How many of you have heard of Bitcoin, the digital currency? Just as I tried last week to explain in 10 minutes how secrecy works on the Internet, I want to explain something of how Bitcoin works and more importantly, what are its implications.
Bitcoin is an Internet currency. It is totally electronic, without even the tangible form of that make-believe government money in your pocket. It exists in a collaborative worldwide network of computers. Nobody is in charge – nobody decides who joins the network.
I go way back in history for a metaphor. Think of Homer's Odyssey, or the Bible's Old Testament. These documents existed for many centuries only in oral form. They were passed down from one generation to another. Even the four Gospels of the life of Jesus Christ were not written down for over a century.
The fact that many people knew the story guaranteed their integrity. If some story teller got inventive and changed it, the others would bring him back into line. So far as we can tell, the story did not change too much over time.
Now imagine this worldwide network of computers as nothing more than storytellers. Each storyteller knows the entire history of Bitcoin. They know exactly who paid what to whom for the whole history of Bitcoin. If there is ever a disagreement, the majority rules. There are so many computers involved, and it is so complex that not even the most evil government could take it over by using massive computer power.
Let me offer a couple of words on the technology. Public-key cryptography, which I described last week, is at the heart of the system. Every person on the network has an account number with a password-protected wallet. The system does not know anybody's name – just the account numbers.
The breakthrough technology that holds it together is the block chain. All the transactions for each 10 minute period Are gathered together into a block. That block is tightly encrypted. Among the material encrypted is the cryptographic verification of the previous block. So, all of the blocks in the entire history of Bitcoin are chained together. Nobody could change anything anywhere in the history without the ripple effect being evident everywhere. Technically, it does not take anything more than a large PC to store Bitcoin's complete history. The network approach is entirely workable.
With that extremely brief explanation of what Bitcoin is, let me describe how it is useful. I will compare it with national currencies like the hryvnya and dollar – in both cash and credit transactions, and with gold.
Money serves three fundamental functions. It is a means of exchange, a store of value, and a unit of account. Since governments use accounting reports to compute tax, gold and Bitcoin cannot be used as a unit of account.
Gold is an age-old store of wealth. It is universally recognized. It will buy about as much bread and clothing today as it would in Roman times. It is accepted everywhere. On the other hand, it can be stolen, both by thieves and by governments. It does not come in small denominations. The rate of exchange between gold and silver fluctuates all the time. Government is severely manipulating the price of gold today, to make their sick national currencies look good. Gold, like land, can be a good way to store money long-term, but it is not very practical in the short term.
Government currencies like the hryvnya and the dollar are convenient. If you keep them in cash form, stuffing your mattress, you have to protect them just like gold. If you keep them in the bank, the bank may not let you have them back when you most need them. In any case they lose value. The dollar is worth about two percent of what it was a century ago. When government prints money for its own use, they make the money that you hold worth less. You may have noticed what has happened to the hryvnya over the last few years.
Most of you lived through the total collapse of the Russian ruble and the Ukrainian hryvnya. Every government currency ever devised has collapsed. They last an average of 27 years; the oldest in existence today is the British pound, a bit over 300 years.
The value of national currencies swings up and down according to government policy. You know this as foreign-exchange trading.
Bitcoin has no intrinsic value other than that it is increasingly widely accepted. If you think of it, fiat currencies are the same way. Bitcoin depends on a secret key. If you lose the key, you lose your money. The rate of inflation in Bitcoin is low, temporary and well-defined. Bitcoin is truly international. Governments dislike Bitcoin and discourage its use. The value of Bitcoin fluctuates rapidly - from below $200 to over $400 this year alone. Governments manipulate the value of Bitcoin just like they manipulate the value of gold.
How about as a means of transactions?
A transaction paid in gold is immediate and final. Gold transactions are anonymous. However, gold is not useful for small transactions. There is not enough physical gold in the world to support the volume of transactions. Gold is inconvenient to carry.
Fiat cash is increasingly discouraged by governments. It is outlawed for large transactions. Large amounts are awkward to carry. Cash transactions are anonymous, immediate and final. International transactions are awkward.
Credit transactions are subject to transaction fees. Credit transactions require a trusted third-party. They take time to finalize. International transactions are subject to exchange fees. Credit transactions are visible to tax authorities.
Bitcoin transactions are final in a matter of minutes. Bitcoin transaction fees are small. There is no exchange fee for international transactions. Bitcoin transactions are anonymous. Exchanging Bitcoin for national currencies involves transaction fees. Bitcoin is still a little bit awkward to use, especially here in Ukraine. Brokers charge about 5% on every transaction.
What's the bottom line on Bitcoin?
It is a threat to governments and banks. Governments no longer need to print money, which means they can no longer steal your money through inflation. You no longer need banks in the middle of financial transactions – it puts them out of business. For these reasons you can expect Bitcoin will be at the center of many huge fights.
Ukrainians do not have a safe place to save money. The hryvnya is losing value, and you don't trust your banks. Gold is hard to buy and dangerous to keep at home. It probably makes sense to pay the five percent commission and by a few Bitcoin's. They cost about 10,000 hryvnya apiece.
For those of you programmers and entrepreneurs, Bitcoin may offer an opportunity. It will be an alternative way to safeguard money, to get it in and out of the country, and simply to do business. There is a Bitcoin association here in Kyiv – I think you should be familiar with it.
That's the bottom line. Bitcoin is real, it is here, and it is radically different. You should know something about it. Madame ToastMaster.
GOLD