BitCoin – Currency of the Underworld ? Ponzi Scheme ? Or Just Another Cryptocurrency ?- Part 1

Posted by Admin on Jun 23, 2011 in Tech | 49 comments

Written By : Haricharan

Experts all over the world, have begun slamming it as a “scam”, “a ponzi scheme” and “a ridiculously short sighted economic system – that is filled with potholes”.

Well, if you are wondering what we are talking about, we are talking about BitCoin.

Until now, to transact online, you needed to have an account with a third party, say PayPal, and you will pass on the payment instructions to them, hoping that they would do the needful. The framework of financial transactions till now has been such that no currency could be exchanged “untraceable” between two parties without a third party intermediary.

BitCoin is something like Facebook credits where you can buy virtual goods on Facebook applications. You pay in dollars, get your FB Credits and then spend them on what you need to buy on FB, except that BitCoin is a far too complex than that.

Bitcoin is an open-source project created in 2009 by Satoshi Nakamoto and is the world’s first distributed and anonymous digital currency. Bitcoin works a lot like Cash, except that its digital and solves the problem of Double Spending. Basically “double spending” is when you can keep re-using the same digital currency as there is no record or token whether the currency has been used up previously or not. Digital currencies existed before BitCoin and even as we speak, dozens of Digital Currency frameworks are being formulated, but what remains to be noticed is that all of BitCoins predecessor’s suffered the “double spending” syndrome.

BitCoin is revolutionary because it does not use accounts or any information about you, to identify you. Instead it uses Public Key Cryptography. Its like buying on the street. There is no record of the transaction. You don’t know the seller’s name. He doesn’t need to know yours. Hence even by scanning through rows and rows of transfer data, we will never be able to arrive at “who sent money to whom”.

BitCoin is revolutionary in more ways than one mainly because it claims to have found the cure for inflation. In most countries, a regulatory body controls the money supply. And they do not mail money to their citizens. What the government/regulatory body does is to buy something from the market so that they can infuse/inject cash into the system. Or they lend some money to the banks, who in turn will lend it to the people and the effects will trickle down. But BitCoin has no such regulatory body, rather, it is dependent on an algorithm, which effectively controls the “growth” rate of the currency. The rate at which the new BitCoins are introduced into the system is based on an algorithm and is therefore perfectly predictable.

Purists pooh-pooh BitCoin, but the scientific community is looking at it with a great deal of interest. The BitCoin Protocol is extremely transparent and is based on a published paper. All its implementations are open-source. And as mentioned earlier, there is no central regulatory authority to change the rules.

Without taking sides and not using Technical Mumbo-Jumbo , let’s just “see-through” what BitCoin has to offer us.

First, to buy or sell anything using BitCoins, you first need to create an account. One way is to install the BitCoin client on your PC. This will automatically create a “wallet” which you can use to accept payments or send payments from. A Wallet is simply a datafile that stores your currency. Basically its a text file that is worth its weight in exactly the same amount it stores. Transactions to and from a wallet are sent via an encrypted Peer-To-Peer network and are processed across the network, eliminating the need for a banking server for the user to login to.

Second step is to add BitCoins to your Wallet. The most common way of doing this is to purchase them on the open market. But the transaction is a bit round about. One of the popular exchanges is Mt.Gox, obviously a take on Fort Knox. You need to add funds directly into your Mt.Gox user account. Once you’ve got funds into your Mt. Gox account, you can purchase BitCoins. Once bought, your Mt. Gox account will be debited and BitCoins will be sent to the address of your wallet. Currently One BitCoin is approximately 17 dollars.

Third step is to perform the actual transaction. Let’s say you buy a coffee mug at Ayarikubazar.com. Once you have checked out the item to your cart and proceed to payment, there is an option that allows you to pay in BitCoins. In your Wallet’s Send field, there is a provision to provide the address of the receiver. Enter the address given by the site into the wallet and “ship” the coins. Note :: Transactions done through BitCoin are non-reversible and all transactions are final. And Presto, the payment is done to the organization.

As an end user, this is all you need to know, but here is the mechanism of what happens “after” the transaction is done.

Whenever you do a BitCoin Transaction, the record of this transaction is sent to the various nodes in the network. At fixed intervals, each node summarizes all its transactions into a data structure called “block” and proceeds to solve a mathematical puzzle that takes the block as an input. The puzzle is so randomized to ensure that each node gets an equal chance at cracking the puzzle. The first node to solve the problem announces the success to other nodes. Since finding a solution is tougher than verifying it, all other nodes start verifying if all the transactions in the new block follows all the rules of the BitCoin protocol and that the solution to the problem is correct. Once winning solution has been identified, all nodes treat the transactions in the block as the new entry in the global transaction register. Apart from this, the system has an inbuilt incentive system. Each “award” winning node (basically the winner of the race between nodes) is entitled to 50 BitCoins (currently set at this level) which becomes part of the official transaction history. Hence the winner is also minting some BitCoins for himself for participating in the transaction-verification process.

BitCoin worshippers are calling it the “messiah” of the online payment industry. For some, its the equivalent of electronic gold, perhaps even better.

Here are some of their arguments,

• Its decentralized, hence they cannot be printed or minted at the whim and fancy of the regulating authority
• It cannot be destroyed by attacking the central point of control
• BitCoins are easy to transfer, easy to secure and easy to verify.
• BitCoins are not pegged to any currency hence more dependable.
• BitCoin is backed by SHA256 and ECDSA which are proven industry standard algorithms.​