In this blog post, we analyze the potential and limitations of Bitcoin becoming a financial innovation capable of replacing existing currencies.
What is Bitcoin?
These days, the currency attracting the most attention in global financial markets isn’t the US dollar or Japanese yen, but the cryptocurrency Bitcoin. When first announced in 2009, Bitcoin’s price hovered around $0.4 per coin. By December 2023, it reached a market price of $4,000 per coin.
As the value of this cryptocurrency surged and its market size gradually expanded, the U.S. Treasury Department designated Bitcoin as a subject for transaction oversight. The People’s Bank of China, the central bank of China, also advised against Bitcoin usage. However, the regulatory policies of various governments towards Bitcoin paradoxically focused more attention from the general public. To this day, Bitcoin continues to make headlines daily, with interest in it steadily increasing. What is the principle behind Bitcoin, a virtual currency, and why has it garnered so much attention?
A decentralized cryptocurrency invented by an anonymous figure
Bitcoin was announced in 2008 by an anonymous figure named ‘Satoshi Nakamoto’. The reason ‘Satoshi Nakamoto’ is referred to as an anonymous figure is that no one has ever seen his actual appearance. Furthermore, it is uncertain whether the name ‘Satoshi Nakamoto’ is even a pseudonym or his real name. In 2008, he published a 5-page paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” under the MIT license. The core concepts of Bitcoin introduced in this paper were developed by numerous activists and software developers, ultimately forming the current Bitcoin system.
Bitcoin is often called a distributed cryptocurrency. Unlike traditional currencies, it has no central governing body. Instead, its issuance and management are handled through cryptographic algorithms and by all participants in the Bitcoin network.
Traditional currencies we use require a governing authority. For example, national currencies like the US dollar, Japanese yen, and South Korean won are issued by each country’s central bank. The central bank issues currency considering various national economic conditions and manages the process under strict government oversight. Furthermore, existing virtual currencies, such as in-game currency for online games or points for online shopping malls, are also controlled and issued by the companies operating those services.
Bitcoin, however, lacks such a specific governing authority. Bitcoin consists of numerous lines of computer code implementing an algorithm and the users participating in the Bitcoin network. The issuance, management, and use of Bitcoin are carried out by this algorithm and the network participants. In other words, in Bitcoin, every participating individual becomes both the producer and the governing authority of the currency.
Currency Issuance Through Cryptographic Decryption
To participate in Bitcoin’s currency production and transactions, users must meet the following conditions. Bitcoin traders are issued a string of approximately 30 characters, composed of random combinations of lowercase and uppercase English letters and numbers, to identify individuals. In Bitcoin, this string is called a ‘wallet,’ which can be seen as serving a role similar to a bank account in the real world. Individuals can generate as many Bitcoin wallets as they wish, and since no personal information is required when creating a wallet, anonymity is guaranteed.
Peer-to-peer currency transactions on the Bitcoin network consist of information including the sender’s wallet string, the recipient’s wallet string, and the amount. This information is broadcast to all users within the Bitcoin network. These transmitted transaction records accumulate for approximately 10 minutes before being stored in a form called a ‘block’.
The blockchain is a chain linking all such blocks together, forming a massive data file recording every transaction ever made on the Bitcoin network. In other words, the blockchain is the ledger containing every transaction history on the Bitcoin network, from the moment Bitcoin first came into existence to the present day.
Bitcoin issuance occurs during the formalization process when a newly created block, formed by accumulating transaction records, is successfully cryptographically processed. A user wishing to issue Bitcoin must combine the contents of the newly created block with those of the previous block and solve a series of cryptographic algorithms. This involves summarizing the result into a 32-digit hexadecimal number and appending an arbitrary hexadecimal digit X to it. The goal is to find X such that this summarized value is smaller than the number specified by the current Bitcoin algorithm. There is no specific solution or algorithm to find this X; the only method is to systematically try every possible combination. Consequently, this process is difficult for the human mind to perform and is typically done by computers. Higher-performance computers demonstrate greater efficiency. The user who finds X becomes the owner of the Bitcoin allocated to that block. They then propagate this to users trading Bitcoin. If multiple users find an X that satisfies the conditions, the first user to find X becomes the owner of the Bitcoin. This Bitcoin issuance process takes a long time, so it is called ‘mining’ because it is similar to extracting coal or gold.
According to the Bitcoin algorithm, the difficulty of the cryptographic problem in this mining process gradually increases over time. Furthermore, the total possible production of Bitcoin is capped at 21 million coins, and the issuance of new Bitcoin is scheduled to end around the year 2140. For these reasons, Bitcoin achieves currency issuance and production volume control without the need for a separate governing authority.
Bitcoin’s Transaction Method Following Democratic Principles
So how exactly do Bitcoin transactions occur? In Bitcoin, a transaction is simply the act of recording the sender’s wallet, the recipient’s wallet, and the amount of Bitcoin being sent within a block. Based on these records, the sender and recipient calculate their balances by summing all Bitcoins they have received and sent to date, thereby determining their Bitcoin holdings. These transaction records spread to all users in the Bitcoin network immediately upon creation. Users wishing to mine begin processing transactions as described earlier. Because multiple users process blocks containing transaction records, it is impossible for malicious users to commit fraud or manipulate transactions. This is because even if a malicious user alters a specific transaction, the correct information remains recorded in the blocks being processed by other users. In Bitcoin, following democratic principles, the transaction records held by the majority of users are deemed correct, not those of the minority. Even if a malicious user uses multiple devices to get their malicious transaction records accepted by many, the correct transaction records will still remain in the blocks held by the majority of users on the network. Therefore, transaction manipulation is impossible unless the malicious user owns more than half of the world’s computers.
The Uncertain Future of Bitcoin
Despite these somewhat complex technical principles, Bitcoin has gained immense global popularity. Exchanges trading Bitcoin, similar to stock markets, are proliferating rapidly in many countries worldwide. Additionally, internet shopping malls adopting Bitcoin as an additional payment method are increasing. Bakeries and cafes accepting Bitcoin payments have emerged as a topic of discussion, and recently, ATMs dispensing Bitcoin have even been installed.
Bitcoin’s popularity stems from its advantages: enabling stable, fast, and anonymous global transfers without exchange rate burdens or fees. Its appeal also lies in being an independent, free system unaffected by any central authority, as network participants directly engage in currency issuance and transactions.
However, whether Bitcoin can firmly establish itself as a currency remains uncertain. The primary reason is its high volatility. In December 2013, Bitcoin reached a price of $1,000 per coin, but within a month, its price dropped by 30%, trading at $700 in January 2014. If someone had exchanged $1,000 for Bitcoin in December 2013 and then purchased $1,000 worth of goods that same month, they would have incurred a $1,000 loss. Generally, a currency must maintain stable value over time; if it is highly volatile, it cannot properly function as money.
Furthermore, Bitcoin currently fails to provide one of the crucial functions for establishing itself as a currency: payment guarantee. For a Bitcoin transaction to be finalized, a majority of computers in the Bitcoin network must agree to validate it. This process requires extensive cryptographic calculations, and as the number of network users increases, the time required to confirm transactions is growing. Even if payment is made in Bitcoin, if the transaction isn’t confirmed immediately, its practical use in daily life is inevitably limited.
Furthermore, legal regulations for Bitcoin have not yet been established. As a cryptocurrency without a specific governing authority, governments worldwide are debating how to regulate it. This is because Bitcoin’s nature makes it susceptible to use for illegal purposes. For example, Bitcoin can be used to fund illegal activities such as drug trafficking, hacking, and terrorism. Furthermore, governments worldwide express concerns about potential tax issues and money laundering arising from Bitcoin transactions. For these reasons, how Bitcoin will be subject to future legal regulations in various countries remains uncertain.
Conclusion
Since its emergence, Bitcoin has garnered significant attention in global financial markets. As a decentralized cryptocurrency, Bitcoin possesses a unique structure distinct from traditional currencies, attracting the attention of countless users worldwide. Bitcoin enables currency issuance and transactions through the cooperation of network participants without a central authority, allowing free and independent transactions anywhere globally. However, Bitcoin has not fully fulfilled its role as a currency due to issues like its volatility, transaction inconveniences, and legal regulations. While Bitcoin’s future remains unclear, its potential still exists, and many people are watching its development possibilities closely.
