Introduction
Almost a year ago, January 2014, the price of one bitcoin stood at $913, down slightly after reaching an all-time high of over $1,200 earlier in December. The new cryptocurrency came a long way from trading below $4 just two years ago. Major online and offline retailers are starting to add the new currency as a payment method. But what exactly is bitcoin?
According to a recent Bloomberg poll, only 42 percent of Americans correctly identified bitcoin as a virtual currency. Six percent thought it was an iPhone app.
Bitcoin is a peer-to-peer digital currency launched in 2009 by "Satoshi Nakamoto". Satoshi worked on the project alone for 2 years before releasing the code to the public. He disappeared shortly after creating the cryptocurrency, but before leaving he posted the now infamous quote:
‘’It might make sense just to get some in case it catches on’
Satoshi Nakamoto, January 17th, 2009.
What’s so special about Bitcoin?
Bitcoin is a cryptocurrency and a new and unique financial vehicle, unlike anything the world has ever seen. It's called a cryptocurrency because it uses cryptography to control the creation and transfer of money. Despite the name, there is no physical coin to speak of, Bitcoin is a completely electronic form of money.
Bitcoin solves the so called "double spending problem" present with digital goods. For example, if I have an mp3 file or an ebook on my computer, I can freely copy that file a thousand times and send it to a thousand different people. For a digital currency, the possibility for unlimited copying would mean a quick hyperinflationary death. Bitcoin solves this by maintaining a peer to peer network and recording each transaction in a public ledger called the block chain. Say I send 1 bitcoin from my bitcoin address to my friend John. The bitcoin network records that transaction in the block chain and I no longer have possession of that bitcoin. The coin "moved" from my bitcoin wallet to John's wallet.
What's so special about Bitcoin? There are many arguments on whether the new virtual currency will succeed or fail. We will not get into this nor discuss the politics behind the project. Our concern is strictly with the profit opportunities provided by this new payment phenomenon.
In the next few pages on the new digital currency we will outline our thoughts from the perspective of a trader and a potential investor in this upcoming market.
Bitcoin Basics
Bitcoin is a peer-to-peer virtual currency. This means that in order for a transaction to occur, no middle men or central authority is needed. You can send any amount of bitcoins to anyone living anywhere in the world, completely eliminating the need for traditional third parties like banks or money transmitters. The cryptocurrency also allows the bypassing of capital and AML restrictions.
In order to send or receive bitcoins, all you need to have is a bitcoin address and internet access. You only need to be online long enough for the transaction to process. Similarly to traditional bank accounts, you can receive bitcoins to your bitcoin address even if you're offline. When you want to "collect" your coins however, you"ll have to find an internet connection.
How to get a bitcoin address
Like we mentioned previously, in order to send or receive bitcoins you will need to have a bitcoin address. You can get a bitcoin address either by downloading the bitcoin client or by getting an online wallet. The two most popular btc clients are Bitcoin-qt and Multibit. The main difference between these two clients is in the size of the block chain that needs to be downloaded. If you decide to go with Bitcoin-qt, have at least 10 Gigabytes free space on your hard drive for the block chain. As Bitcoin-qt is the "official" bitcoin client, if you can spare 10 GB, go for this option. Here's a page that has step by step instructions on installing Bitcoin-qt.
Multibit is a lightweight version of the bitcoin client. You can read more about it here.
Where are my bitcoins stored?
But where are the bitcoins actually stored? After you install one of the two clients above, you can find your bitcoins in a file called wallet.dat. If you use windows this file will be located in the application data section. If your computer gets stolen or lost and you haven"t made a copy of the wallet.dat file you will lose your bitcoins. It is always recommend to backup this file.
The bitcoins can also be stored in online wallets. There are specialized websites that offer bitcoin wallet services. However due to these sites being a frequent target for hackers, keeping bitcoins in online wallets is not recommended when you can easily store them offline on your computer. Wallets can be useful for storing small sums of bitcoins so that you can make quick online purchases. Some of the more popular wallet services are Blockchain and CoinKite.
Btc exchanges are a somewhat safer place for your bitcoins compared to online wallets because they keep most coins in what is known as ”cold storage”. Usually over 90% of the bitcoins deposited on an exchange are kept offline. A small 5 to 10% reserve is kept onsite for immediate redemption purposes. There are plenty of guides online on how to store/secure bitcoins, go over them. It's always safer to take care of this process yourself then to trust a third party with a substantial amount of bitcoins.
Bitcoin Advantages
Bitcoin has several advantages compared to traditional money transmitting services. We already mentioned two of these above, the elimination of the need for third parties and the bypassing of restrictions.
Another major plus of the new cryptocurrency is the very low cost for sending and receiving bitcoins. While it is possible to send transactions completely free of charge, it is recommended to pay the small fee in order to speed up the sending process.
The fee amount depends on the data size of the transaction. A typical transaction is 500 bytes and carries a fee of 0.0001 BTC. At current prices of $250 per bitcoin, this amounts to a charge of 2.50 cents.
Because the fee is completely dependent on a transaction's data size and not on the number of bitcoins being sent, a $10 transfer will carry the same fee as a $10 Million transfer. The fee will take a 0.25% piece of a $10 transfer but that same fee will only take 0.00000025% of a 10 Million transfer.
Bitcoin offers benefits to merchants as well, as transactions that involve the digital currency are secure and irreversible. Without the risk of fraud or fraudulent chargebacks, merchants can offer their products at a discount thereby generating more sales or pocket the difference themselves. In addition, with card processors out of the picture, merchants can save on the percentage cut taken by Visa / MasterCard.