Table of Contents
1. Explanation of Bitcoins
1.1. Bitcoins and their history
1.2. Blockchain system
1.3. How to buy Bitcoins
1.4. Current legal status of Bitcoins and other cryptocurrencies
1.5. Current legal state of Bitcoins in Australia, the United States of America and Europe/UK
1.5.2. United States of America
1.5.3. Europe and United Kingdom
2. Future of Bitcoins
3. Risks behind Bitcoins
3.2. Unregulated system
3.3. Bitcoins and illegal transactions
List of Figures
Cryptocurrencies have been causing major public attention for the last few years. Especially the most prominent one, Bitcoins. In between all this internet activity people seem to overlook the real meaning of Bitcoins, how they work and how they could be integrated in the economic world as it is right now. The goal of this pre-scientific paper is to explain the function of Bitcoins, reveal it's risks and to elucidate the possibility of Bitcoins making an impact on the future of online commerce, by detailed literature and internet research.
In general, this paper is going to consist of an explanation of Bitcoins and the Blockchain-system, followed by the results of the question if Bitcoins could impact the future of online commerce. Additionally, this paper will exhibit the risks of investing or working in this decentralized trading system. To show the procedure of purchasing Bitcoins or other cryptocurrencies, I am going to conduct a self-experiment and procure a cryptocurrency and document the process of doing so.
Ever since human beings started inhabiting planet earth, trading has been a big part of their lives. For a very long time people used to trade objects for other objects, for example food for wood. As time went by, societies started to introduce money in the economic circle. In the beginning silver or copper coins were used as a way of payment, but after some time even that system became obsolete and according to Kann (1993) the Chinese started to incorporate banknotes in their economic trading system sometime between 600 and 1300 A.C.1
In order to match the industrial evolution, newer ways of trading money had to be developed. For instance, the credit/debit card system, which is being monitored by state regulated banks. The newest of those systems are virtual currencies, or also known as Cryptocurrencies. Bitcoins are among the latest addition to the currency market.
The objective of this scientific paper is to outline the working process of Bitcoins and to question if Bitcoins will have a major impact on the future of online commerce. By the end of this paper I hope to have given a clear explanation of how the Bitcointrading-system works and how they will have a major impact on the commercial intercourse.
In order to reach my expectation, I will include interesting literature, mainly from digital sources, considering Bitcoins are a very recent system with only limited printed literature. Other than that, I will conduct a self-experiment, whereby I will document my try of purchasing a cryptocurrency and explain the details of that purchase.
The first chapter of this paper will give a brief explanation of Bitcoins and the technology behind it, including their history. Thereupon I will explain how to buy Bitcoins by c onducting a self-experiment of myself purchasing a cryptocurrency. To finish up the first chapter I will give a brief overlook of the current legal status of Bitcoins around the world with a focus on the United States of America, Australia and Europe.
The second chapter will explain the importance of investors and talk about the biggest investors in the cryptocurrency markets. Also, I will elaborate if or how Bitcoins currently impact the online commerce and how they will in the future.
The last chapter will shed a light on the risks of owning, buying or selling Bitcoins. I will also talk about the meaning of Bitcoins being an independent currency without any regulators or governments overlooking its safety of its promoters and trading places. To finish this paper, I will finally elaborate the potential of Bitcoins, or other cryptocurrencies, being used for illegal transactions in the Dark Web.
In the end I will briefly summaries this article and state the outcome if and how Bitcoins have or will have an impact on the future of online commerce.
1. Explanation of Bitcoins
This Chapter is going to consist of an explanation of Bitcoins and their history, the Blockchain-system behind Bitcoins, a self-experiment and the current legal status of cryptocurrencies, such as Bitcoins.
1.1. Bitcoins and their history
What are Bitcoins and what makes them so extraordinary? Bitcoins are known as a decentralized virtual currency and can be used as money in the internet. The main difference between Bitcoins and traditional currencies is that there is no central issuer, such as a state or a bank, behind this system. This means that there is no authority behind the issuing of this currency but a mathematically generated system by the computers connected to the network. There is not a central computer or database, which is the reason why it is a decentralized currency.2 "Bitcoin is not the only digital currency, nor the only successful one. Gamers on Second Life, a virtual world, pay with Linden Dollars; customers of Tencent, a Chinese internet giant, deal in QQ Coins; and Facebook sells "Credits”. What makes Bitcoin different is that, unlike other online (and offline) currencies, it is neither created nor administered by a single authority such as a central bank.”3
The whole structure is built by an anonymous community all over the world. Every single participant is connected to the network with his personal computer and some may give their private capacity to operate various commands.4
The Bitcoin and the system behind it was the first legitimate execution of Wei Dai's initial idea from the year 1998 and was officially published in 2009 by an anonymous person, which works under the name of "Satoshi Sakamoto”. The first description and verification of its capability was released in a mailing list under the name of "Bitcoin: A Peer-to-Peer Electronic Cash System”. It is an open source project, which allows users world-wide to join in on the project. In 2012 the Bitcoin Foundation was created to "standardize, protect and promote the use of Bitcoin cryptographic money for the benefit of users worldwide.”5
In order to understand the 'hype' behind Bitcoins its obligatory to take a look at its rapid value expansion. In March 2013, one Bitcoin was worth around 47.00 USD and since then the market value steadily kept on rising, until reaching its all-time high on December 16th 2017, with one Bitcoin worth about 19,400.00 USD. Shortly after that, the so called "bubble” popped and the price started to descent again. As of August 22nd, the value stands at about 6,700.00 USD, with bearish tendency.6
Each user connected to the Bitcoin network is the owner of a wallet, which can be chosen from various providers online, and his own private key, which is the only possible way to gain access to his Bitcoins. The data and thereof the Bitcoins are locally stored on the memory card of the computer. If the PC with all the data crashes, gets lost or gets reset without any valid backups, the personal key and hence the Bitcoins are lost indefinitely or until the data is recovered. Unlike when opening a bank account with a state bank or other financial institution, it is not obligatory to conjoin yourself while obtaining a Bitcoin wallet. Because users are not required to declare their identity with any authorities, transaction may result in criminal actions, due to the payer’s and receiver’s anonymity. This paper will go further into detail with this topic.7
As already addressed Bitcoins are a decentralized system, without any authority issuing or regulating this currency. There is no security system, but a "distributed system that makes fraud or attack very difficult”8. To understand what is meant by that it is very important to take a look at the way transactions are being made in this system. Every transaction is immediately being broadcasted around the system and is waiting to be confirmed by other users in this network. "This is done by verifying the public ledger, which is bookkeeping of transactions made with bitcoins since its creation ”9. Herewith it’s possible to track every single Bitcoin, their owners and transactions back to the day it got issued by the system.
While some users may only enjoy the convenience of owning Bitcoins or trading them, others may provide their personal computers to support the blockchain to create blocks, which are crucial for the system to work. By doing so a user might be rewarded with Bitcoins. This process is called "mining”.10 In 2013 about 25 Bitcoins were given out every 10 minutes, which were each worth about 2750 USD. (price of Aug. 24th, 2013)11
In order to prevent controlled inflation, unlike with the fiat money system, where a National Bank has the authority to create money whenever they deem it for necessary, the maximum number of Bitcoins being generated by the mathematical system is tied to exactly twenty-one million Bitcoins. This number is set by the "maximum number of hashes that are valid as Bitcoins”12 having been mined. As forecasted by Bruno Saboia de Albuquerque and Marcelo de Castro Callado the number of all Bitcoins being issued is circa the year 2140.
To ensure that double-spending is avoided, which means that the Bitcoins have been spent twice, the system uses a public ledger, to verify every transaction and adding it to the blockchain. Also, if malicious hackers try to modify the blockchain to, for example reward themselves with Bitcoins, this process will most likely be refused by the other users of the network, who have to verify the blockchain.13
1.2. Blockchain system
The Blockchain is the operating system on which the Bitcoin is based on. The main idea behind it is, that the system is creating "blocks”, to record all the data to each Bitcoin in the system. Every 10 minutes one of those so called "blocks”, which contains all the transactions from the past 10 minutes, is created and added to the chain. By keeping that chain going it is possible for the system to trace every single Bitcoin back to it’s creation, containing all the owners and dates. The blockchain system works with a peer-to-peer system, which means that every user is connected to the other user in the transaction without any intermediaries.
Besides Bitcoins, there are many other utilizations of the Blockchain-system. It can for example be used as a verifier between two contractors. Mike Schwartz from TED Institute gave a great example in his lecture for a use of the Blockchain system. He said, that a software engineer from Tanzania could work for a company in Canada. He could sign a contract with the company, where he gets paid as soon as he submits his work, with some certain pre-agreed terms, to the company. The Blockchain-system could read and execute the contract between them and pay the worker in time. By that, those agreed terms are incorruptible by humans and the worker will not be exploited.14
Many high ranked economists have made a statement regarding the impact the blockchain system will have in the future. Nasdaq Chief Executive Bob Greifeld, for instance, said: "Blockchain will bring levels of efficiency to the financial markets that we’ve never seen before.”15
1.3. How to buy Bitcoins
In order to obtain Bitcoins, one first has to own a "wallet”, which is a program on your personal computer to store the Bitcoins. There are many different software options, but the most popular ones are Bither, Trezor and Electrum.16 Furthermore there are three different ways to receive Bitcoins. One either purchases them from another user or distributor for other payment methods, such as cash or credit/debit cards. Besides that, it is also possible to get paid from another user in form of Bitcoins for several services.17 Also it is possible to get rewarded with Bitcoins by the system for allowing the decentralized system to use your computers capacity for bookkeeping purposes of the transactions being made.
This self-experiment will consist of me purchasing Bitcoins in the worth of 10€ and explaining the whole process of doing so. In this experiment I chose to use the Exodus Wallet to store my purchased Bitcoins.
The first thing I had to do is download one of the many wallets from the internet. While installing the Exodus wallet, the system gave me a seed, consisting of twelve random words, such as pear, three and peanut, which I should write down and keep secret in order to gain access to my wallet. After writing down the seed I was told to choose a password for my wallet. When I finished the progress of installing the wallet a very basic program opened with three main categories: History, send and receive. The history is yet blank, while the send and receive page are full of information. In the send page you are able to type the wallet address, description and number of Bitcoins of the receiver. On the receive page there is a QR code, which can be used instead of the thirty-four-character word to address your wallet.
After setting up one’s wallet one must purchase the Bitcoins from an online market or an intermediary. In order to do so, one has to be at least 18 years old. Unfortunately, I am not 18 years old yet, and could not purchase Bitcoins from an intermediary.
1.4. Current legal status of Bitcoins and other cryptocurrencies
"Bitcoins are a form of intangible private property”.18 They are worth a certain amount of money and are valuable to their owner, who can trade whenever he or she wants to.
Rhys Bollen compares Bitcoins with other non-physical valuables, such as digital music, trademarks, copyright, domain names and frequent flier points.19 Unlike those things listed, Bitcoins don’t have any other use, other than as a currency. As previously mentioned there is no central issuer or authority, but a group of individuals working together to run the system. There is no contract with a set of rules which have to be followed, but some "central rules and protocols”20 imbedded in the system, which can barely be defrauded.
Besides users, who exchange Bitcoins for other goods, there is another form of participants. People that trade Bitcoins for other currencies, such as the USD or the Euro, or marketplaces (eg. MtGox) for buying and selling Bitcoins, usually do so on a profit-making basis, which by that means are restrained to the general laws which apply to intermediaries.21
1 Saboia de Albuquerque & Castro Callado, “Understanding Bitcoins: Facts and Questions”, page 8, 2015
2 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 1.
3 Virtual Currencies: Mining digital gold, The Economist. online: <https://www.economist.com/> (read on 20. August 2018)
4 Saboia de Albuquerque & Castro Callado, Understanding Bitcoins: Facts and Questions (2015) page 8.
5 Bitcoinfoundation.org. online: <https://bitcoinfoundation.org/about/> (read on 24. August 2018)
6 Bitcoin Price (BTC), www.coindesk.com online: <https://www.coindesk.com/price/bitcoin/> (read on 22. August 2018)
7 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 11.
8 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 11.
9 Saboia de Albuquerque & Castro Callado, Understanding Bitcoins: Facts and Questions (2015) page 8.
10 Floriane Bruneau, The Bitcoin Event: how bitcoin and blockchain are challenging the established order and the practices of our economic system. (2017) page 14.
11 T.S., The Economist explains: How does Bitcoin work? The Economist. online: <https://www.economist.com/> (read on 28. August 2018)
12 Saboia de Albuquerque & Castro Callado, Understanding Bitcoins: Facts and Questions (2015) page 11.
13 Saboia de Albuquerque & Castro Callado, Understanding Bitcoins: Facts and Questions (2015) page 11.
14 Mike Schwartz, "The potential of blockchain”, TED Institute, 2016
15 Rich Daly, Blockchain: Wall Street's Most Game-Changing Technology Advance Since The Internet, forbes.com, online: <https://www.forbes.com/> (read on 16. January 2019)
16 Choose your Bitcoin wallet, bitcoin.org. online: <https://bitcoin.org/> (read on 22. September 2018)
17 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 12.
18 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 13.
19 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 13.
20 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 13.
21 Rhys Bollen, The legal status of online currencies: Are Bitcoins the future? (2013) page 14.