The internet has revolutionized the way people communicate and share information, but up until recently, money and financial systems had remained pretty much the same. Sure, there were new systems over which to send money like PayPal and Skrill, but the system worked under the same old laws we all know. Until cryptocurrency was created.
Cryptocurrency, at its most basic is a form of online currency which is virtual and cannot be converted into physical currency. Nevertheless, it still has value, and that allows holders of cryptocurrency to exchange it with actual currency, just like a farmer would sell a cow to get some dollars.
The first major form of cryptocurrency ever created was Bitcoin, and it was created by a programmer that goes by the pseudonym Satoshi Nakamoto. To date, the creator of this cryptocurrency has not been identified, and some even speculate it may not be a single individual but a cabal of programmers.
How bitcoin works
The backbone of the bitcoin network is something called blockchain, which is like a ledger or database on which all bitcoin transactions are noted. Whenever a single individual from wherever in the world makes a transaction using bitcoin, this transaction is recorded in this ledger for everyone to see. At this point, things get a little confusing – if there were just a single ledger, then the entire bitcoin system would essentially be centralised, but it isn’t.
One of the amazing characteristics of bitcoin is that it is not centralized, which means that the blockchain is not stored in a single computer. Instead, the blockchain ledger is managed by a network of computers, and it is updated regularly to ensure all transactions are listed in the blockchain.
However, not everyone has access to the entire blockchain that notes all transactions since 2009 because it is simply too large - estimated to be over 65GB in size. This leaves the responsibility of maintaining this blockchain in the hands of several hundreds of users worldwide, but still keeps the integrity of the system. Since there are a lot of people with a copy of the ledger, then it is impossible for all of them to alter the entries in the blockchain.
To make the blockchain even more secure, it is turned into a hash. Basically a hash is the product of a mathematical formula applied to the entire blockchain, which produces a series of random numbers and letters in sequence after a synthesis of the data in the blockchain. The hash is then stored at the end of the blockchain in order to identify it since it is very difficult to go through the entire list of transactions in the blockchain. The hash makes the authentication of the blockchain simpler, and any changes made maliciously to the blockchain changes the hash, alerting the miner to realize of a possible hack.
The miner is basically one among many custodians of the blockchains, and they are collectively responsible for keeping the network secure.
Subsequent entries to the blockchain will be checked against the hash to ensure the transactions are legitimate, making the entire bitcoin network simpler, accurate and more secure.
As for the end user who wishes to buy bitcoin and use it for some purpose, they simply have to rely on the integrity of the server providing them with bitcoin. When this individual buys bitcoins, the number of bitcoins in the server are deducted and credited to the individual’s wallet. The wallet is like a virtual bank account where bitcoins are stored, and this can be in an online account, a smartphone app or hardware device. This transaction will then be broadcasted by the server to the blockchain where the value of the transaction is recorded.
Everyone’s wallet balance is visible, so anyone will be able to see how many bitcoins you have. To enhance security, though, your wallet balance is only assigned an account number, rather than your actual name, which is generated automatically through an algorithm in the bitcoin network that is virtually impossible to crack. In addition to your account number, a private key is also generated using an algorithm, which will act as your digital signature or account password whenever you want to make a transaction.
This private key is very important, since it is the only measure for securing your bitcoins. To receive bitcoins, you only need to provide your account number, but to send bitcoins, you would need to enter the private key as well. It is just a random series of characters which are unique only to you, and should be kept secret. There have been several cases of individuals who lost their private keys and basically lost all their bitcoins. You see, unlike a regular bank account where you can verify your identity using your passport or national ID card, your account number is generated randomly and there is no way of verifying the owner of the account.
History of bitcoin
Prior to bitcoin, there were other cryptocurrency systems available, but bitcoin was the first to create a system that was completely secure to protect people’s accounts and preserve their anonymity. The entire design is explained in a paper by the supposed creator Satoshi Nakamoto in 2008, and it became available in 2009.
The first ever bitcoin transaction was made on the 3rd of January 2009, in which Nakamoto created the first blockchain and rewarded himself 50 bitcoins. This is how new bitcoins are created, when a bitcoin miner creates a hash from a blockchain. As more miners got into the blockchain network, the reward for creating a hash kept reducing, but at the same time more bitcoins were created.
The reward for creating a hash is halved after 210,000 blocks are created, and this has brought down the reward to $12.5 at the moment. With more miners, though, and improving computer technology, the next 210,000 blocks will be reached much faster.
According to Nakamoto’s research paper, he estimated that the reward for creating a hash for bitcoin would reduce to zero by around the year 2140 when the number of bitcoins would reach 21 million in the world.
Reception of bitcoin
Needless to say, bitcoin has not been very well received by various financial bodies, but its increasing popularity has made it impossible to completely shut down. Although it is not recognized by the various banks offering Forex trading, many shops accept bitcoin as a form of payment, and so do major online stores such as Dell, Newegg and Zynga. Chief among the reasons why it has been so well received is due to the low rates of commission compared to credit card charges.
At the moment, there are over 100,000 known stores that accept bitcoin, and many more retail traders who also accept it.
Features of bitcoin that make it unique
Bitcoin is not only an online payment system as it was originally intended, but instead has become a form of currency on its own right. There are some characteristics of bitcoin, though, that make it very unique from other forms of currencies, and hence why it is still not officially recognized as a currency. To understand these differences, you have to understand what constitutes a form of currency:
- Acceptance – people must put their trust in the currency
- Durability – currency is not supposed to expire, which is why old notes are destroyed and replaced with new ones
- Portability – barter trade was very inconvenient because traders had to carry around large goods
- Divisible – most goods can’t be divided, but currency should have the capacity to be divided into smaller parts without losing value
- Limited supply – something is only valuable if it is not easily acquired
- Have intrinsic value – this is why money is so unique, to make sure it is not like regular paper
- Consistency – currency must have the same look as every other person’s currency
Bitcoin does not follow all these conditions that make a currency recognized in any bank or financial institution, but it does share some of the important aspects such as:
- Limited supply – bitcoins have been designed to have a sort of expiration date, estimated to be around 2140. To create or earn bitcoins, it takes tremendous computing power and energy resources, which makes the commodity have a limited supply
- Acceptance – bitcoins have become very widely accepted, and there are very many merchants who accept bitcoin as a form of currency including PayPal and Microsoft. There is even talk of bitcoin being accepted by the Japanese government for the payment of utility bills
- Consistent – bitcoins are universal, and they are all the same
- Divisibility – bitcoins are extremely divisible, and can be divided into a hundred millionth of a bitcoin, 0.00000001 bitcoin, which is even smaller than any currency
On the other hand, there are some characteristics of bitcoin which make it unique and thus equally favoured and disliked by various parties. For example:
Once you have exchanged your currency for bitcoin with a merchant, you are automatically assigned an account number which is generated using an algorithm and which is impossible to reverse. With that account number and a private key, you can then perform transactions without ever revealing your personal details.
Normal currency is not designed to ‘end’ in the future, in fact, the opposite is true. The amount of money in the world right now is more than it has ever been, and yet central banks keep printing money, meaning that there will always be money. This is not so with bitcoin, because the inventor Nakamoto put an upper limit of 21 million bitcoins, after which there would be no more bitcoins created. This measure would curb inflation and keep the value of bitcoin consistent from that point on.
All commodities are either tangible such as wheat, have intrinsic value such as gold, or have value because it is backed by the government such as fiat money. Bitcoin’s only value is in the faith placed upon it by individuals who use it and it is not backed by any institution or government.
Bitcoins are not monitored by any single institution, but are instead governed by mathematical formula. These mathematical formula ensure that the bitcoins cannot be forged and that there can never be an oversupply of bitcoins which would lead to inflation and the loss of value. This is unlike the current situation in the world where central banks print out more money to undertake certain activities and end up raising the rates of inflation.
Because of these characteristics, bitcoin has been termed as virtual currency by the United States Treasury Department and other financial bodies.
Other forms of cryptocurrency
Even though bitcoin is the most popular form of cryptocurrency, other programmers have come up with their own forms of cryptocurrency. At the moment, there are more than 275 kinds of cryptocurrency that use the same peer-to-peer methodology as bitcoin. There are so many forms of cryptocurrencies right now because the source code for bitcoin is open-source, meaning that anyone can download the source code and create their own cryptocurrency.
These alternative forms of cryptocurrency are referred to as altcoins and some of these are:
Compared to bitcoin, these altcoins are not very popular, and you may find yourself without a willing recipient while holding onto one of them. Then there are certain avenues for which each of the altcoin’s peculiarities makes it ideal.
Cryptocurrency as a trading tool
Now that you know exactly how cryptocurrency works and how it came about, you’re probably wondering how it could be of use to you as a Forex trader. Every investor knows that the only way to make money off a particular trading instrument depends on how much volume is being transacted, and there’s sufficient volume being traded every day to whet a trader’s appetite.
Ever since bitcoin became acceptable, it began to be treated as a commodity, although it is still not considered to be a form of currency. At the moment, there are numerous CFD trading Forex brokers who provide bitcoin as a commodity which can be bought and sold by traders, while there are also options to buy bitcoin futures or binary options.
Furthermore, bitcoin is among the most volatile commodities a trader can profit from right now. Compared to gold, for example, bitcoin is 7 times more volatile, and also 8 times more volatile than the S&P 500 index. Even compared to currencies, such as the US dollar which accounts for almost 80% of all Forex trades, bitcoin still has almost 18 times greater volatility.
Just yesterday, there were over 200,000 bitcoin transactions which amounted to trading volume of over $150 million. Considering that this week has been somewhat slow, you can imagine just how much volume can be traded when major financial news hits. Besides, bitcoin is quickly gaining momentum, which might just make it one of the most volatile commodities in the world. You see, it’s not just about the volume traded, $150 million compared to $5.1 trillion in the Forex market, but volatility creates chances for making huge profits.
Due to these reasons, bitcoin and other forms of cryptocurrencies can be used by Forex traders in various ways:
The value of bitcoin has grown exponentially since it was first introduced in 2009, when it was valued at 5 cents per ‘coin’. At the moment, the same ‘coin’ has a value of $628.51 when looking at Forex charts online, which is a dip from its highest ever value of $995.99 in January 2014 and the previous high of $785 in June 2016. Compared to other trading instruments like Forex exchanges, bitcoin is still a very small niche, with only about $20 million in value of bitcoin being traded in a single day. It’s gaining traction, though, and is even being traded every Monday in the Union Square in New York just like a trading floor on the NYSE.
This presents a great investment opportunity for speculators who see bitcoin merely as a commodity for hedging and have no intention to use it for purchases. Just like other commodities, there is a lot of volatility with bitcoin, and there are high chances of making a fortune off this technology. In fact, bitcoin may actually have a higher volatility despite the relatively low volume being traded, and this is what speculators thrive on. Despite statements from some detractors who have claimed bitcoin may be on its deathbed, evidence points to the contrary, and speculators can be confident when trading cryptocurrencies.
Given the high volatility of bitcoin and the concept of leverage provided by various Forex brokers, speculators may benefit a lot from trading this cryptocurrency. Not all brokers offer bitcoin as a trading tool, though, which is why a trader should be careful when choosing a Forex broker to know whether this commodity is available. You can find some of the bitcoin Forex brokers in this link if you’re interested in trading with bitcoins.
Contrary to what some people believe, bitcoin miners don’t create bitcoins, instead, they are rewarded for their job. We already saw how miners help to keep the blockchain secure by creating a hash, but did you ever wonder why someone would take that responsibility for themselves. This is it, for every hash created by a miner, they get a reward of 12.5 bitcoins, and given the current value of a bitcoin, you can understand why this would be a lucrative position.
Another relevant question in regard to mining would be, why not just mine bitcoin consistently? The simple answer is that bitcoin mining is very difficult. To create a hash, you only need a computer, and with modern computers which have high computation power, it’s possible to create a hash. At the start, back in 2009 – 2012, many miners used their personal computers to mine bitcoin blockchains, but now there are very many miners and the process had to be made more ‘difficult’. In fact, there is a difficulty metric in the bitcoin network which rates the difficulty of creating a hash from a particular blockchain.
The hash needs to look a certain way, with a specified number of zeroes at the start and then the subsequent characters. Mining software can create a hash, but the miner has no way of knowing what the final hash will look like. This decreased the chances of a miner creating a correct hash. In order to find the correct has, the miner would have to create many hashes before finding one that is acceptable, and this requires a lot more power that can be provided by a standard desktop computer.
Miners therefore need to find mining pools where they combine the processing power of several computers to create a kind of supercomputer in order to create a correct hash. This means that the miners would have to consume a lot of electrical power and time in order to get their reward.
How about a regular joe like you or me who does not have a network of miners to join? Well, there are now bitcoin cloud mining services, which one can pay for just like a subscription to Netflix. These companies probably have a supercomputer of their own which they use to mine bitcoins, and then share the rewards with all members who have subscribed. The subscription fee is just like a cost for the time and energy it took to create the hash.
Therefore, if you’re interested in bitcoin mining, you have several options, assemble your very own mining farm made of very powerful computers, join a mining pool or subscribe to a cloud mining service. Whichever you choose, you’re still going to enjoy the benefits of using bitcoins as a trading instrument.
Cryptocurrency as a payment system
Before transacting in your trading account, you first need to deposit money into your account. This can be done in various ways including bank transfers, credit card payments or using online merchants like Skrill and Neteller. None of these transactions are free, and there is always a fee charged as commission to the company facilitating the transaction.
A normal commission range could be anywhere between 2% - 5%, and some merchants may even have a lower commission. However, bitcoins’ commission rate is much lower compared to any other payment system in the world. Most of the transfers made from one wallet to another are free, but Forex trading companies may charge as little as 0.1%. This is very good news for any trader because it allows them to feel free to deposit a bigger bulk of their money into their trading account.
Watch this to learn more about how cryptocurrencies work -