Bitcoin: Its Origin, Functionalities, and Risks of the Virtual Currency

Bitcoin Money Dollar Crypto How Works
Bitcoin Money Dollar Crypto How Works
Bitcoin Hits 2021
Bitcoin Hits 2021

Bitcoin is a virtual, independent and decentralized currency since it is not controlled by any State, financial institution, bank or company. It is an intangible currency, although it can be used as a means of payment just like physical money. As stated in the document “Virtual currencies or currencies: the case of Bitcoin”, prepared by the General Directorate of Operations, Markets and Payment Systems ” virtual currencies or currencies”, including bitcoin, “They constitute a heterogeneous set of innovative payment instruments that, by definition, lack a physical support to back them up.”

The term bitcoin has its origin in 2009, when it was created by Satoshi Nakamoto (pseudonym of its author or authors), who created it with the aim that it be used to make purchases only through the Internet. The same document to which we referred previously from the Bank of Spain expands this objective: “Bitcoin was born with high ambitions: to provide citizens with a means of payment that enables the execution of fast transfers of value, at low cost and that, moreover, does not it can be controlled or manipulated by governments, central banks or financial entities ”. The virtual currency uses cryptography to control its creation. The system is programmed to generate a fixed number of bitcoins per unit of time through computers called  miners.  Currently, that number is set at 25 bitcoins every ten minutes ,  although it is programmed to cut in half every 4 years. Thus, starting in 2017, 12.55 bitcoins will be issued every ten minutes. Production will continue until 2140, when the ceiling of 21 million units in circulation is reached.

How Bitcoin does it work?

To make use of this virtual currency, we will need to download software on our computer or mobile phone that will act as a virtual “wallet” and that will generate a bitcoin address, which can be used to send and receive money from other users. In addition, the sending of bitcoins is instantaneous and all operations can be monitored in real-time. Transactions with this currency involve a transfer of value between two bitcoin addresses, public but anonymous. To guarantee security, transactions are secured using a series of key cryptographies, since each account has a public and a private key. 

Bitcoin risks

As in other virtual currencies, bitcoin also has a series of risks that must be highlighted in order to know exactly the magnitude of this currency. To identify them, we turn again to the report of the General Directorate of Operations, Markets and Payment Systems  of the Department Payment Systems of the Bank of Spain, which groups them in:

  •  Financing of illicit activities and / or money laundering. Due to the decentralized nature of the scheme, transfers take place directly between the payer and the beneficiary, without the need for an intermediary or administrator. This implies a difficulty in the identification and early warning of possible suspicious behavior of illegal activities.
  • The widespread use of emerging electronic payment systems by organized crime networks can create a negative reputation for digital payment methods.
  • Although, in principle, any computer can actively participate in the process of creating new units of bitcoins, the high computational capacity required means that, in practice, this activity is dominated by a small group of actors.
  • Possible fraudulent transactions. To the extent that the protocols on which bitcoin is based are open software developments, the implementation of its different versions does not have to occur in a uniform way among all users.
  • Impact on price stability and financial stability, since the private trading platforms where Bitcoins can be exchanged for legal tender currencies are marked by high price volatility due to speculative movements.
  • From the point of view of fraud, bitcoin presents a significant weakness compared to other widespread payment methods in the online world, such as cards.

Has it crossed your mind to  invest in bitcoins ? The news about the  price of bitcoin  against the euro or the dollar occurs at the same rate that doubts about this virtual currency increase. How does it work? Is it safe ? We solve these and other questions clearly and succinctly.

What is bitcoin and how does it work?

Bitcoin is a cryptocurrency or virtual currency. It is a self-regulated payment unit without physical reference or endorsement from a country, which preserves the anonymity of its owners and whose transactions are carried out through the internet using encrypted codes and confirmed in a multiple-way by the members of the network themselves (through the so-called ‘blockchain’ technology, in practice an accounting book or shared record of the activity). Knowing a code makes you the owner of that asset (cryptocurrency). It is a completely digital currency. One of the most controversial aspects is the process of creating bitcoins, which has come to be called mining. In practice, it has come to be controlled by a few hands, most of them organized groups based in Asia. 

What is the price of a bitcoin?

The price of bitcoins is known through internet portals specialized in the trade of this virtual currency. There is a quotation in real-time, as a consequence of the demand and supply movements that are registered by the members of the system. Given that in the case of bitcoin its number is limited in time, experts argue that its price will also tend to increase if the number of users continues to increase (hence its controversial pyramidal nature). Proponents of bitcoin defend that it is not a pyramid as no one is promised returns and there is no single issuer that benefits. But as with any investment, there is no guarantee that the value of bitcoin will not change. 

Bitcoin challenges the system

Bitcoins are priced as long as they are useful as a currency and people are willing to accept it as a means of payment. It has the characteristics of money (durability, portability, fungibility, scarcity, divisibility and recognizability), but based on mathematical properties (it is increasingly scarce), but it does not have the backing of any State. If the number of people in the club grows, its price will increase. Otherwise its price will plummet, as in any financial derivative. It does not take a significant amount of money to change the price of bitcoin. It is valued at about 300,000 million. When it reaches 10 trillion its world weight will be relevant for the economy of the entire planet. 

How was bitcoin created?

The concept of cryptocurrency was first described in 1998 by a computer scientist named Wei Dai on the “cypherpunks” email list, where he proposed the idea of ​​a new type of money that would use crypto to control its creation and transactions, in rather than being done by a centralized authority. The first bitcoin protocol specification and proof of concept was published by Satoshi Nakamoto in 2009 on an email list. Satoshi, it is not known if he is an individual person or a working group, he left the project in late 2010 without revealing his real identity. The bitcoin code is open, any computer scientist can review it or create their own modified version.

What can be done with bitcoins?

With bitcoins you can pay for a good or a service. You can buy bitcoins in exchange houses or create bitcoins using machines designed for it. But in practice the number of transactions is minuscule compared to other means of payment. The bitcoin would be the result of the payment for the theoretical consumption of the energy required in the process of its creation. Without having a merchant account you can have bitcoins. Payments are generally made through mobile or computer applications, entering the recipient’s address (the bitcoin account), the amount to be paid and pressing send. Once the button is pressed there is no going back, the virtual currency will have changed hands. 

What are bitcoin miners?

The new bitcoins are generated by a decentralized process called “mining.” This process is based on the fact that individuals are awarded by the network for their services. Bitcoin miners process transactions and secure the network using specialized ‘hardware’ and collect bitcoins in exchange for this service. Bitcoins are created at a predictable and decreasing rate. The number of bitcoins created each year is automatically halved over time until bitcoin issuance comes to a complete stop at 21 million bitcoins. This conception tends to raise the price of bitcoin.

How and where to buy bitcoins?

Bitcoin is bought in exchange agencies on the internet. Here you can find an example list of those intermediaries. The process requires:

1. Open an account with one of the providers mentioned above. 

2. Deposit money in the newly opened account (for example, by bank transfer, credit card or PayPal).

3. Buy the chosen currency (for example, Bitcoins, Ethereum, Ripple, Litecoin or Dash).

4. Sell the currencies when you want.

5. Credit the balance to a private account.

Is it safe to invest in bitcoins?

Bitcoin advocates argue that no one organization or individual can control bitcoin and the network remains secure even if not all of its users can be trusted. In any case, security firms warn of the possibility of code theft from any user or computer attacks against exchange houses. Hackers design programs for that theft. Kaspersky analysts disclosed the identification of the CryptoShuffler Trojan, for example, designed to change the addresses of users’ cryptocurrency wallets on the clipboard of the infected device. Since the operations carried out cannot be canceled and it is anonymous, any data theft has no solution. 

What does it imply that it is a virtual currency?

Bitcoin is as virtual as the credit cards and banking networks that people use every day. As virtual as the money that the ECB gives to the banks and the banks to the ECB. Money has long since ceased to be exclusively cash to be just virtual payment commitments. Bitcoin can be used to pay ‘online’ and in physical stores like any other currency if those involved in that transaction agree. Bitcoins balances are stored in an immense network and theoretically cannot be fraudulently altered by anyone. In other words, bitcoin users have exclusive control over their funds and bitcoins cannot vanish just because they are virtual. But the implantation of bitcoin is small. And the implementation of other cryptocurrencies is even smaller.

How is it taxed to have earnings in bitcoins?

Bitcoin is not a legal tender fiat currency in any territory, so the regulations are not very specific. In practice, any capital gain must be listed on the Treasury as an increase in equity. There are doubts whether a profit in cryptocurrencies is invested again in cryptocurrencies after a theoretical capital gain not transformed into a legal tender asset. It is not clear in that case. It is also not clear whether that asset is considered an asset abroad or in Spain (for which it should be declared in form 720). In the event that an estate was not declared abroad, the Treasury could impose a fine even higher than its valuation.