What is Bitcoin?

Unless you’ve been hiding under a rock, you have by now at least heard of Bitcoin.

Bitcoin is essentially a digital currency (AKA, electronic cash or cryptocurrency) where transactional integrity is secured cryptographically. Bitcoin stores those transactions on a distributed database called a blockchain.

The whole cryptocurrency craze started in 2008, when Satoshi Nakamoto published a paper entitled Bitcoin: A Peer-to-Peer Electronic Cash System, in which he stated “a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” He then went on to implement an actual blockchain and began mining Bitcoins.

Mining is a necessary step in the computationally-intensive process of validating new transactions and is how new coins are created. It is supposed to be analogous to mining gold, which is labour-intensive and has low yields. For Bitcoin, mining takes place on computers spread all over the Internet.

For a long time, Bitcoin wasn’t worth much. On May 22, 2010, Laszlo Hanyecz bought two pizzas (worth about US$25) in exchange for 10,000 Bitcoin which is widely recognised as the first time that Bitcoin was used as payment for goods or services. By my math, one Bitcoin would have been worth only about US$0.0025.

By February of 2011 Bitcoin had reached parity with the U.S. dollar and today, that 10,000 BTC would be valued at a whopping US$257.5 million.

I first heard about Bitcoin sometime after “Pizza Day” but most of my knowledge was limited to knowing that it required a network of computers to perform computations, which was just the kind of thing a tinkerer like me would have felt right at home with. However, I’d already donated several years of my spare CPU cycles to the SETI@home project and had little interest in further CPU crowdsourcing. At less than a penny per coin, there was little that could have overcome my apathy. 

I took a more active interest in Bitcoin when Robert X Cringley started writing about it in 2013. I shared Robert’s scepticism and have continued to be critical of it today. That said, if I had mined Bitcoin when I first heard about it, I would be a multi-millionaire now.

Cryptocurrencies have become a cult phenomena that appeals to libertarians, anarchist and conspiracy theorists alike. Now people are trading them like they’re stocks and bonds. A growing group of crypto-geeks see Bitcoin as a store of value, like gold, silver or real estate.

From where I sit, the rise of Bitcoin has nothing to do with any intrinsic value, and that the price is a function of scarcity (by design) and FOMO (fear of missing out), which fuels demand.

I do see the utility of Nakamoto’s proclamation, especially given my own frustration with sending money overseas from Japan. I am also in favour of less institutional meddling in my personal affairs, so I totally relate to the libertarian ideology. As for conspiracy theories, I do love them if only for their entertainment value. But I find it scary to imagine what an anarchist would do with 10 thousand Bitcoin!

For Bitcoin to become a viable alternative to fiat currencies, it’s going to need to overcomes some serious obstacles, which I will explore here.

Scarcity Versus Liquidity

The value of any monetary instrument stems from its utility. When scarcity is factored in, that value can rise.  Without maintaining the delicate balance between supply and demand, scarcity goes up, driving the price up and liquidity down. High price and low liquidity will both hamper adaption rate.

Network Effect

The network effect follows from Metcalfe’s Law which states that the financial value of a network is proportional to the square of the number of connected users of the system ().

While the scarcity of Bitcoin itself is guaranteed programatically, there is nothing stopping other digital currencies from stealing its thunder.

What I’m referring to is the Bitcoin clones, which are little more than forks of the codebase onto a new blockchain, or by the creation of entirely new crypto currencies. With all these competing crypto-clones, it’s hard to envision any one of them gaining enough traction.  For Bitcoin to function as a currency, it’s going to need mass adoption and it’s going to have to be the clear choice amongst its crypto-competitors.

It’s Too Cumbersome

Right now, my 85-year-old mother can use her credit or debit card to pay for her purchases at a cash register, with just a “tap”. The slowest part of the transaction is waiting for the cash register to print her receipt. Validation of Bitcoin transactions are way too slow for retail use, typically 10 minutes and sometimes a lot longer.

Meanwhile, my mother cannot fathom the concept of generating a public and private key pair, as required for creating the metaphorical “wallet”, and then funding that wallet, so that she can spend from it.

If Bitcoin is going to see widespread adoption, it’s going to have to match the speed and ease of use of debit and credit card transactions. We are starting to see the development of “payment channels” such as the Lightning Network, which holds the promise of instant payments.

I see two problems with instant payments. Firstly, to reduce the transaction verification time from 10 minutes down to a few seconds, we’ll need to perform transactions off the blockchain, which means trusting third parties for payment processing and transactional consistency with the blockchain. It smacks of payment processors like PayPal which, to be a viable business, need to charge transaction fees.

The second problem is wallet security. Are we going to have to entrust our private keys to a payment channel?

Resistance by Banks and Governments

By the end of 2010, Wikileaks, the infamous publisher of classified documents, was no longer able to accept donations through conventional payment processors, including PayPal, under pressure from the United States and other governments. In 2011 they opted to accept donations in Bitcoin to circumvent the blockade. This has put a negative spotlight on Bitcoin, that will no doubt play into future legislation around cryptocurrencies and their boundaries. Such legislation will likely ride on the coat tails of anti-money laundering and racketeering legislation.

Also expect to see a strong anti-crypto lobby from the banks, because it directly competes with their business model.

Due to the distributive nature of the Bitcoin ecosystem, as much as governments may outlaw it, I don’t think they’ll be able to block Bitcoin transactions from occurring anyway. However, they can block the conversion into dollars or other currencies, unless those transactions remain totally peer-to-peer, without banks or payment processors as gatekeepers. 


The value of any commodity or currency is subject to price elasticity which is part of what makes forex trading difficult, but you need to allow the value to float, for proper price discovery to occur. Too much volatility and price discovery becomes futile.

Ever seen a firehose that got away from the firefighters, flailing all over the place while they tried to regain control of it? Welcome to the world of Bitcoin!

I imagine the Bitcoin price will stabilise somewhat when it has a wider adaption, but the wild fluctuations we see are going to make it difficult to place a Bitcoin price on a purchase.

Personally, I could not see using Bitcoin to buy a cup of coffee because, like a day trader, I’d be too worried about timing the buy. 


Big money is always going to attract phishers, scammers, hackers and thieves. Now that Bitcoin has become big money, we’ve already seen some examples of this.

On February 24, 2014, the Japanese cryptocurrency exchange, Mt. Gox, got hacked, and around US$350 million in bitcoin went missing. Mt. Gox filed for bankruptcy and its remaining holdings liquidated. Some argue that at least some of the lost coins never existed at all, due to the exchange over-stating its reserves. This is a problem that we are likely to see repeated.

On August 2, 2016, Hong Kong-based Bitfinex lost 1500 Bitcoin in an apparent hack on the exchange. They survived, but customers lost about US$400,000.

Lesser known, is the hack attempt against the blockchain itself, in which a transaction sending 184,467,440,737 Bitcoin was broadcast in August, 2010, apparently possible due to a bug in the validity checking of the Bitcoin software. Luckily, the transaction was noticed by Satoshi Nakamoto, who performed a hard fork of the blockchain to completely remove that transaction. With the higher transaction traffic on the blockchain today, I don’t think such a hard fork would even be possible.

Lastly, we turn to the human element. Despite all the checks and balances and cryptographic validation, millions of dollars of Bitcoin loss is due to lost or misplaced private keys, and people falling for phishing attacks or investment scams, all crafted to separate people from their coins.


As far as mining Bitcoin is concerned, I feel that any early-adapter advantage and return on investment potential is now gone. I could be wrong, but that’s what I tell myself because I have neither the CPU power nor the mental bandwidth to make it happen. 

As for network effect, maybe I’m wrong there too. As of February 2015, over 100,000 merchants and vendors accepted bitcoin as payment. According to research produced by Cambridge University, there are 2.9 to 5.8 million people with cryptocurrency wallets, most of them using Bitcoin.

As a store of value, we are a long way off from Bitcoin becoming “digital gold”. Volatility seems to be the main issue.

Ease of use and transaction speed issues will eventually be solved but it is going to take place off blockchain, involve third-party trust and probably significantly higher transaction fees which, to be competitive, will have to be kept lower than what the banks charge.

One aspect of Bitcoin I haven’t touched on is its underlying technologies, specifically the use of a blockchain with a cryptographic proof system. This solves a very specific problem I was having while designing a distributive accounting system for restaurant chains that would resist data tampering. I think there is a whole class of problems that could be solved with blockchains. How Bitcoin, or any other crypto-currency will fit in, I have no idea. But that’s a topic for another day.

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