• Like

CI First Look - Bitcoin and Virtual Currency Basics

  • 1,135 views
Uploaded on

Virtual currencies are a decentralized form of “electronic cash” that users send to each other through a peer-to-peer payment system in exchange for goods and services. Consumers and investors have …

Virtual currencies are a decentralized form of “electronic cash” that users send to each other through a peer-to-peer payment system in exchange for goods and services. Consumers and investors have long debated the new type of currency’s long-term legitimacy. While some have flocked to use and invest in virtual currencies, others warn of a possible bubble in the making.

This whitepaper offers an introduction to the world of virtual currencies. We begin by looking back at the history of currency and point to successes, failures and trends in an effort to show what is required of any currency to be successful. With that context, we then provide an overview of the predominant virtual currency, Bitcoin.

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Be the first to comment
No Downloads

Views

Total Views
1,135
On Slideshare
0
From Embeds
0
Number of Embeds
4

Actions

Shares
Downloads
11
Comments
0
Likes
2

Embeds 0

No embeds

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
    No notes for slide

Transcript

  • 1. 1 CI FIRST LOOK BITCOIN AND VIRTUAL CURRENCY BASICS
  • 2. 2 ABOUT CORPORATE INSIGHT Corporate Insight (CI) provides competitive intelligence and user experience research to the nation's leading financial institutions. For over 20 years, Corporate Insight has tracked new developments in the financial services industry through our Monitor research and custom consulting services. We are known for our detailed, objective research, unmatched expertise, and emphasis on the actual user experience. There are no assumptions in Corporate Insight’s work – we use live accounts at the firms we track to benchmark their effectiveness and give our clients unparalleled competitive intelligence. Corporate Insight is continuously tracking and identifying best practices in online asset management, banking and investing, insurance, annuities, mobile finance, active trading platforms, social media and other emerging areas. In the process, we have helped our clients -which cover the entire spectrum of financial services -- to stay on top of industry trends and improve their competitive position. PRESS COVERAGE MEDIA INQUIRIES Corporate Insight is happy to discuss our research with the media. To set up a media interview with one of our analysts, please contact our PR firm, Intermarket Communications, at 212-8886115 or corporateinsight@intermarket.com. CONNECT WITH CI © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 3. 3 WELCOME FROM CORPORATE INSIGHT Corporate Insight is the leading provider of competitive intelligence and user experience research to the nation’s top financial institutions. Our mission is to analyze and understand the evolving technological landscape across the financial services industry and identify the innovations that will shape the future. Our research examines the various pathways that prospects, clients and advisors travel when interacting with their financial institutions. We place a special emphasis on assessing the online customer experience offered by leading firms as well as the social media and mobile finance initiatives that are changing the way financial institutions engage with consumers. Corporate Insight’s analysts also strive to stay ahead of new digital innovations and trends that extend beyond financial services. John Greenough, a Research Associate on CI’s Banking and Credit Card team, has been researching Bitcoin and virtual currencies for the past several months. He has explored not only their rise to mainstream acceptance, but also the user experience behind the mining, exchange and use of these decentralized, digital forms of currency. The first installment of his research offers a basic introduction to the world of virtual currencies. We begin by looking back at the history of the currency and point to past practices and trends in an effort to show what is required of any currency to be successful. With that context, we then take a closer look at today’s predominant virtual currency, Bitcoin. We hope you find this whitepaper valuable! Sincerely, INSIDE… Introduction ................................................................................................................................... 1 What Makes a Currency? A Brief History ....................................................................................... 2 Four Keys to a Successful Virtual Currency..................................................................................... 3 A Closer Look at Bitcoin .................................................................................................................. 4 Benefits of Bitcoin ............................................................................................................... 5 Concerns about Bitcoin ....................................................................................................... 6 Corporate Insight Thought Leadership ........................................................................................... 7 Contact the Author ......................................................................................................................... 8 © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 4. 1 INTRODUCTION In 2013, Ben Bernanke, the chairman of the Federal Reserve, wrote a letter to Congress giving a slight nod of approval to virtual currencies. Since then, consumers and investors have been debating the new type of currency’s long-term legitimacy. While some have flocked to use and invest in virtual currencies, others warn of a possible bubble in the making. Virtual currencies are a form of “electronic cash” that users send to each other through a peer-to-peer payment system in exchange for goods and services. These products aim to eliminate the need for a central bank, therefore introducing an unregulated world currency similar to the exchange of gold. However, as many skeptics point out, virtual currencies often hold no intrinsic value but are valued solely on the principle of supply and demand, a factor making its price volatile. Despite the lack of collateral these currencies hold, merchants and consumers have begun to adopt them into their everyday life as the number of merchants accepting Bitcoins jumped 81% in the month after Ben Bernanke made his statement regarding virtual currencies. 1 Today, virtual currencies are being viewed more as an investment device rather than as a legitimate method of payment. Investors have begun to buy large sums of virtual currency with the hope that more merchants will begin accepting them, thus driving up their exchange value and price. As more merchants begin to act as the first adopters of virtual currencies, others may follow, creating an active marketplace. This whitepaper offers an introduction to the world of virtual currencies. We begin by looking back at the history of currency and point to successes, failures and trends in an effort to show what is required of any currency to be successful. With that context, we then provide an overview of the predominant virtual currency, Bitcoin. Study on Bitcoin Mining, Exchanges, Wallets and More Coming Soon! In mid-February, Corporate Insight will release an in-depth examination of Bitcoin. Our upcoming study features first-hand analysis of the average investor’s experience using Bitcoin exchanges, digital mining tools and wallets including Slush’s Pool, Coinbase, Mt. Gox and Blockchain.info. The study will also explore the future of Bitcoin, examining growing investment funds, possible government regulation and competing virtual currencies. 1 http://www.coindesk.com/surge-in-real-locations-accepting-bitcoin/ © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 5. 2 WHAT MAKES A CURRENCY? A BRIEF HISTORY While the history of exchange dates back to the bartering system, many historians point to the cowrie shell as being the first form of currency. By roughly 1,100 B.C.E., the Chinese began to forge imitations of the widely-used shells out of copper and bronze, which soon led to the notion of metal coins. By 500 B.C.E., the first minted coin was introduced by King Alydattes of Lydia, quickly proving the need to use precious metals such as gold and silver for their scarcity and intrinsic value. 2 Soon, the minting process spread to the kings and rulers of countries throughout the world. At times, this led to corruption. By 54 A.C.E. the first notable devaluation of a currency was committed by Emperor Nero of the Roman Empire, who along with his successors gradually debased the coin known as a Denarius from roughly 94% silver down to just 0.02%. Eventually citizens saw no value in the Denarius and it began to die off. 3 More legitimate coins remained the only viable currency in circulation, though. By 806 A.C.E. the Chinese instituted the first paper money, so-called “flying money,” in an effort to ease the transfer of funds between merchants across the vast Mongolian empire. To legitimize the “flying money” currency, Kublai Khan confiscated all gold and silver and decreed that merchants and traders must accept the currency under the threat of death. However, as the empire grew, Kublai Khan and his successors were forced to print more money, causing rapid inflation and devaluation of the currency, and paper money gave way back to coin.23 Five hundred years later, in 1816, England instituted the gold standard, allowing gold to be exchanged for standard banknotes at a fixed rate. By 1900, the United States followed suit, a very short-lived practice. In 1933, to help ease massive inflation during the Great Depression, President Roosevelt suspended the gold standard, banned private ownership of a significant amount of gold coins and fixed the price of gold at $35 per ounce to make the dollar more attractive. In 1971 the United States was facing an economic downturn, and President Nixon ended the practice of exchanging gold for paper money, therefore officially making the dollar a fiat currency. 45 Today, the dollar’s value lies in that U.S. citizens trust in that others will accept the currency in exchange for goods and services. While not as extreme as Kublai Khan’s threat of death, the government legitimizes the currency by making its citizens pay taxes with the dollar or be faced with jail time. However, unlike Kublai Khan’s failed system, there are alternative currencies in the market, such as the Euro or Yuan. 2 http://www.pbs.org/wgbh/nova/ancient/history-money.html http://dailyreckoning.com/fiat-currency/ 4 http://www.econlib.org/library/Enc/GoldStandard.html 5 http://www.fas.org/sgp/crs/misc/R41887.pdf 3 © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 6. 3 FOUR KEYS TO A SUCCESSFUL VIRTUAL CURRENCY Based on the brief history of currency, there are four major points that can be applied to a successful virtual currency: #1 A Currency Must Be Easily Transferrable As the introduction of “flying money” in China showed, there is a distinct need for consumers to be able to transfer money between each other over long distances. While paper money may still be predominant, studies show that electronic transactions are gaining momentum and will soon overtake cash. Furthermore, virtual currency networks are based around desirable electronic transaction networks of their own. #2 Inflation Is Dangerous Emperor Nero’s devaluation of the Denarius is one of many examples of a government overproducing currency, resulting in hyperinflation. The primary benefit of many virtual currencies is that they cannot be easily controlled by a government, who may be tempted to overinflate them. Additionally, the supply of many virtual currencies is often a finite amount that has been pre-determined by its creator. #3 A Currency Must Have Value One of the primary reasons for a currency to fail occurs when society sees no value, as happened to both the Denarius and “flying money.” In modern society, the paper money exchanged also holds no intrinsic value, yet is still accepted as a legitimate form of currency because governments enforce taxes that are payable with those currencies. Virtual currencies often hold no intrinsic value and cannot be directly used to pay taxes – a problem that many point to as a potential shortfall. #4 Everyone Must Accept It Kublai Khan’s threat of death to those that rejected “flying money” recognizes the need for widespread acceptance of a currency for it to be legitimate. Currently, this is one of the biggest problems that virtual currencies are facing. While more merchants are slowly beginning to accept virtual currencies, they cannot be legitimized until they are accepted on a large scale. © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 7. 4 A CLOSER LOOK AT BITCOIN Bitcoin is the predominant virtual currency available, recently garnering attention due to its dramatic, and highly volatile, rise in price over the course of 2013. Bitcoin embodies the main benefits of virtual currencies – it is easily transferred and has no central bank controlling its supply. However, its volatility and lack of government or commodity backing can be weaknesses as well. The following examines the origins of Bitcoin and explains the process of obtaining, storing, trading, and using a Bitcoin. Brief Overview of Bitcoin Bitcoin was created in the wake of the 2008 financial crisis by an unknown cryptographer acting under the pseudonym Satoshi Nakomoto. Nakomoto posted a report explaining his idea for a “cryptocurrency” in which users would combine computing power to run a peer-to-peer payments system using Bitcoins as a currency. The Bitcoin network is available to the public through open-source software (a program that is published online and able to be taken and manipulated by anyone). The network is designed to be decentralized, meaning that it requires individuals to dedicate their computing power to help run the system by processing and verifying the transactions that occur. In order to incentivize people to help run the system, the network releases a certain number of Bitcoins to users who have dedicated their computing power to process other Bitcoin users’ transactions. The network rewards Bitcoins to the first users to solve a complex algorithm that helps to consolidate the transactional information to be stored within the Bitcoin public ledger, referred to as the blockchain. This highly complex process is known as mining and will be detailed in our upcoming study. When he developed the Bitcoin system, Nakomoto decided on a finite amount of 21 million Bitcoins to be released slowly over time. To ensure that the Bitcoins cannot be mined all at once, Nakomoto put into place two guards for the system. The first is that when more “miners” join the network, the difficulty of the algorithm goes up to make sure that each algorithm is solved once roughly every ten minutes. Currently, a user is awarded with 25 Bitcoins for solving the algorithm first. Nakomoto’s second guard was to have the system automatically halve the number of Bitcoins per algorithm solved every four years. For example, by 2017 a user will be awarded 12.5 Bitcoins per algorithm solved and by 2021 will be awarded 6.25. Once the Bitcoins are dispersed, the user’s digital wallet stores a 64-digit code linking their account to the Bitcoin network and their associated Bitcoins. This code is also referred to as a private key. Customers must hold the private key, while the previously-mentioned blockchain holds the public key, in order to access a Bitcoin. Wallets are available online, on a mobile platform and in the form of a QR code on paper making for use at a brick-and-mortar store. © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 8. 5 Benefits of Bitcoin The Bitcoin Network Source: Bitcoin.org The key benefits of the Bitcoin peer-to-peer system arise from its decentralized, open-source network: #1 Bitcoins Are Not Controlled by a Central Bank Bitcoins do not rely on government action or regulation. Currencies such as the dollar fall in value with politicians’ poor economic choices. Bitcoin is able to keep the power of the system with the users. Additionally, the set limit of Bitcoins released ensure there is no inflation for the value of one Bitcoin. Instead, Bitcoins will be deflated over time as the demand for Bitcoins rises. That process has already resulted in labels for fractional Bitcoins, such as one “satoshi” being equivalent to 0.00000001 of a Bitcoin or currently less than one one-hundredth of a penny. #2 Bitcoins Are the First World Currency The open-source Bitcoin software has created a network in which anyone with computing power can mine for or obtain a Bitcoin, therefore making it arguably the first “world currency.” Many believe that Bitcoins and other virtual currencies will offer those in underbanked areas a more reliable currency that cannot be physically stolen or taken by a corrupt government. For instance, the Economist reports that over two-thirds of the adult population in Kenya hold a mobile wallet capable of accepting Bitcoin. 6 Because of this, services such as BitPesa have emerged giving Kenyans working abroad the ability to send money home in the form of Bitcoins. #3 Bitcoins Are Inexpensive to Transact Another benefit of the open-sourced peer-to-peer network is the low middleman fees that are associated with transacting payments. Because the network is decentralized, the cost for sending Bitcoins is very low relative to the cost of a wire transfer. 6 http://www.economist.com/blogs/economist-explains/2013/05/economist-explains-18 © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 9. 6 Concerns about Bitcoin The concerns many have with Bitcoin may outweigh the benefits that they hold. Here are the three biggest issues facing the virtual currency: #1 Bitcoins Are Anonymous From the eyes of the government, the biggest threat of Bitcoin is that it provides a level of anonymity that can mask criminal activity. Before their rise in price in 2013, Bitcoins were primarily used for illicit activity. The most notable occurrence was on Silk Road, a recently shut-down website that had facilitated the transfer of illegal goods such as drugs, weapons and fake documents. Governments are also concerned that the currency could be used to facilitate money laundering and tax evasion. #2 The Price of Bitcoins Is Highly Volatile Bitcoins’ pricing relies strictly on supply and demand. While the supply is finite, the demand is constantly fluctuating, primarily due to the number of merchants that accept Bitcoins. The more merchants who accept Bitcoin, the higher their value becomes. Recently, Zynga announced they would accept Bitcoins for their gaming platforms, and the price skyrocketed. Conversely, China announced in December that they would not allow financial institutions to accept Bitcoin, halving the price in two days. #3 Lack of Merchants Accepting Bitcoin Currently, very few merchants accept Bitcoins. However, that number is rapidly growing as the currency gains more legitimacy. Interestingly, Bitcoins are becoming widely accepted by charities or for other donations, such as political campaigns. However, the lack of merchants trading physical goods hinders Bitcoin’s ability to be seen as a legitimate currency. © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 10. 7 CORPORATE INSIGHT THOUGHT LEADERSHIP Next-Generation Investing: Financial Startups and the Future of Financial Advice CI tracks over 100 startups that cover a wide range of new ideas across financial advice and investing. The study, which is out now, focuses on each idea, compares them to what established financial institutions offer and examines the potential impact on the industry. Download the study preview featuring excerpts now! Tablet-Friendly Web Design: Best Practices for Financial Services The study examines the tablet-friendly website features provided by four leading firms across financial services and provides recommendations for financial services firms building tablet-optimized websites. Online Personal Financial Management: A Closer Look at Manilla and Mint This slide deck analyzes two of the major players in the PFM space: Manilla and Mint. While different in terms of functionality and purpose, both PFMs offer userfriendly websites and apps that are popular with consumers and continue to grow. Alternative Investments: How Asset Management Firms Frame Their Funds This whitepaper examines the online content leading firms are using to educate investors and financial advisors about alternative investments and takes a look ahead to what's next for these products. Peer-to-Peer Lending: Examining the industry and the Borrower experience This slide deck offers background on the P2P lending industry and takes a closer look at the borrower experience by profiling two leading firms in the space – Prosper and Lending Club. Five key takeaways and tips for P2P lenders are also highlighted. 2013 Mobile Finance Trends and Innovations This study includes commentary on mobile developments, key takeaways for financial services firms and thoughts on what’s next for mobile finance. © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight
  • 11. 8 CONTACT THE AUTHOR JOHN GREENOUGH RESEARCH ASSOCIATE BANK AND CREDIT CARD MONITOR John Greenough is a Research Associate for Corporate Insight’s Bank Monitor and Credit Card Monitor research services which analyze the online user experience and products offered by leading banks and credit card issuers. One of John’s passions is researching digital innovations in the financial services industry. In 2013, he released thought leadership pieces on the rapidly growing peer-to-peer lending industry and online personal financial management systems, reviewing top providers in each space. John has conducted extensive research on Bitcoin and virtual currencies over the past several months. The second installment of John’s research, set for release in mid-February, will focus on the user experience behind the mining, exchange, storage and use of Bitcoin. John graduated from Trinity College in 2013. CONTACT JOHN T: 646-751-6963 E: jgreenough@corporateinsight.com CONNECT WITH CI © 2014 Corporate Insight, Inc. corporateinsight.com Bitcoin and Virtual Currency Basics Follow Us on Twitter @CInsight