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What are Bitcoins? – Gold for Geeks?

Does the Fiendishly Clever E-Money Algorithm Mimic the Role as Gold as a Store of Value?

by Xavier Basil

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Bitcoin’s Unknown Progenitor

Bitcoin as a concept – and a working product – appears first to have been publicised by someone calling themselves the said Satoshi Nakamoto in a post to The Cryptography Mailing List, then hosted at an obscure domain, on 1 November 2008. It probably doesn’t matter too much who invented bitcoin as a digital medium of exchange, any more than it’s relevant today to know which ancient community first started to treat gold as a store of value. But whereas we all know pretty much everything there is to know about gold – as a substance and as an investment product – exactly what makes bitcoin tick remains something of a mystery to most people outside the computing sciences.

Peer-to-Peer – The Key to Bitcoin

So before we can make a meaningful comparison between gold and bitcoins, we need to have at least a basic understanding of the latter. Here’s how its inventor conceived it:

A purely peer-to-peer version of electronic cash [which] would allow online payments to be sent directly from one party to another without going through a financial institution.

Interestingly, apart from its use in the title, the word ‘bitcoin’ is not anywhere employed in the paper and use of the world ‘coin’ to reference the payment mechanism is restricted to just 16 occasions in the 3,200-word document. It’s apparent that the marketing of brand ‘Bitcoin’ was not high on its progenitor’s priorities at the outset, which may explain why he/she suddenly dropped out of sight during 2011 and hasn’t been heard from since.

The notion of ‘electronic cash’, aka ‘electronic money’ and ‘electronic funds transfer’, is of course not especially new. In the modern usage of the terms, they’ve been around pretty much since the advent of the Internet but the idea of transmitting monetary value electronically – rather than the movement of physical money – has been with us since the first ‘wire transfers’ were sent by Western Union over its telegraph network in 1871.

What makes bitcoin special is that expression ‘peer-to-peer’ (known to the cognoscenti as ‘P2P’). By virtue of the algorithm – some 30 thousand lines of code - which both created bitcoin as a payment mechanism and which gestates each new unit of the ‘crypto-currency’, validation of the issue and subsequent transfer of a given bitcoin is performed not by any central authority – a bank or a ‘mint’ – but by a networked array of computers performing a ‘mining’ function. Those computers can be operated by anyone, anywhere in the world, who has downloaded the open source software and assembled the number-crunching hardware needed to perform the extremely complex ‘hash’ calculations which provide validation of both the existence and transaction of bitcoins.

Bitcoin Mining – The Elegance of the Solution

The original generation of bitcoin data ‘blocks’ – back in 2009 before the concept memed – could be and was performed on bog-standard PCs, in homes, offices and university dorms, by anyone who’d (a) become a believer and (b) had the necessary tech capability. The algorithm is so constructed that the earliest issued bitcoins were also the easiest to mine – by deliberate analogy with gold mining – and as the rate of issue increases, so does the degree of difficulty in block generation. It works in reverse too – if the hash solution becomes too difficult, measured by the time taken to reach it, the difficulty level is eased off to compensate. And the whole process is automatic, with no human intervention needed. In ways unknown to ordinary folk, Satoshi Nakamoto (as he then was) has seemingly written the most elegant solution to a P2P payment mechanism yet conceived.

The easy money in bitcoin mining has already been made, by the early players – tech-savvy people, mostly in the United States, in on what was an open but little-known secret and who pointed significant computing resource at the process when the math was relatively easy – relative to now and in the future - and when each solution (or ‘block’) was rewarded with the issue of 50 bitcoins. Now, and again by analogy with the experience in real-world gold mining as a mine is increasingly worked, the bitcoin product is getting harder to locate, with progressively more computing effort needed to produce the solution for each new block and the reward halved to 25 bitcoins.

Today, bitcoin mining to make money, ie to earn new bitcoins, is beyond the capabilities of ordinary computers. Your PC will eventually get there but long after the bitcoin-producing numbers have been crunched by someone else, in the process invalidating your own effort. Serious players are now either using expensive GPU (graphics processing unit) hardware with many times the computing power of even the most advanced CPUs, or operating in pools, organised by providers such as ‘the Slush Pool’ at mining.bitcoin.cz, in which earnings in awarded bitcoins are shared amongst the pool members.

This built-in halving will progressively continue and the rate of issue will reduce in sympathy out into the future, with the mathematical likelihood being that, whereas most of the 21 million bitcoins provided for in the algorithm will be issued over the next 20 years, the last of them will finally trickle out around 127 years from now, in 2140AD.

Bitcoin and Gold – The ‘Known Quantity’ Factor

Let’s move now to examine the similarities or otherwise between bitcoin and gold. They’ve certainly been getting a lot of mentions in the same breath in the past month or so, since the world suddenly woke up to bitcoin. We can start with ‘rarity’ – an attribute routinely cited as central to the enduring appeal of gold as an investment product. Although no-one knows how much of the precious metal is available to be extracted, or how much will be brought to market in the future, an important part of gold’s perceived value lies in its relative scarcity. This is a key factor, so its advocates argue, in differentiating gold from fiat currency, the supply of which can be inflated at the will of the issuing government, with each fresh printing devaluing those units issued before.

With bitcoin, as with gold, its advocates argue that an equivalent scarcity is to be maintained with the universal knowledge that no more than 21 million units can be issued. But actually, it’s not quite that simple. The algorithm is so written that each bitcoin is subdivisible to eight decimal places, allowing for units denominated at 0.00000001 of a bitcoin, with each such unit being dubbed a ‘satoshi’ in honour of the late pseudonymous founder. Given that there have been 11,036,475 bitcoins dispensed at time of writing, there are currently 1,103,647,500,000,000 – or 1.104 quadrillion in round figures – bitcoin ‘satoshis’ on issue, each with a notional value in US dollars or any other nominated currency determined by trading on the various bitcoin exchanges.

By contrast, according to the United States Federal Reserve there is currently around $1.18 trillion in US banknotes and coins currently in circulation, with the smallest subdivision – one cent – making them roughly 9.3 times scarcer than bitcoin ‘satoshis’. And whereas the number of US dollars on issue cannot be increased without the printing or minting of fresh units, there is still a long way to go before the total number of bitcoins provided by the algorithm are in play.

Presently of course, ‘satoshis’ as a payment unit each have a microscopically small value. Nevertheless, and viewed in this way, bitcoins are not really scarce at all. As their value increases, should that happen on a long-term basis, so the subdivisions, into tenths and hundreds – perhaps one day one hundred-millionths (the ‘satoshi’) - will become more relevant. And whilst bitcoins could conceivably be renominated, as has happened with conventional currencies in the past and with their subdivisions being reduced accordingly, this must necessarily and profoundly affect the critical mining process by which bitcoins come into being and are transacted.

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