Bitcoin Blog a1

Friday, April 29, 2016

The Future of Currency and Bitcoin

The Future of Currency and Bitcoin
The Future of Bitcoin
Bitcoin is a type of cryptocurrency which, in its simplest form, is digital currency that operates without a central authority or bank. Bitcoin finds its place in the world of cryptocurrency as one of the most used and well known types. With a market cap of about $5.7 billion (as of February 6, 2016), the future of bitcoin looks rather promising (coinmarketcap.com). However, it must be kept in mind that even with all of its potential, bitcoin, from a technical standpoint, is not the best cryptocurrency and has quite a few issues that other cryptocurrencies better resolve.
For starters, bitcoin is often praised for the level of anonymity it provides to its users. However, it isn’t really as anonymous as one might think. Bitcoin allows one to send and receive bitcoins without providing any personally identifying information. A bitcoin user is assigned an address with which they can use to perform transactions. So what’s the issue? An article on bitcoinsimplified.org states that, “Every transaction involving that address is stored forever in the blockchain. If your address is ever linked to your identity, every transaction will be linked to you.” So while bitcoin does offer a low level of anonymity, it is still possible that transactions could be linked back to a specific individual.
Not only do people want more anonymity, but they also want things done quicker. With the evolution of currency, the speed at which a transaction can occur has continuously increased. With the advent of electronic payments, we have seen that transactions can take place rather quickly. For example, when your job deposits your paycheck, the funds are usually available for use a day or two later. When bitcoins are sent to another party, a third party of people, who are referred to as miners, confirm the transaction. Transactions are grouped and confirmed in blocks; a bitcoin block is solved every ten minutes. This means that a transaction may receive one confirmation every ten minutes (bitcoin.org). Many businesses want at least three confirmations of payment before they are mostly confident that they have the coins (assuming that the spender doesn’t control a significant amount of bitcoin’s mining power). But three confirmations take 30 minutes to obtain. If you are skeptical of someone you might want more than three confirmations. This means to do a transaction in bitcoin you will require 30 minutes of time at least. While 30 minutes is a lot quicker than a couple days, it is slower than other types of cryptocurrency.
Another downside to bitcoin is the limited volume of transactions it can currently perform. Only about 7 transactions a second can be processed, while Visa for example, can process 10,000 transactions a second (washingtonpost.com).  Bitcoin transactions are executed in blocks, which are batches of transactions. In order to reduce the threat of spam and potential denial-of-service attacks on the network, the amount of transaction data that could be carried in a block was drastically reduced (coindesk.com). This added level of protection, however, could lead to a backlog of transactions. As bitcoin becomes more popular, there is an increasing amount of transactions. With the increased level of bitcoin transactions, many of the transaction blocks are being filled and, as a result, other transactions have to wait. Visa, on the other hand, processes on average nearly 2,000 transactions a second (usa.visa.com). So unless bitcoin can scale up their operations and still provide a high level of security, they may be headed down a difficult road.
Lastly, bitcoin has many technical barriers to entry. In its current state, an individual needs quite a lot of technical knowledge to use bitcoin. Additionally, you must have proper safety and security measures in place to ensure you will be able to access your bitcoins and others will not. It may take time for everyday users to understand bitcoin and how it operates. Hopefully in the future it can be simplified and can grow on a larger scale to be user friendly for the masses.
The Future of Cryptocurrency
While bitcoin in particular may not be the future, it is possible that cryptocurrency in one form or another could be. A simple search for cryptocurrency on the internet will return information on hundreds of different types of cryptocurrency. As of February 2, 2016 there were 676 cryptocurrencies available for trade in online markets but only six had a market capitalization over $10 million (coinmarketcap.com).
It is clear that bitcoin is currently the most valuable cryptocurrency as far as market capitalization goes but yet, as mentioned earlier, it lacks important features that other cryptocurrencies excel at. The following paragraphs will detail other cryptocurrencies that clearly outperform bitcoin in certain areas.
Other coins have higher levels of anonymity; Dash (formerly Darkcoin) and XCoin are the best example of this. In order for bitcoin to be able to maintain more anonymity of transactions, it needs to rely on other add-on services. Dash has anonymity features built into its algorithms which allow it to mask transactions and IP addresses of participants of a network (cointelegraph.com).
As mentioned earlier, bitcoin transactions take about 10 minutes to confirm. Other cryptocurrencies have even faster transaction times. For example, Litecoin and Dash take about 2.5 minutes. Back when Dash was still called Darkcoin, they introduced InstantX technology which “makes payments instant” (thus it charges a small additional fee). However, even by taking into account incomparably higher speed, commission charges when using Dash are tens times less, than when using bitcoin (cointelegraph.com). As can be seen, cryptocurrencies are improving very quickly and becoming more and more efficient. Cryptocurrencies may have the potential to replace traditional fiat currency.
When comparing bitcoin to other types of cryptocurrency, other coins are able to process more transactions. For example, of the top six cryptocurrencies with a market capitalization above $10 million, bitcoin has the fifth smallest available supply of currency at about 15.2 million units (coinmarketcap.com). This is compared to Dogecoin and Ripple (other types of cryptocurrency that are in the top six cryptocurrencies) that have 103 billion and 34 billion units, respectively.
The Future of Money
It is clear that the world is moving away from the use of traditional fiat currency. People use credit cards and debit cards more and more, along with a trend of using more digital forms of payment like ACH payments for employees instead of traditional checks. In addition, technologies like EFT are becoming more common in the market.
As traditional paper based currencies and forms of payment are abandoned, it seems natural that digital solutions, like bitcoin, might take their place.  We can see a clear progression of currency changes throughout time. At first, people accepted commodities as a form of payment; the most used commodity was gold. Later, precious metals, like gold, were minted into coins which were used as currency; the metal in the coins gave them value. Next, paper currencies were issued that were redeemable for gold. The fact that they were redeemable gave them value and people accepted them. Finally, fiat currency was introduced. Fiat currency has no gold standard but the fact that the government and the people support the currency means that it has value.
In the US, there is a significant problem that many coins, in addition to lower denomination bills, are expensive to mint in relation to value. It costs nearly two cents to make one cent, and that just doesn’t make sense (USmint.gov). Digital currencies can eliminate this problem as the cost of creating this type of currency is essentially nothing. The next progression in the currency evolution is that the government no longer prints physical currency and everyone uses digital currency instead.


References
“2014 Biennial Report to the Congress”. USMint. 2014-12-31. Retrieved 2016-02-09.
“Bitcoin: A Peer-to-Peer Electronic Cash System”. Satoshi Nakamoto. 2008-10-31. Retrieved 2016-02-09.
“Bitcoin Money Supply”. CoinBase. 2016-02-08. Retrieved 2016-02-08.
“Bitcoin needs to scale by a factor of 1000 to compete with Visa. Here’s how to do it.”.Timothy B. Lee, The Washington Post. 2013-11-12. Retrieved 2016-02-09.
“Bitcoin Simplified”. BitcoinSimplified. Retrieved 2016-02-04.
"Crypto-Currency Market Capitalizations". CoinMarketCap. 2016-02-06. Retrieved 2016-02-06.

“DASH: Young Cryptocurrency With An Interesting Story”. CoinTelegraph. 2016-01-13. Retrieved 2016-02-04.

“Run your business”. USAVisa. Retrieved 2016-02-09.

“What is the Bitcoin Block Size Debate and Why Does it Matter?”. CoinDesk. 2015-21-08. Retrieved 2016-02-04.

Tuesday, April 12, 2016

Bitcoin Banking?

I have recently made an account with BTCpop.co. The site has some interesting features, one is its peer-to-peer lending options. People ask for a loan for various reasons and the people that want to fund these loans do so. In addition to loans, BTC pop also offers a 5% savings account as well as some IPO services. I want to focus on the bank like aspects of BTCpop today.

This method of lending has some interesting risks associated with it. The largest risk to these loans is credit risk, or the risk that lenders will not pay the money back. This is universal to essentially all loans (except some government bonds). These loans also carry some interest rate risk and inflation risk; however, this is quite small due to the short-term nature of these loans.

These loans also have many features not associated with similar commercial loans. One is transaction risk, the risk that the bitcoins you used to extend the loan are worth less than the bitcoins you receive at the end of the loan. This is longer than normal because it takes time to exchange bitcoins for regular currency.

In addition, these loans carry an “institutional risk” or the risk that the website/institution will fail.  In this case, the loan makers may not see any of their money.This risk is the primary risk of the 5% savings account. If the institution as a whole fails, you will not get your money in your savings account.

This savings account also has more risks associated with it than a regular savings account. As long as the bank has enough bitcoin reserve to pay off withdrawal requests, there is no problem. However, if depositors want their money bank and the bank doesn’t have enough reserves, then the bank faces a liquidity crisis. Regular banks have a few tools to avoid this problem. They are able to loan money to each other, so if one bank has excess reserves, they can lend it to another that is lacking. They also are able to borrow directly from the Federal Reserve, or the appropriate central bank.  Banks also engage in the repo market, there they give securities (like bonds) as collateral on a short term loan. It may be possible for this bitcoin bank to translate on the repo market. But that still leaves the institution with only one of the 3 tools regular banks have to handle liquidity issues.

Also, the overall risk of the bank is very likely tied to the overall credit risk of its borrowers. The bank almost certainly invests its deposits in loans to people on the site. This also means that if enough  borrowers default, the institution is at risk. So even if you have not lent money directly, by putting it in the bank's savings account, you still may lose your money. Its also important to note that normal banks are insured by the FDIC for up to $250,000. However, this bank offers no such protection. This means that the bank's approach to risk is even more important than normal.

All of this addition risk seems to be rewarded. User initiated loans have rates that at crazy even by payday loan standards. The site’s savings account offers 5% compared to less than 1% at commercial banks. The difference in rates is so great, I don’t think all the loans follow the Security Market line in the way that they should. However, that is an issue for another day.