I've been thinking a lot about Bitcoin lately and decided that I really wanted to understand it better so the decision was made to compose this essay. After doing a ton of research it became apparent that this technology can be seriously disruptive but that many people don't yet understand the value it can bring. Hopefully this essay will help fill in the blanks for people who don't quite yet understand completely how it works.
Bitcoin has the capability to be an extremely disruptive technology but it still has a lot to prove. In order for it to really take off, more people need to start using it as an exchange of value. The ability to make everyday purchases with it will certainly help its adoption rate increase. As it stands, many traders and some early adopters are treating it more like a speculative financial instrument, holding it in hopes that the price will increase the way it has been moving over the past six months. But there could be a higher adoption rate if more people would start spending it on goods and services. After all, Bitcoin could be the next natural step in the evolution of money. So how can we get more mainstream adoption, what else can it do, and what could it look like in the future?
For starters, Bitcoin is the first real money (currency) to be born on the internet and used in the real economy. There are over 12.85mn Bitcoins in circulation with a total market cap of $8.3bn. This is astounding seeing as how it was basically mined out of thin air not more than five years ago after Satoshi Nakamoto released his paper. But what is even more astounding is that as a protocol for the exchange of value, it does not need any intermediary (such as a bank or credit card company) to make a transaction happen. All transactions are validated using its public ledger, known as the block chain, by miners. These miners essentially donate their computer power in exchange for the chance to gain Bitcoins. There is also a fixed supply of 21bn coins and no monetary authority creating them. So what does this mean for Bitcoin as a store of value? It means they are deflationary and since no central authority can make monetary decisions with it, it cannot be defended with policy actions.
So what differentiates Bitcoin from other financial technologies? First of all, it is peer-to-peer meaning there is no need for an intermediary to validate any transactions as I stated earlier. It is also open source and yet still securely authenticated with the combination of the miners and block chain validating each block. I won't go into the security mechanisms but I highly recommend anyone read the original paper as it is described how it works there. Finally, it is a self-propelling because it uses its own product to pay the miners who are authenticating each transaction. It is able to function properly based on all these actors and processes participating within in its system.
In order for this system to truly work though there needs to be a higher adoption rate. But it order for that to happen Bitcoin needs to be used more as store and exchange of value, not as a highly speculative financial instrument. With price volatility occurring almost on a daily basis, there could be more cause for concern among people who have not adopted it yet. And eroding the trust of potential users is not what the community should want. If more governments begin offering guidance, then more businesses may be willing to start accepting it, giving consumers a better reason to spend it. However, too much guidance may cause potential entrepreneurs to balk at regulations. Security concerns will also top the reasons for a low adoption rate and the implosion of Mt. Gox sent many negative signals to potential users. There simply needs to be tighter security implemented into future banks and exchanges. Perhaps following the protocols of traditional banks should be looked into.
Beyond it's currency aspects, there are many other products and services that be built using this technology. For one, it simplifies the process of transferring assets. This is where the block chain really comes into play. For example, by denoting small portions of Bitcoin as physical property, also known as colored coins, it can then be used to publicly identify who currently owns a piece of property, the record of past ownership, and the history of that property. Think of titles of cars, financial contracts, and real estate. Each owner of these coins could then directly transfer their property with out the need of an outside broker (such as a lawyer or notary).
Identity management is another idea that could be implemented with block chain. For example, instead of needing a passport to travel from country to country, one could simply provide their public key, which could then be implemented as an entry on some block chain network. This concept could also be applied to IP addresses where each address is a payment layer. I didn't have time to dig to deep into this idea so I recommend reading this post.
But for any of these ideas to take hold there must be a healthy amount of trust among potential adopters. In order for that to happen, the current Bitcoin community should work on solving those trust and security problems. Another exchange meltdown, security problems, and continued high volatility will create more problems for the system and ultimately keep it from potential new adopters. Although it goes against many of the early and current opinions of how Bitcoin should work within the system, governments that issue guidance and create safeguards for mainstream consumer protection could help the benefits of the technology become more realized.
Bitcoin is a great example of how a truly new and revolutionary technology can seemingly pop out of nowhere. And consumers, companies, and governments should keep a close eye on it because of its potential for impacting many aspects of our lives on a daily basis.