Blockchain & Bitcoin

To truly evaluate Bitcoin's novelty, its potential impact, and the challenges it faces, we must look past the hype and delve deeper into the details of the protocol.

Bitcoin's promise is mainly a result of the combination of features it bundles together: It is a purely digital currency allowing payments to be sent almost instantly over the Internet with extremely low fees. Like cash, it is nearly anonymous, and transactions are effectively irreversible once they are committed. Bitcoin addresses (the equivalent of accounts) are free, and anyone can open as many as they would like.

Set apart from other existing forms of digital currency, Bitcoin is based on a decentralized protocol: There is no organization or government in control of its tion. As a consequence, there is no central entity able to apply monetary policy, and its supply has been set in advance—there will never be more than 21 million bitcoins.

The question is not whether Bitcoin has value; it already does. The question is whether the efficiencies of a cyber-currency like Bitcoin can be merged with the certainties of an honest central bank.

Bitcoin has value because people accept it—the same reason any form of money has value. "Money" is a medium of exchange, a store of value, and a unit of account.

Bitcoin has all three properties. Money can be wampum, shekels, yen, euros, dollars, rubles or renminbi. Money can be rock (gold), paper (notes), or scissors as long as people take it in trade, keep it as wealth, and measure it in prices.

Bitcoin's main data structure, the block chain, is the key to understanding how information consistency is maintained between nodes and how conflicts are resolved. The block chain, as its name suggests, is composed of blocks—batches of approved transactions that have been grouped together. Each block contains the cryptographic hash of its predecessor that, for all intents and purposes, serves as a unique identifier of the previous block (hash collisions are very rare, and difficult to find—an important property of cryptographic hash functions).

Blockchain Technology has attracted attention as the basis of cryptocurrencies such as Bitcoin, but its capabilities extend far beyond that, enabling existing technology applications to be vastly improved and new applications never previously practical to be deployed.

A blockchain (also called a distributed ledger or a cipher chain) is a distributed, ordered, back-linked list of blocks. Each block contains transactions that are hashed into a binary hash tree (also called a merkle tree), with the top of the tree (also called the merkle root) stored alongside the transactions. Each block also contains the previous block’s hash, thus guaranteeing the chain’s integrity back to the first block (the genesis block).

Blockchain distribution is coupled with trust creation and a consensus mechanism for determining agreement on the next block to add. Without such distribution and without a solution that provides Byzantine fault tolerance (resistance to detrimental actors), a blockchain would be no better than a file or database of transactions. Also, the trust created by the system would be limited to the trust available in that one file or database.

Most of the ideas in bitcoin that have generated excitement in the enterprise, such as distributed ledgers and Byzantine agreement, actually date back 20 years or more.

Beyond its role as a protocol for managing and transferring money, the Bitcoin protocol creates a complex system of economic incentives that govern its inner workings. These incentives strongly impact the protocol's capabilities and security guarantees, and the path of its future development.

An unbalanced reward allocation of this sort creates a bias in favor of larger miners with more computational power, making them more profitable than their smaller counterparts and creating a constant economic undercurrent toward the centralization of the system.

Cryptocurrencies, although a seemingly interesting idea, are simply not fit for purpose. They do not work as currencies, they are grossly inefficient, and they are not meaningfully distributed in terms of trust.

Risks involving cryptocurrencies occur in four major areas: technical risks to participants, economic risks to participants, systemic risks to the cryptocurrency ecosystem, and societal risks. Fortunately, for all but the last case, there is little risk to anyone not directly participating.

Cryptocurrencies use a lot of energy. The "mining" process that creates bitcoin uses more energy than Serbia, says Digiconomist, a self-described "platform that provides in-depth analysis, opinions, and discussions with regard to bitcoin and other cryptocurrencies … on a voluntary, best-effort basis."

According to Bitcoinist, another industry site, the average cost in electricity to mine a bitcoin in Serbia is about $3,100, making it quite profitable to mine the coin there (among other countries with,low-cost electricity).