What are bitcoins?
The process of currency transactions has experienced significant changes over the years. Right from barter systems in the past, where participants had to be face to face to instantly verify the properties being exchanged, to the use of third parties like credit card issuers during transactions, and finally to digital transactions that was introduced on the onset of the introduction of technology and use of the internet.
However, despite the commendable improvements in the field of currency transactions, the proliferation of digital operations and the enhancement of the web have resulted in exposure and several limitations to traditional currencies in the electronic world. These include increased expenses, security risks and time delays during transactions. Such limitations can prove egregious particularly if the transactions involve different foreign currencies, complex products or parties involved being on different sides of the globe. Such inhibitions led to curiosity and the idea of having an international currency which is independent of nations or central banks and provides anonymity to holders, security from fraud and theft, and protection from inflation. This resulted in the concept of having a digital currency which enables cash or its equivalent, to be used over the internet.
Bitcoins, started in 2009, is the most recent and most popular outcome of these efforts. It refers to a math-based, peer to peer, cryptocurrency system which is decentralized and is designed in a manner that allows online users to process their transactions using digital exchange units. These units are what are referred to as bitcoins. Bitcoins are generated by a computer through a unique process of computing and solving complex numerical algorithms. They can also be obtained through the purchase of standard currencies which are then placed into a ‘Bitcoin wallet’ – the public digital files where every party keeps private encryption keys which prove ownership. This is done through computers or smartphones. Proponents of the use of this new currency suggest that: • The payments are instant and can be made to any individual internationally. • The need for third parties is unnecessary. • Transactions can’t be reversed once processed • The supply of these bitcoins cannot be manipulated by any institution, e.g., banks, the government or any individuals. The potential of bitcoins compared to other electronic payment methods. When compared to other payment mediums like PayPal, Fedwire and Western Union, the transaction volumes of bitcoins completely surpasses all of them collectively.
Bitcoins can also handle large transaction capacities of about seven transactions per second internationally.
Advantages of bitcoins.
1. Protection from fraud when making payments. Since bitcoins are digital, they can neither be reversed arbitrarily nor counterfeited by the sender, unlike other payment systems like credit cards.
2. There is a minimum possibility of identity theft. Bitcoins operate using a ‘push’ mechanism whereby, the bitcoin holder sends exactly what they want the recipient to receive with no further information such as personal details. This is unlike credit cards which use a ‘pull’ mechanism such that the receiver initiates the payment process and extracts the designated amount from the sender’s account. As a sender, when giving your credit card to another party, you give them access to your entire credit line no matter how small the transaction is. This increases your risk to potential identity theft and fraud.
3. Tax – free purchases. Given that there is no way for any third parties to track, identify or intercept any bitcoin transactions, sales tax are therefore not added to the purchase cost resulting in major saving.
4. There are direct transfers for any immediate settlement. Unlike the purchase of real property which entails involving third parties, delays in payment and requirement of additional fees payments, Bitcoin contracts are typically designed to eliminate any third party approvals such as banks, government or any other financial intermediary, and any time delays. Moreover, the transactions take less of the expense and time which would usually be required to complete traditional transactions. Such financial intermediaries have no way of interrupting user transactions or placing any freezes on the bitcoin accounts. They are thus convenient and highly efficient.
5. Reduced transaction fees. Bitcoin exchanges do not generally involve any transaction fees during a transaction. The bitcoin miner is usually compensated by the bitcoin network with a new issue of bitcoins. However, despite having no transaction fees, most users will need to engage the service of a third party such as Coin base in order to create and maintain their personal bitcoin wallets. Such services provide an online transfer system for bitcoins and may charge a transaction fee.
6. There is now access to previously inaccessible markets. Did you know that there are over 2 billion individuals with access to mobile phones and the internet, but do not currently have access to any of the traditional exchange systems? This is so much unexploited potential that introduction of bitcoin services aims to tap into. In Kenya for instance, the use of the M-PESA system, a mobile phone device based money transfer service and a micro-financing service recently adopted the use of a bitcoin appliance. A high percentage of Kenyans now own a bitcoin wallet thus increasing the market reach.
Cons and risks of using bitcoins.
1. Bitcoins could be used to finance immoral or illegal activities. Critics to the use of bitcoins claim that it could easily be used anonymously to commit a crime such as any illegal, antisocial of immoral acts. In the recent past, digital currencies have reportedly been used to facilitate a verse array of criminal activities such as stolen identities, the sale of drugs, prostitution, child and human trafficking and the sale of illegal weapons. Additionally, cyber criminals are using such payment platforms for services such as the development and distribution of malicious software.
A case that brings this to light was in October 2013 when the notorious website Silk Road was shut down by the FBI. More than 100,000 bitcoins worth $28 million was seized. The operation was allegedly used buy or sell drugs anonymously, sell guns and assassins and to offer tutorials on how to hack into ATMs. It was solely reliant on digital currency transactions. However, it could be argued that any payment system, medium of exchange and financial institution, with proper planning could easily be used for any illicit activities and money laundering, not just the use of bitcoins.
2. There is a high risk of loss. Using bitcoins as a mode of money exchange could result in a number of losses. Users, therefore, need to be aware of probable causes and to be cautious about them. They include:
• Lack of security when using bitcoins. There is no perfect way or a safety net to protect one’s bitcoins neither from technical glitches such as malware or hardware failures nor from human error, e.g., user passwords. Several web-based companies that offer to exchange Bitcoins into other currencies have gone out of business due to such insecurities.
• The possibility of increased and stringent regulations. Despite the fact that there are currently benign guidelines in place concerning the use of bitcoins, there is a possibility that law enforcement agencies could decide to enact more strict guidelines and regulations. This is especially due to the recent cases of money laundering schemes that use bitcoins as mediums of payment. This would resultantly lead to diminishing of the currency’s value.
• Limits on the speed and number of transactions. Despite its popularity, there are several limits when it comes to using bitcoins regarding the speed and the volume of transactions that can be processed. This implies that it is highly unlikely the there will come a time when bitcoins will get to replace familiar and conventional credit card systems.