Continued from Big Picture part 1/3.
Now you might be thinking that this new Bitcoin sounds all very well, but what are the risks and how does it work? If there are no government controls at all and transactions are totally private, then can’t it be used by criminals and what happens if my Bitcoin gets lost or stolen? These are good questions that have only been partially answered by Bitcoin supporters.
It is true though that with no controlling organisation, it means there can be no-one to complain to if things go wrong. The police, however, will investigate Bitcoin fraud and some companies insure themselves against losing your Bitcoin which means there is a basic level of protection if you use those companies. This is a start, but there are still major issues around hackers and scams aimed both at individuals and exchanges where a lot of cryptocurrency is stored. Criminals do use Bitcoin but it’s not as untraceable as they thought, with many now in jail.
Many of the websites and apps too are not as easy to use as they should be. They are still often made for computer and financial wizards, not normal people, which makes it too easy to accidentally and permanently lose your money with a slip of the mouse or finger. There is no customer service department to complain to or reset a forgotten password. Things are quickly improving in this area but still, do your research and understand what is happening to your money. More on this in a future article.
Now, you might be confused here because I’ve just talked about using Bitcoin companies right after I said that there is no company that controls Bitcoin. Bitcoins and other cryptocurrencies are held on the internet, on a ‘blockchain’, which is (usually) not controlled by any company. To buy, access and spend your crypto though, you need to use software and/or online services such as exchanges and wallets. In practice, that means software and services produced by companies. Wallets are usually free, but exchanges will usually charge you a fee. As you would expect, some companies are better than others and they all do things slightly differently, so you need to understand what is going on before signing up.
There is also a fee whenever you send any crypto to someone else. This fee doesn’t go to a software company but to the companies that provide the services which run the cryptocurrency network – the blockchain. On the Bitcoin blockchain, they are called ‘miners’, while other blockchains call them other names such as ‘validator’. In return for processing transactions on the Bitcoin blockchain, miners receive a fee from the sender and are allowed to create new Bitcoin for each block of transactions (currently B6.25). Hence, miners ‘mine’ for Bitcoin. No, Bitcoin mining has nothing to do with picks and shovels.
Only one miner receives the fee and the new Bitcoin for each block. All the thousands of miners in the world have to compete for the right to bundle the recent transactions into blocks and receive the reward. Miners compete by calculating a mathematical problem and the first to get the answer wins. In Bitcoin, this is called ‘Proof of Work’, because the miner has to prove they have spent resources (computer power and electricity) on solving the calculation to get their reward. This mining process triggers two common criticisms of the Bitcoin network, however.
The first is that all these miners need a very large amount of computer power to compete, which uses a very large amount of electricity. An extremely large amount. In total, more than is used by some small countries. Obviously, this isn’t very eco-friendly. Some miners have located themselves where there is cheaper renewable power or have solar panels so they can make their own power for free, but most take it from their local grid.
The second criticism is that the ridiculous amount of electricity used has meant that countries with cheaper energy have most of the miners. Some of the cheapest electricity is in China, so about 65% of the world’s mining power is located there. In theory, if they all acted together they could pose a threat to the Bitcoin network’s security. In practice, however, they combine computing power from around the world into pools which they have little control over. Also, the Chinese government tolerates the miners but isn’t friendly to them, so some are moving to locations such as Canada where they can get non-expensive hydroelectric power.
If the Bitcoin network is run by the miners, then can they be hacked? In theory, yes, of course. But, Bitcoin was designed assuming it would be under constant attack and so far, none have been successful. This is because to attack the Bitcoin blockchain you would need to use the Proof of Work mechanism which is expensive in terms of electricity. So expensive in fact, that it actually works out cheaper to just be a standard miner than to attempt an attack. Also, it would be impossible to hide a successful attack, leading to a general panic, so any Bitcoin you stole would immediately crash in value as people left the network. In Bitcoin, honesty is the cheaper policy.
Bitcoin was designed as a currency, but the blockchain technology behind it can do much more than just create digital money. Other cryptocurrencies have since been invented which are challenging whole industries. More in the next article.
The Big Picture continues in article 5 – The Alts.
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