can also highlight weaknesses anywhere in the complete system.
How does it work?
Allowing digital information to be recorded and distributed but not altered is the main purpose of blockchain which then makes it a pioneer for immutable ledgers (records of transactions that cannot be edited, altered, deleted, or even destroyed). That is precisely why it is also termed as Distributed Ledger Technology (DLT). The first widespread application of the blockchain concept emerged in 2009 – The Bitcoin. Let’s see how a transaction gets into a blockchain (how it works) figuratively:
How does a transaction get into the Blockchain?
Can there be other Uses of Blockchain?
Digital currencies are just the tip of the iceberg when it comes to the utility of Blockchain. There are numerous areas where blockchain technology is used without the necessity for use of bitcoins or other cryptocurrencies. A few areas include:
⦁ Voting in elections
⦁ Improving Logistics and Supply Chain Efficiencies
⦁ Improving Healthcare Inefficiencies
⦁ Securing the Internet of Things (IoT) Networks
⦁ Real estate
⦁ Insurance
⦁ Reducing the cost of data breaches
⦁ Securing national identity data etc.
Blockchain and Pakistan
Pakistan deployed blockchain technology for the first time in 2008 in the banking sector for cross-border remittances from Malaysia to combat terror financing and money laundering. This will make the financial transactions more secure and speedy besides logging each and every step taken both by the sender and the receiver of any remittances which will also help combat the Hundi (a form of remittance instrument to transfer money from place to place) and Hawala (money transfer without money movement) systems. It is worth mentioning that the deployment of Blockchain does not mean that Pakistan has accepted international financial transactions in Bitcoins or cryptocurrencies, which is still banned in Pakistan. It has just allowed the use of block- chain technology which has a large number of other uses besides crypto- currencies.
Conclusion
“Long Island Iced Tea”, a New York- based beverage maker announced that they want to change their name to “Long Blockchain Corp.” as they want to focus more on Blockchain Technology. The mere announcement, without any measures to shift towards Blockchain Technology, sent the company’s stock surging by nearly 300%. GPSs have shifted the focus from paper maps and barely anyone these days uses paper maps and memorizes tips and turns; smartphones have transformed mobile technology to an extent where it is now not just mobile anymore; google has made information accessible to our fingertips; rideshare applications like Careem, Indrive, Uber, etc. have generally out- classed traditional taxis in many ways. The point is as these technologies have become a normal part of our society, blockchain is likely to do so in the near future as it has the capability to create a trusted, unfilterable, un-editable repository of data and information accessible to all.
Adopting blockchain, wherever it can be adopted, would help us redefine many of our systems and create better business structures that are more secure, trustable, and efficient.
