Bitcoin is a decentralized digital currency and the first digital cryptocurrency invented in 2008 by an individual or a group of individuals that goes by the name Satoshi Nakamoto. The initial release was in January 2009 and it is now one most of the popular and widely accepted currencies in the world alongside Ethereum.
Explaining Further: How Does Bitcoin Work?
Blockchain technology is at the heart of Bitcoin. To understand further how this cryptocurrency work and how it is created, it is first important to note that a blockchain is a type of database consisting of records or a ledger of transactions.
All relevant data about a particular transaction are contained within and represented by a block. Each block is linked or chained further to a previous block, and further to all other previous blocks, thereby creating a recorded chain of transactions.
Each Bitcoin is created as a reward to individuals for performing and completing a record-keeping process called blockchain mining that involves recording and authenticating each related transaction using cryptography through network nodes.
Bitcoins can be stored in a digital wallet, sent from user to user on the peer-to-peer Bitcoin network without intermediation, used to purchase goods and services, or exchanged to currencies based on fiat money and other cryptocurrencies.
Remember that cryptocurrencies are decentralized. The network of Bitcoin miners fundamentally holds control. However, it is also worth mentioning that developers of cryptocurrencies or the underlying blockchain technology provide and enforce standards and protocols.
Source of Value: Why Do Cryptocurrencies Have Value?
The transition from the goal standard to the fiat system was a turning point in the history of money. Currencies before had intrinsic value because they were backed by precious metals such as gold and silver. However, the gold standard was abandoned in 1932
Modern fiat currencies such as the U.S. dollar and the British pound have no intrinsic value. However, they function as a medium of exchange, a store of value, and a unit of account because they demonstrate six fundamental characteristics or attributes.
These attributes are scarcity or limited supply, divisibility, utility, transportability, authenticity, and trust or acceptability. Furthermore, economics defines two essential characteristics for a commodity to have value: utility and scarcity.
While they do not have intrinsic value, the advantages of a blockchain as a public distributed ledger fundamentally equips cryptocurrencies with the aforesaid attributes and characteristics, thereby making them a suitable form of a currency.
Bitcoin has a supply cap of 21 million. There is a limited supply in circulation, and as such, it is also deflationary by a nature. However, several cryptocurrencies such as Ethereum are inflationary because of the constant flow of new cryptocurrency-related assets.
The Pros: What are the Advantages of Bitcoin?
Remember that the reason why Bitcoin has value is that it has demonstrated the known attributes of existing fiat currencies and other valuable commodities. Moreover, aside from being an alternative to traditional currencies, it has specific advantages and applications that stem from the notable characteristics and use cases of distributed ledger and blockchain technologies.
1. General Advantages of Cryptocurrencies
Decentralization is the main selling point of cryptocurrencies. Compared to fiat currencies such as the dollar of the United States or the euro of the European Union, there is no central bank or monetary authority that controls the supply and value of money
Note that central banks can influence the value of money through specific monetary policies. Some critics have argued that a centralized control gives a single institution a substantial amount of power that can be misused and abused.
Several instances have proved the aforesaid argument. For example, in Greece during the debt crisis in the European Union, the Greek government prevent people from withdrawing their money from their bank accounts to prevent bank overruns.
The two instances of hyperinflation in Zimbabwe and Venezuela showed how monetary policies can cause not only economic distress but also sociopolitical unrest. The currencies of these two countries lost value after the government increased the money supply in circulation.
Decentralized currencies protect individual users and the general population from bank failures, the shortcomings of a central authority, and the collapse of the financial system, as well as from stringent bank policies and fees.
Nevertheless, decentralization is fundamentally one of the main advantages of Bitcoin. It is more resistant to government interference. Furthermore, it does not require an overreach from a single and central authority to become operational and usable.
2. Benefits of Blockchain and Distributed Ledger
Of course, decentralization has been made possible through the use of a distributed ledger and the specific blockchain technology. As mentioned, blockchain is at the core of Bitcoin and other cryptocurrencies. This technology provides specific advantages,
For starters, it makes a cryptocurrency easy to implement and utilize, thereby making it attractive to populations underserved by banks. In addition, blockchain is a censorship-resistant system but provides openness that allows anyone to view transactions both past and present.
Payments or fund transfers are also borderless and uninhibited. This makes a cryptocurrency truly a global medium of payment. The fact that it is borderless also enables individuals and communities to participate in the global economy.
Remember that cryptocurrencies are digital currencies. They can facilitate electronic commerce transactions while maintaining privacy and security through cryptography. They can also prevent double-spending and provide a transparent record for anyone to inspect.
The use of cryptography in blockchain gives users of cryptocurrencies more control over their personal information and financial data. It also lessens risks associated with counterfeiting or frauds that are rampant in other digital forms of payments like credit cards.
3. Specific Advantages of Bitcoin as a Cryptocurrency
Numerous cryptocurrency coins and cryptocurrency tokens have emerged since 2009. However, Bitcoin remains the largest cryptocurrency in the world in terms of market capitalization. The fact remains that it is the most valuable when compared to other cryptocurrencies.
When compared the Ethereum, the blockchain network that also has its own native cryptocurrency called Ether, as well as the Cardano blockchain platform and its native Ada cryptocurrency, the Bitcoin blockchain was created for the sole purpose of introducing a digital medium of exchange and a store of value.
Both Ethereum and Cardano are intended to introduce and power different blockchain applications. Hence, these platforms are prone to overcrowding, especially with its growing use cases to include crypto tokens and non-fungible tokens, as well as smart contracts, among others.
Note that Ether is the second-largest cryptocurrency in the world. However, it is also important to highlight that Bitcoin is the most recognized not only by users, investors, and traders but also by merchants and other institutions.
The popularity of this cryptocurrency has compelled even El Salvador to decree it as a legal tender starting 7 September 2021. This Central American nation is the first country in the world to make cryptocurrency a national currency.
Bitcoin essentially has the first-mover advantage that has made it the most popular and widely accepted cryptocurrency in the world. Furthermore, its blockchain network has the most established network of peer-to-peer uses, thus providing security and stability.
Another strength of this cryptocurrency is that it has a limited supply. The original plan states that there will only be 21 million coins that will be minted in existence. A supply cap creates scarcity that has the potential to drive up its value further in the future.
The Cons: What are the Disadvantages of Bitcoin?
Cryptocurrencies are undeniably promising. They have the potential to disrupt the existing systems for the betterment of everyone. However, there are some notable drawbacks and issues, and Bitcoin, since it is the first and most popular cryptocurrency in the world, has drawn criticisms and forewarnings from observers and analysts.
1. Notable Drawbacks of Cryptocurrencies
Critics and skeptics have raised concerns over cryptocurrencies and the attached decentralized finance movement in general. They believe that central authority remains essential in keeping order and stability over a particular system.
Their argument centers primarily on the fact that, unlike gold or silver that has value due to their tangibility and rarity, and fiat currencies that have value due to legal acknowledgment, cryptocurrencies have nothing underwriting their value.
Another argument is that cryptocurrencies can be difficult to understand because of the complexity of the underlying technology. Complicated terminologies and concepts, as well as technological applications, hinder widespread adoption.
Legality and acceptability are also important considerations. Cryptocurrencies are not as acceptable as fiat currencies despite hitting mainstream appeal. Furthermore, some jurisdictions have not legalized their use as a formal medium of exchange.
When it comes to investing in or trading cryptocurrencies, note that they are extremely volatile. There are different factors affecting the movements in the cryptocurrency market. Furthermore, the absence of legal status and a tendency for overvaluation due to hype create additional risks.
2. On the Drawbacks of Decentralization
While distributed ledger has positive implications, it has notable drawbacks. For example, because of its decentralized nature, data modification can be difficult. Doing so would require an extensive process just to add or modify data once it is recorded.
Note that in Bitcoin transactions, a payment cannot be reversed unlike in other forms of digital payments such as credit card transactions. While this provides merchants with security from frauds and saves them from charge-back costs, this can be troublesome for users.
The peer-to-peer network that is collectively responsible for adding new blocks or authenticating transactions must also be synchronized. The records must be updated on each participant or node, or forked if only one of the nodes rejects any changes.
3. Hardware and Energy Requirement of Bitcoin
Maintaining the Bitcoin blockchain is energy-intensive. Remember that creating a Bitcoin or processing related transactions requires using computers connected within a peer-to-peer network. Each computer requires powerful processors.
Specifically, running powerful computers consumes a lot of energy. In addition, it also generates too much heat. These computers need an effective cooling system to remain operational and avoid overheating or other hardware damages due to excessive heat.
The Bitcoin blockchain uses a proof-of-work or PoW consensus mechanism. Compared to the proof-of-stake scheme, which is gradually becoming an alternative mechanism used by other blockchain networks such as Cardano, PoW is energy-intensive.
Several studies have revealed that each blockchain network based on a PoW scheme consumes electricity annually that far exceeds the yearly energy consumption of a particular country such as the Philippines, Argentina, or The Netherlands.
Of course, the energy-intensive operation of PoW-based blockchain networks undeniably has negative environmental impacts, which in turn, represents another major disadvantage of Bitcoin. Remember that fossil fuels remain the primary input of power plants.
Prominent individuals like Bill Gates and institutions such as the United Nations have expressed concerns over this cryptocurrency. Gates reminded that the environmental impacts of cryptocurrencies can be offset if the underlying blockchain technology uses clean energy, as well as if it does not crowd out other consumers of energy.
FURTHER READINGS AND REFERENCES
- Baraniuk, C. 2019. “Bitcoin’s Energy Consumption ‘Equals that of Switzerland.” BBC. Available online
- Criddle, C. 2021. “Bitcoin Consumes ‘More Electricity than Argentina/” BBC. Available online
- S. 2008. Bitcoin: A Peer-to-Peer Electronic Cash System. Bitcoin.org. Available via PDF
- Haber, S. and Stornetta, W. S. 1991. “How to Time-Stamp a digital document.” Journal of Cryptology. 3(2): 99-111. DOI: 1007/bf00196791
- Leible, S., Schlager, S., Schubotz, M., and Gipp, B. 2019. “A Review on Blockchain Technology and Blockchain Projects Fostering Open Science.” Frontiers in Blockchain. 2. DOI: 3389/fbloc.2019.00016
- Stoll, C., Klaaßen, L., and Gallersdörfer, U. 2019. “The Carbon Footprint of Bitcoin.” Joule. 3(7): 1647-1661. DOI: 1016/j.joule.2019.05.012
- Xu, M., Chen, X., and Kou, G. 2019. “A Systematic Review of Blockchain.” Financial Innovation. 5(1). DOI: 1186/s40854-019-0147-z